The author attempts to give an explanation behind the monetary parameters of bitcoin chosen by Satoshi Nakamoto by making references and comparisons to Nick Szabo’s blog Unenumerated and John Nash’s concept of Ideal Money, specifically in regards to the industrial consumption price index Nash highlights.
An Arbitrary Choice?
Let’s examine for a moment the monetary policy behind bitcoin:
Bitcoins are created each time a user discovers a new block. The rate of block creation is approximately constant over time: 6 per hour. The number of Bitcoins generated per block is set to decrease geometrically, with a 50% reduction every 4 years. The result is that the number of Bitcoins in existence will never exceed 21 million[1].
There has been much speculation as to why the exact parameters were chosen by Satoshi, wiki continues with their explanation:
This algorithm was chosen because it approximates the rate at which commodities like gold are mined
This seems like a logical and intuitive explanation but what might the justification be and is there any significance to this system? The wiki page also links to an interesting discussion with Milton Friedman, and when asked what his ideal system for monetary policy would be he had this to say:
… Suppose the federal reserve said it was going to increase the quantity of money 4% every year week after week month after month… that would be a truly mechanical project. You could program a computer to do that…what you want to do is if possible is to have a mechanical system. If there was any virtue to the gold standard it was that virtue. Maybe you could create the same thing now…I would if I had my choice, freeze the amount of high powered money…and hold it as a constant. And have it as sort of a natural constant like gravity or something.
It seems Satoshi fulfilled exactly that wish of Friedman’s and one might even wonder if Satoshi did in fact consider Friedman’s advice.
What is the Ideal Money Printing Schedule?
“Our view is that if it is viewed scientifically and rationally (which is psychologically difficult!) that money should have the function of a standard of measurement and thus that it should become comparable to the watt or the hour or a degree of temperature.”-(from the lecture Ideal Money)
It seems reasonable to suspect there was a period in which Satoshi had to consider different schemes for implementing and bootstrapping bitcoin. If one did some research into the history of money, they could compare different designs of different currencies and look for the ideal structure or implementation. In other words, bitcoin’s money printing schedule is likely not arbitrary. So what might that ideal be? Satoshi would have been wise to consult Dr. John Nash since Nash has been (especially in the few years prior to the 2009 release of bitcoin) ranting about a concept of linking national and international currencies to exactly that ideal schedule (Southern Economic Journal 2002, 69(1), 4-11):
We of Terra could be taught how to have ideal monetary systems if wise and benevolent extraterrestrials were to take us in hand and administer our national money systems… A possible non political basis for a value standard…a good industrial consumption price index (ICPI) statistic. From…international prices of commodities such as copper, silver, tungsten…
Nash writes of an industrial consumption price index (ICPI), consisting of different commodities and points to the significance of gold in this regard:
…the suitability of such commodities with regard to the ideal function of facilitating utility transfer depends on the extent to which such a commodity seems to have a value independent of its geographical location. ..in terms of this geographical perspective, gold has historically been optimum, largely because the labour cost of moving it over great distances is so small relative to the value of what is being transported.
Oil as a facilitator of exchange is also seemingly significant in creating the ICPI:
Crude petroleum could also be used for barter and in view of the present state of the global economy it would seem a proper component of an index of prices of internationally traded commodities that enter into the cost of industrial consumption.
This point seems random but in the context of this entire article it might be something to come back to and read again. Nash points out the ICPI must account for perhaps a new energy, but still doesn’t really go into any details on how to do such a thing:
We can see that times could change, especially if a “miracle energy source” were found, and thus if a good ICPI is constructed, it should not be expected to be valid as initially defined for all eternity. It would instead be appropriate for it to be regularly readjusted depending on how the patterns of international trade would actually evolve.
The ICPI is a sort of formula that creates a standard which dissolves government control over printing money:
Hence, it seems that such an ICPI could be calculated in an essentially scientific fashion after some practical initial choices were made. Moreover, this standard, as a basis for the standardization of the value of the international money unit, would remove the political roles of the “grand pardoners”
The most mathematical he gets in his explanation is found here:
For example, the prices of copper and nickel might very well represent, over long periods, the actual costs of industrial production, while the prices of silver and gold might tend to vary comparatively much more smoothly than those of the baser metal. It is possible to construct a prices index based on moving averages that would have the smoothness of the prices of the gold and silver and yet, over longer periods, would basically follow the values of the baser metals. This index could be constructed by computing a moving average of the index for the base metals computed by pricing them modulo the index of the precious metals.
He seems to be describing a very granular aggregate of the change in price, that can be used as a responsible backbone for our money supply system:
In actual application, it would not be a matter of base and precious metals but rather of a variety of commodities that would be selected for their suitability in on sense or another. Also, for the index formed on the basis of things with naturally smoothly varying prices, it seems that it would be intrinsically quite feasible to make use of sorts of services, energy, or prices, that depend on the national location of the definition of the commodity, service, or asset being priced. Hence, by using this approach, the temptation to include things that would otherwise seem inappropriate just to obtain stability or smoothness can avoided.
What is an International Consumption Price Index?
Ideal Money is a theoretical notion promogulated by John Nash, to stabilize international currencies. It is a solution to the Triffin dilemma. He proposed that international exchange rates be fixed by pegging the value of each currency to a standardized basket of commodities, called the industrial consumption price index. Such a policy would curtail the ability of central banks to make monetary policy.-http://en.wikipedia.org/wiki/Ideal_money
That is about as best as Nash does, in his lectures and papers on ideal money, at explaining the ICPI he suggests should be the basis for our currency system(s). What’s apparent about the index is it is seemingly quite complex with many variables and adjustments. So one might ask whether or not either Nash or Satoshi took the time to gather these variables and plot them out in some useful fashion. Regardless someone DID make many relevant considerations with respect to what would might constitute an ICPI-that person is Nick Szabo.
Szabo’s blog Unenumerated is a giant encyclopedia of subjects related to todays current changing economic climate (bitcoin). And weaved throughout its vast maze of knowledge, there is embedded an intricate description of the behaviors and roles of commodities in our global economy.
For example, in his post Commodity Hysteria– an Overview, Szabo describes the pitfalls of the floating currency system, as if he already envisions a way out. He explains the value of a commodity for the individual as a hedge against fluctuating currencies, and similar to Nash’s thoughts in Ideal Money the theme seems to be that commodity backed indices could be used as a solution to printing money:
The fault lies with poorly managed floating currencies, not with attempts by currencies users to protect against the damage done by floating currencies, for example by hedging their dollar-denominated investment portfolios with long commodity positions. If or when inflation expectations decrease, we can expect (contrary to peak oil theory) oil pumping to greatly increase, as having dollars will once again become more valuable than having oil in the ground… In the era of floating currencies, not only are commodities a legitimate asset class, they are an essential asset class. We may be seeing only the first stages of a switch from floating currencies, which may be proving to be unworkable, to commodity-backed currencies. …in particular currencies should be eliminated in order to allow payment terms denominated in commodity indices to be as simple as payment terms denominated in dollars. These kinds of reforms will bring the benefits of stable commodity money from Wall Street to the man in the street. If the Federal Reserve decided to use leading indicators (e.g. commodities) instead of trailing indicators… or decided to go to a de facto commodity index or back to the gold standard, and stopped bad practices such as “printing” dollars…we would not need to otherwise use commodities for monetary purposes.
Furthermore in another post Szabo talks about a foresight into a better kind of currency and continues to explain the relation of commodities to our currency system:
…humans also have foresight and can reason by analogy, and so can design an exchange to trade new kinds of securities, a new kind of insurance service, or a new kind of currency. Indeed the commodities with the most liquid markets and inelastic supply, such as oil and gold, tend to move in lock-step with each other. Such price movement is strong evidence for the movement being primarily a phenomenon of changing money supply or demand rather than of changing supply or demand for particular commodities.
He makes an important point, in that in defining the prices of gold and oil, we can seek to ignore unnatural fluctuations by adjusting for them. The reasoning behind this seems to be if gold and oil fluctuate in tandem there is likely an external unnatural cause, namely the sudden change in supply of currency:
…we see oil and gold moving together, and indeed the price of oil in terms of gold and silver has been practically flat in the recent commodity boom. This is almost entirely due to expected or actual increases in the supplies of the currencies they are traded in (and especially recently in the weak dollar) rather than to “real” factors.
Szabo delves deeper in regards to inflation and gold/oil with respect to the Euro and the USD (notably two of the most prominent international currencies):
…if greater inflation is expected in both the euro and the dollar, the price of oil will increase in both euros and dollars. The euro/dollar exchange rate reflects relative monetary changes between the dollar and the euro, and the monetary component of the dollar oil price reflects absolute monetary changes in the dollar. …the costs of alternative energies and conservation are also inflating — they are simply much stickier than oil prices and will thus lag but eventually catch up to them …we do not face an imminent demise of the oil economy, only a very long and very gradual increase in the technological/geological scarcity relative to consumption demand for oil Extrapolating the same rate as the last 50 years, the price of oil in terms of gold will take 80 years to double.
Here he seems to have organized his findings in a tangible computational form:
I have run some Monte Carlo simulations of hypothetical oil prices implied by long-term inflation expectations.
In other posts Szabo seems as interested as Nash in the effects of the Fed decreasing its printing schedule:
Commodity prices in dollars will level off, and then move back down close to historical trends based largely on just industrial consumption, if or when the Fed stops increasing the supply of dollars faster than the demand for dollars
Satoshi, Szabo, and the ICPI
Imagine its some year pre-bitcoin (Pre BC?), perhaps 2008 or 10 years before that or 20 or more, and you have just come to the realization through insight that computers could be used to implement a digital currency. You now understand Milton Friedman and Austrian economics in regards to a decentralized authority and you are beginning to consider the ideal printing policy for your liberation e-coin.
Then, looking back on the history of money (this might be a good time to review Shelling Out) one could see, as Nash and Szabo point out, that gold has generally served as a great backbone to our economy, but because of different political events eventually the optimal strategy for competing governments (as happened with the US) is to defect and begin printing money NOT backed by gold. Furthermore all countries follow suit because the policy makers stand to gain the most with the Keynesian policy of printing money.
So it becomes obvious then, that the ideal schedule for bitcoin would be an aggregate of the production of certain stably produced commodities to represent the kind of benefits that gold gave us while keeping the printing schedule out of the hands of any central planners.
The task for demystifying the controlling factors of commodity prices would be incredibly daunting as would simulating the factors in order to create a reasonable estimate of the ideal schedule based on the ideal basket of indicating commodities. But it seems Nick Szabo has spent his time doing exactly that.
A Paradigm Shift Satoshi Entered First
All this would be incredibly difficult to explain, and even more difficult to understand without the listeners having a deep and expansive overview of the entire economic history of mankind as well as an entire technological overview right up until Satoshi’s whitepaper (and beyond). The ICPI is essentially just a formula, which Satoshi likely used to code bitcoin’s money printing schedule. 21 million coins, starting with 10 million released at a decreasing geometric rate of 50% every 4 years. The author would like to suggest this number is a function of the ICPI. In this we can think of bitcoin as like a new metal superior to the function of gold in our monetary system and its superiority comes from the very fact that (by the authors conjecture) it has a mining algorithm perfectly based on an extensively adjusted ICPI that was optimally defined by John Nash/Szabo.
Nash suggested we are to link our currency system to the ICPI. This often leaves people wondering, if bitcoin is ideal money then where is the commodity basket to link bitcoin to? OR how do we link the currency bitcoin to an ideal commodity basket? But as Szabo explains extensively gold or oil themselves CAN in fact function like perfect currencies even though they are in fact commodities. In this light bitcoin starts to make perfect sense. It is a commodity in the sense that it is the perfect currency, based on an ideal printing/mining schedule constructed from a properly adjusted aggregate of commodities. It also has the benefit of super granularity of today’s paper currency and more. If the authors conjecture is true, Bitcoins are backed by the ICPI based schedule, and so always have the ideal quality that John Nash prescribed to them. (The process ideally backed money creates is referred to as asymptotically Ideal Money whereas the limiting result is Ideal Money)
Interestingly a new finding seems to suggest Satoshi was working on the bitcoin solution and its relevant aspects since earlier than previously thought (at least as early as 1999).
thewealthofchips 
Great attention to detail!