The stocks and the forex market have been subjected with much instability of prices every second of that trading day. However, the crypto market is experiencing much bigger swings wherein Bitcoin could lose as much as 50 percent in values in just few hours of trading due to several factors. This feature of ‘cryptos’ makes them unfit to be an accepted currency, it has a long way to go to replace banks in their current condition. Thus, the better proposal of Friedrich A. Hayek’s idea of Improved Bitcoin (IBC) comes to light.
Bitcoin system manifests two major instabilities. The first instability stems from an inflexible supply of Bitcoin, which amplifies Bitcoin price volatility. The second instability comes from risks to the sustainability of mining.
To understand fully, the discussion will start from the second instability coming from mining then the first instability coming from the inflexible supply curve of Bitcoin.
In order for a cryptocurrency to come to its existence, they must be mined like gold.
How does it take place? Mining coins require GPUs and computers with high computational power such as that of gaming laptops to form a mining rig or a mining farm.
Then, after the setup, the farm will be installed with mining applications such as Hash Miner applications.
Finally, it will then be operational, the computers will be allowed to mine on its own by solving the non-complex to complex mathematical puzzles or algorithms provided by Satoshi Nakamoto day and night.
Firstly, at the onset of the introduction of Bitcoin, Nakamoto assigned a specific or limited number of coins to be mined (i.e., 21 million Bitcoins).
Therefore, as the numbers of coins get exhausted, the harder the mining process gets. For example, if in 2009, the number of Bitcoins to be mined on a complete operation will be 50 BTC and then this number gets halved every four years.
These farms require tremendous amount of electricity since it operates 24 hours every single day and the costs associated with mining process are also high intensified by the general inflation of the economy.
These results to costs exceeding benefits, consequently, for every Bitcoin transaction of a user will be charged with high fees just to maintain the global system. This statement is in contrast to one of the major advantage of Bitcoins presented above; this is mainly due to the growing number of transaction worldwide clogging and is joined with higher costs of mining.
Aftermath of this event creates ‘mining pools’ where miners could share their computing powers to reduce the costs of mining. Although, it creates a strategic behavior, it can also create an opportunistic behavior where large miners can push their costs to retail miners due to decreasing profits causing them to exit.
Their greediness keeps on towering mining BTCs even if they are only able to produce measly amounts of such coins generated by the ‘scarcity’ feature affecting the price of Bitcoins dramatically.
Secondly, the instability coming from the inflexible supply of BTCs. Central Banks has expansionary and contractionary policies to influence the supply of money and inflation of economies.
Thereby, it creates more stability as a whole leading to sustainable growth.
These policies can also be called as ‘positive demand shock or deflationary shock’ for increasing money supply and ‘negative demand shock or inflationary shock’ for decreasing money supply’.
However, in the case of the crypto markets, it does not have such feature since the number of coins to exist are already set by the main developer/s or pre-mined.
This generally promotes wild fluctuations in the market.
Hayek’s money or the Improved Bitcoins provided two major solutions to problems of the current system. It includes Built-in Revaluation Rule for Exchange Rate and Implicit Inflation Target Cryptocurrency.
The Built-in Revaluation Rule for Exchange, this is the first step to establish a monetary policy without the interference of a Central Bank. Earlier discussion above, explicates that the number of BTC to be mined gets halved every four years and is expected to be exhausted by 2140 magnifying volatility.
To address this, we may have to control the supply of IBCs by increasing and decreasing it much like the expansionary and deflationary monetary policies of central banks. We can influence the prices of the coins to reach its real value or the benchmark level.
However, we cannot eliminate supply in this manner creating an unexpected inflation rate in the near future concluding with the value of these coins to devalue swiftly and driving away investors and users.
Thus, Implicit Inflation Target Cryptocurrency is needed strategy.
Production of coins depends on computational power and it requires significant amount of electricity, the current situation allows disproportionate costs and benefits.
To address the issue on inflation, we can set a fix number of coins to be mined in proportion to a computational power or electricity costs and deviate from the original Satoshi plan which halves the production every four years.
Due to it, in the long run the overall general computing power costs reduces since it is being spread to bigger production.
Also, this can help absorb the effects of inflation coming from upward demand policies.
The solution proposed above is a policy without a central bank. However, we can also address the issues by allowing central banks to issue their own coins called, ‘Fedcoin’.
Then, we can then set a supply number of these coins and have it backed by the government with a one-to-one ration with physical bank notes. We may not worry again with unsatisfactory spikes of prices and to whom we will run after a major collapse happens since it is already backed by the state.