Inflation/Deflation In Tokens

I remember back in 2011 when I first learned about Bitcoin, we started talking about the technology and the model internally at USV. My partner Albert had done a lot of reading about it and he raised the 21mm hard cap as something that had both pros and cons associated with it.

Ever since then I’ve been mindful of that when looking at the design of various crytpo currencies. Most have a hard cap or some small inflationary model (like ETH).

Yesterday Albert wrote a blog post explaining some of the issues that hard caps create for crytpocurrencies.

In his post, Albert explains that the hard cap approach:


results in extremely rapid appreciation of tokens well ahead of their use value.

We are certainly seeing that at play right now with the rapid price escalation across the crypto landscape. Of course, some of that is the speculative fever that has invaded the sector.

But it may also be related to the inherent monetary policy that most teams are choosing for their tokens. And so I think it’s a good thing to have this discussion and think about whether a hard cap is a feature or a bug.


Comments (Archived):

  1. @mikeriddell62

    Token should only ever be issued in exchange for value added to the community it serves. In that sense there is no need for a cap just a collective understanding of what the value added to the community looks like.No cap needed, in our community anyhow.Thanks.

    1. Greg Gentschev

      Unless the token represents an asset or service, it behaves like a currency. Since transaction costs are low, you can’t really tell whether a transaction adds value or is just manufactured to manipulate the token price. There’s no simple way to tell whether a transaction adds value or how much, so there’s no obvious basis for collective understanding.For example, let’s say I take out a big loan denominated in a token currency. Then I create a ton of transactions in that currency, creating perceived value and causing the money supply to be expanded. I’ve thus inflated the currency, making my debt smaller in relation to other currencies that I hold.So I agree with you in principle, but I’m not sure it’s possible to enforce value-based token issuance in practice, unless the token is asset-backed.

      1. @mikeriddell62

        In our case the asset is backed by time: time spent participating in an activity that contributes to the wellbeing of our community.In other words, tokens are earned into existence for the added value they produce.

  2. Vitomir Jevremovic

    If tokens are associated with real world value that is brought into the system, like real-estate for example, creation of new real-estate should generate more tokens. Like when the gold is dug, money is printed, thus tokens are created. You cannot cap this, right? I’m not sure how will things play-out, but there will probably be models covering tangible value, and intangible value, especially digital value.

  3. kidmercury

    No cap needed. Monetary policy is the means by which a token will have a government that allows for wealth redistribution — including basic income and other such social benefits — and so there needs to be great freedom here, not arbitrary caps. Monetary policy is also how blockchains get “closed” and allow value to be captured by companies and for users to get great user experiences that total dectentralization cannot offer (like basic income).Amazing we are now having these conversations seriously and with a growing audience. Belief is 80% of the battle. Utopia is almost here!!!!!

  4. jason wright

    Has scarcity lost its value?

  5. William Mougayar

    When Vitalik designed Ethereum, a built-in inflation rate was one of the characteristics he implemented, because he didn’t believe a fixed coins supply was advantageous. (today ETH inflation is at about 14%, but gradually decreasing over time).However, – although some inflation is a good release valve for not letting tokens appreciate too quickly ahead of their real use value, that’s not enough. Speculative market demand can bulldoze past the inflation bumper and still drive token prices up.That said, inflation in token designs is one of the characteristics I enumerated in my post that Albert referenced.

    1. Vitomir Jevremovic

      but what if tokens are associated with real-world assets? (sorry for duplicating the comment from the main thread)

      1. William Mougayar

        how different is that from public companies issuing more stock (or buying it, on occasions)? it floats back in the market and finds an owner. in the case where they are a proxy for a real ownership, then that’s a token function inside the marketplace or app, and it is accounted for accordingly. i’m not sure if i answered your question properly, but maybe provide a specific example, if i didn’t.

        1. Vitomir Jevremovic

          Lets say we have a big real-estate company starts building a new skyscraper. It creates its own tokens and then sells ownership (even shared ownership) in these buildings on a token market. Every time they create a new building they create a new amount of tokens, so no cap there and I presume no inflation.

          1. Greg Gentschev

            It seems to me that this is a completely different scenario. Tokens backed by assets are more like stocks and wouldn’t necessarily inflate/deflate rather than moving with the value of the asset (and perhaps speculation on it). Tokens without assets are more like currency, and I think that’s when monetary policy becomes a primary driver of price changes.

          2. Vitomir Jevremovic

            Is that then a safer or more stable model then currency? Here a question raises how do we tockenize assets where each individual asset can vary in price over time almost like creating a specific “token” for each represented asset.. and one universal token to trade those assets..

          3. JLM

            .Those are individual new currencies and they own a finite asset. They are more like a stock which has an auction function to set its price.JLMwww.themusingsofthebigredca…

          4. Vitomir Jevremovic

            exactly! they are stocks. It seems that we would need another layer on top of tokens to handle auction models and trading of assets (stocks) on blockchains, like a stock market. Then question is how market values tokens that are used to trade “digital stocks”? as when these tokens rise/fall in value, every d-stock rises/falls in value (probably unproportionally).

          5. JLM

            .This is the classic mutual fund/ETF problem.Does a basket of stocks trade linearly and in lock stop with its combinator function?Does 100 shares of Exxon inside a MF or ETF equal 100 shares held individually?The answer is often “yes and no” but it is not only one or the other. It fluctuates and creates opportunities.It is not a perfect resolution.JLMwww.themusingsofthebigredca…

          6. Pointsandfigures

            Speculators fill the void. But, in listed asset markets like stocks/futures/options, you can go short. No such thing in crypto which means you don’t have a “real” market yet.

          7. JLM

            .I agree with you that there is no “real market” when you cannot bet on both directions of the movement.On the other hand, I am opposed to the shorting of public stocks and as a former CEO, I think it is against the basic reason why companies list their stock on public exchanges.JLMwww.themusingsofthebigredca…

          8. Pointsandfigures

            I disagree about shorting public stock. It provides an economic function. The key is that there should be a cap. All the stock that can be borrowed can be shorted. There have been problems with that in the past, and blockchain is almost certainly a solution to those problems.

          9. JLM

            .I could write for an hour about why shorting a stock is not in a company’s interest.I have a CEO’s view of things.You have a trader’s view of things.Our views will NEVER come into conformance.Public company CEOs should exert more control over the exchanges which would not exist but for public companies agreeing to be listed.JLMwww.themusingsofthebigredca…

          10. Pointsandfigures

            It’s never in company interest to have shorts. it’s never in company interest to have activist shareholders. CEO’s hate it. But, when a company isn’t performing and the CEO is doing a shit job combined with a market perhaps overvaluing a particular stock, shorting provides a good economic function in the marketplace.… is a link to a study that shows shorting isn’t indicative of future performance (in fact, shorts in the market predict gains in the stock) Here is one on shorting, and its effect on prices as determined by firm size http://faculty.chicagobooth… Shorts are good for markets. Healthy.

          11. JLM

            .I will try to stay out of a long debate. The bottom line is this — a stock exchange exists to serve shareholders, not investors or speculators.When companies list their shares, it is done exclusively for the benefit of their shareholders and not for the aforementioned investors and speculators.Shareholders can take advantage of premium prices by selling their shares and repurchasing them in a “wash sale” thirty days or more later.Just because it’s Christmas doesn’t mean anyone can come to my Christmas party. You have to be invited and investors and speculators are not invited. Sorry. [Not really.]JLMwww.themusingsofthebigredca…

    2. Sebastian Wain

      Don’t you think there is an extra factor to take into account in inflation: the divisibility of the currency? In fiat money you have a very strict limit of 1/100 while in cryptoeconomy a currency can be divided in billions of billions

      1. William Mougayar

        It’s a factor that Bitcoin proponents talk about when defending the 21 M coins limit, but the reality is that there is still going to be a value behind these fractions.

  6. pointsnfigures

    If you translate it to a physical good like gold, it’s a bug. One of the causes of the Great Depression was the gold standard. Milton Friedman did some great research on it.

    1. sigmaalgebra

      A gold standard is easily misunderstood: A lot of the money in circulation, the money supply, is just from the multiplier effect:E.g., Joe deposits $100 backed by gold in his checking account in a commercial bank. From Joe’s $100, the bank, then, loans Tom $90. Tom deposits the $90 in his checking account. From Tom’s $90, the bank loans Dick $80. Dick deposits the money in his checking account. From Dick’s $80, the bank then loans Harry $70.So, now we have $100 in gold backing Joe’s $100, but we also have $90 + $80 + $70 = $240 backed by some assets of Tom, DIck, and Harry and otherwise not backed by anything.So, we now have $100 + $240 = $340 in money in circulation.But back in the summer of 1929, Tom, Dick, and Harry invested their $240 by buying $2400 of stock on margin.Then the stock market crashed, and Tom, Dick, and Harry suddenly owed nearly the whole $2400 to the stockbroker and also couldn’t pay back the $240 to the bank.. Then Joe is in trouble: The bank does not have his $100.In a nutshell, that is what caused the Great Depression, started WWII, killed lots of people, and we have still not repaired all the damage.So, buying stocks on thin margin with loans from fractional reserve banking can do really bad things to the money supply even though Joe’s original $100 was fully backed by gold. That is, back by gold does not mean as good as gold!Like any recession-depression, the cure is the easiest thing in the world — the money supply from fractional reserve banking has been destroyed and it has also destroyed Joe’s $100. So, we’ve destroyed a lot of the money supply.So, the solution: Replace the destroyed money, right away now, y’hear? Or in simple terms, print money. Then also, to avoid returning to the problem, have good banking regulations, high reserve requirements, and throttle buying stocks on thin margin.Why did we let ourselves ruin lots of people and families in the Depression and kill lots of people in WWII instead of just print money to replace the destroyed money created by fractional reserve banking? Sure, morals! It would be immoral just to print money! Uh, how moral were the Depression and WWII?We still have not learned our lesson: Starting in about year 2000, for various reasons, we blew an asset bubble in residential and commercial buildings. In 2008, the bubble burst. Then we went into economic disaster land with 95 million US citizens out of the labor force and big Federal deficits.So, why didn’t we just print the needed money? Morals! Yes, we had TARP I and II, but apparently much of that money was for political payoffs for political kick-backs. I and II smelled like rotten eggs.We were in a serious recession for 8 years, 2/3rds as long as the Great Depression.Remember: We went for 12 years in the Great Depression with little evidence of coming out of it. Then, presto, bingo, we were totally out of in in 90 days flat. We could have been out of it in 90 days flat in 1929 except for the moralists.How/why did we get out in 90 days? 12/7/1941, that’s how. For that, we were willing to print money. Suddenly everyone had three or so job offers and took maybe 2 of them.Are we learning yet?If we do another one of these bubble jobs, we could have WWIII and, then, sure no more wars!!!!!!Bubbles are dangerous. It would be good to stop this bubble stuff.

  7. pointsnfigures

    “discount rate = inflation (ZERO by monetary policy of token) + risk free rate (ZERO because of glut of capital in the world) + risk premium (mistakenly near ZERO due to honeymoon phase)”–quoting Albert’s blog. This is extremely important. The last factor is highly misunderstood. The entire risk premium of the crypto is being incorporated into the price, and borne 100% by the holder of the crypto.

    1. Chimpwithcans

      This makes a lot of sense to me – but how to strip out risk premium from other price drivers such as utility?

      1. Pointsandfigures

        That’s a huge math problem that is beyond my ability.

        1. Chimpwithcans

          Haha…me too 🙂

    2. Tom Labus

      Losses will be for next wave of holders

      1. pointsnfigures

        look at the $QQQ meltdown. Wow.

        1. Tom Labus

          long overdue,

          1. pointsnfigures

            agree, I guess that “fat finger” on Amazon was a channel marker.

        2. JLM

          .I love QQQ. It is a no brainer. Tripled since 2009.A 4% dip is nothing. The upward and onward march will continue shortly.JLMwww.themusingsofthebigredca…

  8. lonnylot

    I’m unsure of how eth distributes new tokens, but iirc btc distributes them to miners. The question then becomes: are miners redistributing the tokens or holding them? I think if they are mostly holding them then there is no inflation. If they have nothing to spend them on then it would suggest that the rise in price has less to do w the market cap and more to do w lack of utility.

    1. Greg Gentschev

      Bitcoin is deflationary by design. The fixed cap on tokens means that bitcoin should tend to gain value over time. I think that’s what Albert refers to as being a problem.

  9. Leo Sardilla

    It’s remarkable that we have advanced far enough from the bitcoin genesis block to take for granted the existence of digital scarcity so that we can now discuss whether there is too much digital scarcity. It seems to me that _any_ scarce commodity is subject to volatility. Although governments are sometimes able to reduce volatility through price regulation (think setting the price of eggs) or active supply management (think the Fed for monetary supply), almost everything with a finite supply is volatile. Heck, look at Berkshire Hathaway with its relatively stable number of shares. It has halved during times when earnings were almost constant. And, it has tripled at other times when earnings were up only slightly. Due to relatively finite supply, bitcoin and ether are inherently volatile. To me the question boils down to this: will the volatility calm once the market cap of bitcoin and ether grow sufficiently large? Exhibit A: Coke. For years, it has had a shrinking supply of share through repurchases. Yet it remains relatively stable. Or, will bitcoin and ether remain subject to manias, panics, and crashes? Exhibit B: everything from tulips to the recent Korean frenzy over ether in which those tokens sold at nearly a 40% premium over ether everywhere else in the world.

    1. Pointsandfigures

      Want to know what one of the most volatile commodity products is in the world? It’s not scarce. It’s onions. More volatile than crude oil, by a lot.

      1. Hiyito Patada

        I’d say fractional reserve fiat money is pretty damn volatile, too. Look at the state of the world today. Look at Venezuela.

      2. Leo Sardilla

        Why? (What an interesting piece of information!)

  10. JamesHRH

    Why not set the price, rather than the cap the amount?

    1. Rob Larson

      Setting a price for a fiat currency (crypto or otherwise) is extremely expensive to maintain and ultimately ends up being unstable. The market price is whatever people will pay for it. If you try to set a specific price in dollars, this is effectively declaring an official exchange rate for that currency. The only way to make it stick is to convince market participants that your price is what it is truly worth. Central banks who peg their currency to the dollar do this by using their countries currency reserves to buy & sell their currency vs the dollar in huge quantities, forcing the price to whatever they want it to be. As long as their reserves are deep, the market price will follow along. But this is very expensive to maintain, and as soon as people doubt your ability to maintain it, hedge funds will bet against your ability to maintain the peg, leading to instability. (See George Soros during the 1997 Asian currency crisis, also spilled over into Russia and S America). You can try to outlaw trading at any other exchange rate than the official one (see Brazil and Argentina, historically) but you can’t prevent people from moving their trades to the black market. When people are using your currency as a store of value, they have enormous incentives to trade it whenever they believe the official exchange rate doesn’t reflect the true underlying value.So rather than trying to set the price, it’s much easier and much much cheaper to focus on the supply.

  11. Twain Twain

    IT’S A BUG IN BINARY.A lot of the thinking around Blockchain, bitcoin and Ethereum seems to be bounded by our existing understanding of CLASSICAL two-dimensional economic models. Here’s the ISLM as an example. Albert and I both agreed we don’t like ISLM, but it’s not clear what a more nuanced model would look like.As I noted to Albert, we can’t talk about money supply (or, in this case, bitcoin supply) without discussing savings and value accrual. If the laws of physics apply, then there has to be a counter-balancing force and its variables to bitcoin supply. https://uploads.disquscdn.c…As I’ve said before, I believe Satoshi didn’t think through and future-proof Blockchain and bitcoin for two vital factors of computing:(1.) Getting the machines towards Natural Language Understanding => simply IMPOSSIBLE mathematically with the classic Turing-VonNeumann-Shannon-Rosenblatt models (or, at best, hugely computer inefficient).(2.) The arrival of Quantum computers.It would have been A LOT MORE INNOVATIVE if Satoshi had thought about economics as multi-dimensional quantum models that also factor in the subjectivity of language, culture and values.But he didn’t.

    1. prankeapple

      *Puts on tinfoil hat*

    2. Pointsandfigures

      ISLM is not a good model. A 3 or 5 factor model from finance, or the C+I+G model used by classical economists would be better.

  12. creative group

    CONTRIBUTORS:BITCOINMay 2017 $1,400 June 2017 $3,000 SUNDAY…Bubble? What bubble?We missed our Multi-Million play.Overly conservative…..Warren Buffet advice:Invest in that which you understand. (All advice not equal)

    1. JLM

      .You may be aware I am a skeptic as it relates to bitcoin. Nonetheless back in Jan 2017, I predicted the rise of bitcoin.http://themusingsofthebigre…Many of my friends were aghast as to how the bitcoin skeptic could make such a prediction. It is not the same thing.On one hand, I predicted a huge rise.On the other hand, I continue to be a skeptic and looking for the killer app.I told you. You didn’t listen. You never listen.JLMwww.themusingsofthebigredca…

      1. LE

        As someone who made significant money off the chinese in another runup with another asset (7 figures) I fully concur with your point #4.4. The Chinese are into bitcoin, as miners (creators of bitcoin), owners, traders. There are a lot of Chinese people. In addition, the uncertainties associated with the Chinese economy, the China v Trump impending clash, the artificial price of their native currency, the ability to move bitcoin across borders, the value hedge associated with a renminbi to bitcoin to USD transformation.Now roughly 1.5 years later while they are still paying money it is at about 1/2 of what they were paying at the peak. And roughly what they were paying when they started their frenzy. (Which is almost double what they were paying prior to the feeding frenzy.). [1]Noting of course that you said this:The Boss says, “I think Bitcoin is going to $2,100 by year end 2017.”It’s not the end of 2017. So this is like Cramer telling you when to buy but not when to sell. The question is is it time to sell? If it’s ‘going to be $2100 by year end’ I guess it is?What is your prediction?[1] To illustrate greatly simplified:Price of asset and offers prior to frenzy (for many years): $100Price of asset and offers at start of frenzy: $180Price of asset and offers at peak of frenzy: $350Price of asset and offers currently: $180

        1. JLM

          .We are into a “deep crazy” in which money is drowning anything even remotely resembling common sense.This is like a surfer riding a huge wave.If you don’t kick out before the wave slams you into the shore, you are dead.If you do kick out before the wave slams you into the shore, it was a great ride.I think it goes to $4,000 before the shore is even in sight. There is just way too much stupid money out there for restraint to get a chance to take root.The Trump admin — US SEC and Dept of Treas — will NOT try to regulate bitcoin. That will be HUUUUUUUGE.If they do, get out as fast as you can.JLMwww.themusingsofthebigredca…

      2. Hiyito Patada

        “BitCoin is not just a ‘digital currency’, it’s The Internet of Money.” – Andreas AntonopoulosBitCoin is the killer app.Once you see this open and permissionless network that way, it changes the outlook. I agree with Andreas, price of BTC is almost irrelevant because it’s the tech that is valuable. Unless you’re one of the riverboat gamblers who has bet the farm on BTC.BTC is just the first app, and a killer one, as we’re seeing. If it tanks, so what? There are hundreds of crypto currencies vying to take its place. If anything, I welcome a pop in the BTC bubble, because buying opportunity – although it might reach $10,000 before it happens.You’re right in that none of this is rational, in what we’ve come to accept as conventional. This shouldn’t be happening. But that’s exactly why I like it. FinTech is being disrupted. And deservedly so. To paraphrase Andreas again, “This isn’t soft jazz. This is punk rock.”Get stuck in, JLM. A man like you can do some great things with this.Cheers!

    2. Hiyito Patada

      Well, Warren invested in Wells Fargo. A company, that he, like most of us, didn’t know at all.But yes, crypto will be no different. At the end of the day, it’s either a good promising company or it’s not. The market will sort it out. If some of these BitCoin millionaires lose their coin with malinvestments, all the better, because no other private holder of BTC will bail them out or be forced to.

  13. Andrew Badr

    There’s a reasonable argument that inflation in a cryptocurrency is necessary to incentivize miners and protect the network. But I don’t think it works for preventing rapid price appreciation. Consider that the money supply of Bitcoin is still increasing 4% annually at this point in time, and in the past few years that figure has been much higher. The likelihood that the rate of runaway demand will coincidentally be negated by a predetermined inflation rate is very low, and there’s no pure-crypto way to dynamically match the inflation rate to the price. Finally, consider that “rapid price appreciation” is perceived relative to some starting point, not in absolute terms–and that starting point will be reached quickly regardless of your inflation schedule.

  14. JLM

    .Currency is both a logical measure of value and an “illogical” holder of value.One of the best ways to evaluate currency exchange rates is by using a PPP (purchasing power parity or the Big Mac index) model to ascertain what can actually be purchased locally with a given quantity of currency and to compare that with the actual quoted exchange rates.In this manner, one can identify anomalies which may be symptoms of an inefficient market or a mistake or an opportunity.In its currency costume, crypto currency does not have the burden of having to engage in a PPP exercise as it is not the currency of a sovereign nation or a geographical marketplace. It also cannot be used at McDonald’s, though it theoretically can.This seems to dramatically heighten the risk of its currency characteristic. When a PPP v exchange rate gets out of balance, market forces can come into play to drive it back to equilibrium.I suspect this is just one more element which colors this entire phenomenon as a bubble.JLMwww.themusingsofthebigredca…

  15. jason wright

    is a more aggressive inflationary model a form of demurrage, which would encourage spending and not hoarding?

  16. prankeapple

    You guys are still way too grounded in economics and haven’t yet wrapped your heads around ~cryptoeconomics.~ But you’re getting there. I’d say the biggest issue with a fixed money supply target in cryptocurrencies is that miners become more incentivized by high transaction fees as the currency reward from newly mined blocks approaches zero. We’re already beginning to see this with bitcoin.Whatever the underlying reason is, people seem to be far more comfortable with a little bit of inflation and low transaction fees than with no inflation and higher transaction fees.

    1. Pointsandfigures

      There are Iron Laws of Economics that transcend everything. Crypto is no exception.

  17. jason wright

    on an intimately related point, i accuse the venture capital industry of being largely responsible for the present frenzy in the crypto space. their ‘pre-sale’ positioning is super heating ICOs and creating an unreality. it may serve their needs, but it will set the space back at least 12/ 18 months. how many authentic founders have not yet been corrupted?

    1. Hiyito Patada

      Dot Bomb 2.0But I say let it happen. It’s part of new tech growing up.

      1. jason wright

        This is different. This is VCs behaving like incumbents. Spot the hypocrisy?Bancor was a new low point in describing their process.

        1. Hiyito Patada

          Good point. We’re in new territory now. I’ve withdrawn from participating in ICO’s, at the moment. If it’s a token backed by a promising business with a good team, maybe I’ll trade for it on the exchanges. Ethereum still has a lot of proving to do. Interesting times…

  18. creative group

    CONTRIBUTORS:if you are not in the room when the decisions are being made to capture or dominate a financial sector you are zigging when you should have been zagging.———-Digital Gold: Bitcoin and the Inside Story of the Misfits and Millionaires Trying to Reinvent MoneyNathaniel Popper- May 17, 2016———Gave us reservations as a disciplined DayTrader.Losing our backside during the dotcom bubble was humbling.If you are not holding cryptocurrency it is too late with the big two unless one or both dramatically fall.

  19. Hiyito Patada

    If people want an inflated currency that could also function as a debt instrument, it already exists. It’s called the U.S. Dollar.I welcome anyone to try something different. That’s what this permissionless tech is about. However, if its going to be inflated forever, I think it will stagnate quickly and not be highly valued in this marketplace.BTC and ETH are bubbly, though. But that’s okay. A correction will be healthy and normal, and a buying opportunity. Question for ETH is, is it the MySpace or Facebook of Internet 2.0?As for ICO mania, you’ll know it has jumped the shark when celebrities are spokespeople and its being featured on late night infomercials. Most of these new ICO companies will fail, and that’s good. Second and third wave companies will be better for it.Buckle up, it’s going to be a wild ride.

  20. howardlindzon

    It’s about trust. The hard cap needs to hold … the slippery slope is once you change it once …

  21. JLM

    .I do not, provocateur bread man. I blame Putin.JLMwww.themusingsofthebigredca…