Grinonomics: Monetary Policy, Emissions = Inflation fallacy, and Lambo potential of early adopters

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Grinonomics: Monetary Policy, Emissions = Inflation fallacy, and Lambo potential of early adopters.

It has come to my attention that many here believe (1) that grin is in fact not the future of internet money, and (2) that even if it were to become a highly transacted medium of exchange, the very property that makes grin ideal for high velocity transacting (it’s constant, infinite emissions and low block time) would come at the cost of early adopters purchasing power (in the form of inflation).

Rest assured, this is not the case.

In this post I will present a novel economic theory intended as a rebuttal to the (seemingly) daily posts on this forum (and elsewhere) regarding infinite emissions and the highly inflationary nature of grin whereby speculators call for a change toward a fixed supply of grin or bemoan that a fork/alternative mimblewible coin will “win” mass adoption based on its potential for price appreciation and its qualities as a store of value.

The thesis of this post, that grin’s infinite emissions and highly ‘inflationary’ early period does not pose a disadvantage to its ability to become the best/most used form of internet money nor to its ability to appreciate in purchasing power based on its increased utilization, will draw primarily from my understanding of cryptoeconomic theory and cryptodynamics pioneered by Eric Voskuil. Eric is the lead developer of a C++ bitcoin library and writes extensively on cryptoeconomics which can be read here.

TL;DR comes directly from his writing on the inflation principle, brackets are my own clarification: “Rising supply market money, such as Gold and early Bitcoin, consumes the same value in goods[capital destroyed in mining] as it creates in new units[block reward emitted] - including the opportunity cost of the capital invested in doing so. As such it produces no change in proportionality and therefore no price inflation.” [1]

Firstly, when people refer to inflation in the monetary sense they are generally referring to a reduction in purchasing power (price inflation). Under the purposed economic model, however, the inflation of the supply of grin does not equate to price inflation therefore I will refer to supply inflation as “emission” and the reduction of purchasing power as inflation (price inflation).

The money relation is the proportionality of money to goods, or the amount of goods represented by the money. Another way to understand this is “How many units of the money is there chasing how many goods tradable for that money”. Since the amount of goods tradable for (represented by) a money in a free market is a function of demand for those goods in the money we can say that the purchasing power changes in proportion to a change in demand for goods in the money.

Purchasing power is the proportionality of goods represented by a money.

This is simply supply and demand so an increase in the supply of the money for the same amount of goods tradable for the money would imply a decrease in purchasing power as more units of the money is chasing the same amount of goods thus each unit of the money represents less goods. Accordingly, more units of the money are required to represent the same amount of goods as before the increase of the supply of money. This is price inflation.

At this point, one may be saying, “Ok, no shit. this is basic conventional economic theory, so mining emissions would be an increase in supply of the money implying inflation, why am I wasting my time reading this?”

Glad you asked, hypothetical reader. No this is not the case. In order to understand why, you must first understand the economics of mining.

Gold, Grin and bitcoin are what is known as a market money which is to say that its creation is dictated by a free market process. This process is driven by market competition as opposed to a state money which is produced when a state grants a monopoly of production to a central bank. [2]

Market money is created only as a response to demand for that money. Thus it is produced only if sufficient demand makes its production profitable. This is evident in gold. It is only produced when its cost of production is justified by demand for it in the market. a lack of demand for it at a certain price implies no production if production requires a greater cost (including opportunity cost).

In the mining of crypto currencies this can be seen as profits are competed away. the equilibrium of mining a coin can be described by the following identity:

The price of the coin = the capital required to mine the coin + the opportunity cost of not deploying that capital otherwise

thus in a perfectly competitive market the only profit in mining is the opportunity cost sometimes called the global return on capital. [3]

Since the miner must destroy capital in the form of electricity and hardware in order to make a return in mining they are only willing to destroy as much capital as is offered by the market in return for the coins they are mining. Since if no demand for the coins at that price existed it would imply no production of the money and cost of mining those coins would decrease to meet the price at which those coins are demanded. In this way demand for the coins at a certain price proportionately drives demand for the goods (electricity/hardware) which must be destroyed to create the coins thereby preserving the money relation of goods demanded to units of money thus implying no change in purchasing power (i.e. no inflation).

This can be illustrated as follows:

  • The market demands 1 grin at price X

  • The miners are willing to invest [X - opportunity cost] in mining 1 grin

  • The miners demand electricity, hardware valued at [X - opportunity cost]

  • The miners destroy this electricity, hardware and opportunity in the mining process to create 1 grin

  • The miner sells 1 grin to the market in exchange for X

  • The demand for goods in the money has increased by 1 grins (valued at X)

  • The supply of grin as increase by 1 grin (valued at X)

The important take away here is that demand for the coin translates proportionately into demand for goods to create that coin which implies no change in the ratio of the amount of goods demanded to units of the money. Thus the creation of each unit of money through the market process of mining preserves the money relation and implies no inflation.

in this way, it can be said that Gold, Bitcoin, Grin and other market monies are not inflationary based on their emission curves since they are driven by a market process.

The decrease in the nominal price of a coin is simply due to a lack of demand for goods in the money. Since if one does not want to purchase goods using the money they have no demand for the money.

This explanation is based on my current understanding of the economics at play in these systems, I fully reserve the right to amend, disavow, or flip flop as I study and explore more new information. After all, I used to believe gold and early bitcoin were inflationary currencies until I fully came to understand these proofs offered by cryptoeconomics and had to change my view. New information will undoubtedly alter my views again so please let’s discuss more in the comments.

More Thoughts and theories coming soon. Follow on twitter @HayekCrypto

-Hayek

[1] https://github.com/libbitcoin/libbitcoin-system/wiki/Inflation-Principle
[2] https://github.com/libbitcoin/libbitcoin-system/wiki/Money-Taxonomy
[3] https://github.com/libbitcoin/libbitcoin-system/wiki/Miner-Business-Model

3 Likes
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Fantastic! These are the kinds of arguments and discussions I like to see. I applaud you for your formulation of thoughts on this topic.

To say that market monies are non-inflationary by nature, is an interesting argument. But, I see it as just playing with semantics. Given a certain emission rate X per Y measure of time, we’d expect unit price to be stable given demand for goods in the money to be proportional to X for Y measure of time. Because time is involved, we must consider that. If demand for goods in said money falls proportionally below emission rates, then we see unit price fall and this is what we could observe and call price inflation (or simply inflation). Therefore, emission rates correspond to the expected demand for goods in said money. Another way of saying: having a high emission rate for a cryptocurrency is the same as having a high expectancy for goods in that currency.

So, we observe inflation (price inflation) when demand for the money (for goods in the money, or demand for the money for other purposes such as store of value) does not increase at the same rate as emission of the currency.

The question now is whether Grin’s emission rate accurately predicts the demand for the currency. It may not matter, and a linear emission rate may be no different from any other scheme. It may be the case that making the currency more usable and useful for the purchase of goods is the only effort worthwhile when it comes to avoiding inflation. It could be useful if emissions could respond to demand somehow. This may be impossible, but it would be useful for price stability.

It’s also important to improve perceived value; after all perceiving Grin as inherently deflationary by nature increases demand for Grin–just like the perception that Bitcoin or gold is deflationary because of a fixed emission rate (even though both Bitcoin and gold both currently have high emission rates).

Overall, great topic and discussion thus far. My only question to you is: Do you think there could be a way to make emissions most accurately reflect demand for goods using said money in order to accomplish price stability?

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The model proposed always emits a unit of the currency proportionately to demand (while the nominal amount of units is the same, the capital required to create that unit is always proportional to demand) since the mining dynamically adjusts to remain at equilibrium. If demand increases at all, from X to (X + n) then the mining adjusts to require X + n capital. This is because as there is n more revenue to be made from mining, miners who were not economically viable at X (but are viable at X + n begin to expend capital on mining which in turn raises the difficulty and moves the equilibrium of mining to require X+n capital to mine the same amount of coins.

From this you can see that if demand was X at block Y, and remained at X at block Y + n then the dynamics of mining would be the same, thus the capital required to create each coin would remain the same. Therefore, Purchasing power would also remain the same.

Yes, I would agree with this. In fact since Grin/BTC are not commodity money (they do not have any significant use value outside of use as money) their only use is tradability for goods. The only reason to demand grin is because you demand a good tradable for grin and grin offers better utility(usefulness) versus its substitutes(BTC, dollars, gold etc). So, as its usefulness for purchasing goods increases, people will demand goods in exchange for it and the market will meet this demand by making goods available for trade in the money.

In the Austrian school, all value is subjective and therefore perceived. Price stability, is impossible to “manufacture” since prices are unpredictable given subjective value theory. Additionally, all economic change (growth and contraction) effect price.

I actually thought about this as well when I first came across this “inflation fallacy” theory but now I actually think this is what mining does quite well. If you accept that, in a free market, mining come into equilibrium to match the cost of mining a coin with the value of that coin due to its competitive nature and difficulty adjustment. Thus demand for the coin(therefore demand for goods in the coin) is translated into demand for mining the coin.

This is indeed a very complex and interesting topic. I can’t help but think an exploration of more practical models of the economic and monetary dynamics would make these ideas more understandable than a strictly theoretical exploration.

-Hayek

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I’ve given it more thought. Emissions borrow value at the expense of the value for previous coinbase in order subsidize the cost for mining. It is not that value is injected into the newly emitted coinbase from cost for mining. For example, one could create a network where it is extremely costly to mine a single unit (say $1 million), but this does not mean that the unit should inherit a price equal to the cost to mine. It is only speculation on the miner’s part that the future price for a single unit would equate to the cost (hopefully unit price is greater than the cost in the miners case). It’s important for a miner to evaluate the emission rate in order to make that speculation. Given a linear emission rate, it effects the appreciation of the unit over time as value is borrowed for future mining costs (and this we observe as inflation).

Therefore, a miner would need an expected future value that is higher than the cost to mine in order to account for the level of inflation from the point of coin emission to coin sale. Given a low emission rate, this gives the miner more time between mint and sale. If there was an emission rate of 0, then there would be no inflation and the time of sale for a coin is in the miners discretion. Additionally, if there was a emission rate less than 0, there would be negative inflation, also known as deflation, and it would be in the interest for the miner to never sell.

So, emission rate determines expected future price. Whether that future price is realized by the market, is up to the market subjectively.

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I believe that the value is being injected into the newly emitted coinbase by the demand, this is what the miners are responding to when they decide to invest in mining. Take the $1 million dollar unit, for example, if the chain parameters where established such that it cost 1 million dollars to create a single unit, from an economic perspective, it would be economically irrational to invest in mining that unit (thus, no one would do it) unless there was demand for the unit in exchange for ($1 million + opportunity cost). So, in this way the coin does inherent a price equal to the cost to mine. However, the key point is that the cause and effect are the reverse of what you are suggesting, which is to say that the cost to mine is inherited from demand.

PoW, however, does not depend on cost to mine at, all it cares about is a certain time period of work being done. For grin, this is 1 minute. The blockchain only cares that 1 minute of work was performed and in exchange for this 1 minute of work each miner gets a proportional share of 60 grins. So if a miner is contributing 1/60th of the total work for a minute they would receive 1 grin (assuming 100% pooling of miners). if 1 grin = 1 dollar than only miners whose cost of mining 1 grin (including opportunity cost) is less than or equal to 1 dollar would be actively mining. (Since, an economic loss implies no production). Now, if the price grin went up to $1.25 then miners with cost between $1-$1.25 would join the network to mine and increase the difficulty which directly increases the cost to mine since more hashes are required to find a block. So now, 1/60th of total work toward the block returns $1.25(1 grin) but since the difficulty as been increased that 1/60th represents more work(thus more cost). In a competitive market we know that profits are competed away so this extra cost associated with the price rise would be equivalent to the price rise or $0.25

Demand drives price → Price drives the cost to mine thus Demand drives cost to mine

Speculation, is not necessary in the case of emissions since it is know. Future price does require speculation but this is simply observed as a cost of mining, since this uncertainty can be sold off to other market participants. Gold and Oil miners do this all the time by selling futures to lock in favorable prices and eliminate uncertainty and speculation from their business model.

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I’m not sure what you’re saying here. My position is that the cost to mine is influenced by the price which is influenced by demand. I think we agree on this: demand results in price which results in cost to mine. But, this depends on whether the miner choses to mine a unit at a specific cost; a miner may not choose to mine at current costs even when current prices exceed costs if they speculate on the future price will be less then the cost. A miner does not sell coinbase at current prices, but at future prices, so it has to be speculative.

Hedging is great for miners for at eliminating risk. Miners play a speculative game, and hedging helps to eliminate the risk. Like I said, miners speculate on future prices, so buying a future that shorts the market is beneficial as miners can lock in current prices. This is great for miners, but this does not mean that miner cost determines prices, in fact it suggests the opposite. Demand determines price, and price determines miner costs. That’s what I’ve been saying and also what I think we agree on.