Bitcoin Protocol Modification to Secure Stability through Automated Network Dumping Capacity
Abstract: Being self-referenced Bitcoin and its ilk are inherently vulnerable to price instability, and the only tool at the traders’ disposal is a well-organized shared incentive to keep the coin alive. Proposing to marshal this incentive by taxing each coin a fixed percentage, and making the network as a whole the tax collector. The bitcoins so collected will be used to execute an automated dumping algorithm that will be invoked when the price of the coin reaches a target ceiling value. Such protocol modification will express the will of the traders to prevent unbound price hikes that inevitably are followed by price avalanche. When the price of the coin comes close to the designated ceiling, it will lose its speculators, and be used for normal monetary exchange.
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It is counterintuitive but true: to keep Bitcoin alive, it is necessary to guard against unbound price hike. Because Bitcoin is self-referenced, there is no natural ceiling for its price. When it rises, it sucks in more skeptics and rises even more, and faster. At some point the price will be so ridiculously high that traders will start selling. The same feedback mechanism that shot the price up will then shoot it down. Again, Bitcoin is self-referenced so there is no natural floor for its price. Eventually one downward acceleration would crash the coin to zero.
Indeed, a most worrisome scenario for Bitcoin is unbound price hike. This is the scenario that Bitcoin developers should pay attention to.
Of course, price collapse is the ultimate worry, but to counter it, one needs to buy the currency, and do so with a non-Bitcoin coin. Alas, Bitcoin being a closed system cannot hold maintain, manage or pay any other currency simply through protocol acrobatics. We therefore must focus on means to prevent out of control price hike because that is what leads to price collapse, and that expectation distorts the currency by turning it into an investment instrument rather than cyber money.
Exploiting the fact that all the coins are publicly identified, it is possible to tax them fairly (a percent of each coin’s value) and pass this money to an automated dumping capacity fund (ADC fund) . It’s one of the most remarkable features of Bitcoin — the money is laid out for the public to see, while the owners maintain their privacy. For a taxing algorithm the identity of the owners makes no difference — each coin is taxed per its record on the public ledger. It’s like a municipality charging for water. Each house has to pay, or get cut off. The identity of the owner of the real estate makes no difference. The fund will be owned by the network as a whole. It can be implemented by solving a well-known Bertrand Russell paradox, defining a node in the network as representing the network as a whole. The algorithmic dumping capacity fund would be paid by all other accounts in proportion to their value, and will submit its funds to the revised protocol governing the use of the fund to intervene in the trade of the coin in the event that the price exceeds a designated ceiling value. The algorithm will be very specific as to how fast to dump the money, based on a well-designed feedback mechanism wherein the price effect of the recent dump is guiding the next dump. There are a lot of details in need of design, but here we focus on the concept per se.
The community will decide on an intervention price, I. Should the price of Bitcoin, B, be higher than I: B ≥ I, then the ADC will start dumping its bitcoins to cool the price down. The literature offers several solutions with somewhat similar ideas but they seem to us more complicated, less automated, and too arbitrary to appeal to the entire community. What is exciting about this automated dumping capacity fund is that it can operate dynamically. Bitcoins are siphoned off the outstanding coins “on demand” at rates necessary to keep the price below the set threshold. Dynamics will have to be carefully accounted for. If the dumping is too slow, it is not effective. If it is too fast, it may be an overkill and impoverish the traders.
The effect of the ADC is expected to be a much needed stability. As long as the price of the currency is much below the designated ceiling price I, the message to speculators is that Bitcoin has not yet exhausted its price hike potential, and the incentive is great to buy and hold. We know from Bitcoin history that speculators disrupt the currency from being money and pushe it into a lottery ticket of sorts. As long as the price of the coin is considerably below the designated ceiling than speculators will rush in. Alas, when the price is getting close to that ceiling then speculators lose interest, and the only people to exchange the coin are those who treat Bitcoin as money, not as an investment opportunity.
Of course, the ADC fund comes with no guarantee of price stability. There is a limit to its power to prevent out of control price hike, but it will surely extend the life the currency. Another piece of code will be needed to administer a (recurrent) community vote on the value of the price ceiling target (I). Voting power should be proportional to the vested assets. The people who own more bitcoins have more to lose if it crashes, and pay more money in taxes.
Having a sizeable, automated dumping capacity fund will also distinguish the currency from any new forks or alternative protocols. It will represent the commitment of the community to the well being of the currency.