Hayek-Style Cybercurrency

Hayek and Bitcoin

In his ground-breaking work, Denationalisation of Money: the Argument Refined, F.A. Hayek proposed that open competition among private suppliers of irredeemable monies would favor the survival of those monies that earned a reputation for possessing a relatively stable purchasing power.

One of the main problems with Bitcoin has been its tremendous price instability: its volatility is about an order of magnitude greater than that of traditional financial assets, and this price instability is a serious deterrent to Bitcoin’s more widespread adoption as currency.  So is there anything that can be done about this problem?

Let’s go back to basics.  A key feature of the Bitcoin protocol is that the supply of bitcoins grows at a predetermined rate.1 The Bitcoin price then depends on the demand for bitcoins: the higher the demand, the higher the price; the more volatile the demand, the more volatile the price.  The fixed supply schedule also introduces a strong speculative element.  To quote Robert Sams (2014: 1):

If a cryptocurrency system aims to be a general medium-of-exchange, deterministic coin supply is a bug rather than a feature. . . . Deterministic money supply combined with uncertain future money demand conspire to make the market price of a bitcoin a sort of prediction market [based] on its own future adoption.

To put it another way, the current price is indicative of expected future demand.  Sams continues:

The problem is that high levels of volatility deter people from using coin as a medium of exchange [and] it might be conjectured that deterministic money supply rules are self-defeating.

One way to reduce such volatility is to introduce a feedback rule that adjusts supply in response to changes in demand.  Such a rule could help reduce speculative demand and potentially lead to a cryptocurrency with a stable price.

Let’s consider a cryptocurrency that I shall call "coins," which we can think of as a Bitcoin-type cryptocurrency but with an elastic supply schedule.  Following Sams, if we are to stabilize its price, we want a supply rule that ensures that if the price rises (falls) by X% over some period, then the supply increases (decreases) by X% to return the price back toward its initial or target value.  Suppose we measure a period as the length of time needed to validate n transactions blocks.  For example, a period might be a day; if takes approximately 10 minutes to validate each transactions block, as under the Bitcoin protocol, then the period would be the length of time needed to validate 144 transactions blocks.  Sams posits the following supply rule:

(1a) Qt=Qt-1(Pt/Pt-1),

(1b) ΔQt=QtQt-1.

Here Pt is the coin price, Qt is the coin supply at the end of period t, and ∆Qt is the change in the coin supply over period t. There is a question as to how Pt is defined, but following Ferdinando Ametrano (2014a), let’s assume that Pt is defined in USD and that the target is Pt=$1. This assumed target provides a convenient starting point, and we can generalize it later to look at other price targets, such as those involving price indices. Indeed, we can also generalize it to targets specified in terms of other indices such as NGDP.

Another issue is how the change in coin supply (∆Qt) is distributed.  The point to note here is that there will be occasions when the coin supply needs to be reduced, and others when it needs to be raised, depending on whether the coin price has fallen or risen over the preceding period.

Ametrano proposes an elegant solution to this distribution problem, which he calls ‘Hayek Money.’ At the end of each period, the system should automatically reset the price back to the target value and simultaneously adjust the number of coins in each wallet by a factor of Pt/Pt-1.  Instead of having k coins in a wallet that each increase or decrease in value by a factor of Pt/Pt-1, a wallet holder would thus have k×Pt/Pt-1, coins in their wallet, but the value of each coin would be the same at the end of each period.

This proposal would stabilize the coin price and achieve a stable unit of account.  However, it would make no difference to the store of value performance of the currency: the value of the wallet would be just as volatile as it was before.  To deal with this problem, both Ametrano (2014b) and Sams propose improvements based on an idea they call ‘Seigniorage Shares.’ These involve two types of claims on the system—coins and shares, with the latter used to support the price of the former via swaps of one for the other.  Similar schemes have been proposed by Buterin (2014a),2 Morini (2014),3 and Iwamura et al. (2014), but I focus here on Seigniorage Shares as all these schemes are fairly similar.

The most straightforward version of Seigniorage Shares is that of Sams, and under my interpretation, this scheme would work as follows. If ∆Qt is positive and new coins have to be created in the t-th period, Sams would have a coin auction 4 in which ∆Qt coins would be created and swapped for shares, which would then be digitally destroyed by putting them into a burning blockchain wallet from which they could never be removed. Conversely, if ∆Qt  is negative, existing coins would be swapped for newly created shares, and the coins taken in would be digitally destroyed.

At the margin, and so long as there is no major shock, the system should work beautifully.  After some periods, new coins would be created; after other periods, existing coins would be destroyed.  But either way, at the end of each period, the Ametrano-style coin quantity adjustments would push the price of coins back to the target value of $1.

Rational expectations would then come into play to stabilize the price of coins during each period.  If the price of coins were to go below $1 during any such period, it would be profitable to take a bullish position in coins, go long, and profit when the quantity adjustments at the end of the period pushed the price back up to $1.  Conversely, if the price of coins were to go above $1 during that period, then it would be profitable to take a bear position and sell or short coins to reap a profit at the end of that period, when the quantity adjustments would push the price back down to $1.

These self-fulfilling speculative forces, driven by rational expectations, would ensure that the price during each period would never deviate much from $1.  They would also mean that the length of the period is not a critical parameter in the system.  Doubling or halving the length of the period would make little difference to how the system would operate.  One can also imagine that the period might be very short—even as short as the period needed to validate a single transactions block, which is less than a minute.  In such a case, very frequent rebasings would ensure almost continuous stability of the coin price.

The take-home message here is that a well-designed cryptocurrency system can achieve its price-pegging target—provided that there is no major shock.


Ametrano, F.A. “Hayek Money: The Cryptocurrency Price Stability Solution.” August 19, 2014. (a)

Ametrano, F. M “Price Stability Using Cryptocurrency Seigniorage Shares.” August 23 2014. (b)

Buterin, V. “The Search for a Stable Cryptocurrency.” November 11, 2014. (a)

Buterin, V. “SchellingCoin: A Minimal-Trust Universal Data Feed.” March 28, 2014. (b)

Iwamura, M., Kitamura, Y., Matsumoto, T., and Saito, K. “Can We Stabilize the Price of a Cryptocurrency? Understanding the Design of Bitcoin and Its Potential to Compete with Central Bank Money.” October 25, 2014.

Morini, M. “Inv/Sav Wallets and the Role of Financial Intermediaries in a Digital Currency.” July 21, 2014.

Sams, R. “A Note on Cryptocurrency Stabilisation: Seigniorage Shares.” November 8, 2014.

[1] Strictly speaking, the supply of bitcoins is only deterministic when measured in block-time intervals. Measured in real time, there is a (typically) small randomness in how long it takes to validate each block. However, the impact of this randomness is negligible, especially over the longer term where the law of large numbers also comes into play.

[2] Buterin (2014b) examines three schemes that seek to stabilize the cryptocurrency price: BitAsset, the SchellingCoin (first proposed by Buterin (2014b)) and Seigniorage Shares. He concludes that each of these is vulnerable to fragility problems similar to those to be discussed in my next post.

[3] In the Morini system, participants would have a choice of Inv and Sav wallets, the former for investors in coins and the other for savers who want coin-price security. The Sav wallets would be protected by the Inv wallets, and participants could choose a mix of the two to meet their risk-aversion preferences.

[4] In fact, Sams’ auction is unnecessarily complicated and not even necessary. Since shares and coins would have well-defined market values under his system, it would suffice merely to have a rule to swap them as appropriate at going market prices without any need to specify an auction mechanism.

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  • I am wondering: is there an equivalence, or at least a similarity, between:

    (A) a cybercurrency system that stabilizes the value of the coin through an automatic process of swapping coin for shares; and,

    (B) a monetary policy regime where the CB stabilizes national spending by pegging the value of NGDP futures in a prediction market?

    The similarity in my mind is the introduction of two types of instruments (coin/share, or dollar/NGDP-future), where we aim for stable value for the coin by creating a situation where private parties can make money by engaging in transactions (coin/share swaps) that wind up stabilizing the value of the coin in aggregate?


    • Kevin Dowd

      Thanks Ken.
      I agree that there is, in principle, an analogy between your (A) and (B) – provided that (B) is fully automatic.

  • David Andolfatto

    Kevin, you cannot be serious:

    >P(t) is defined in USD and that the target is P(t)=$1.

    You want this privately issued cryptocurrency to fix the exchange rate against the USD and therefore subject the protocol to US monetary policy? That will get a laugh in the Bitcoin world.

    My own proposal is for the Fed to enter the market directly, which I explain here:

    • David, I think Kevin was using P(t)=$1 as an example. Of course the whole idea of Alt-M is to get away from Fed-monopoly dollars, so in that world, Kevin would target something else for P(t), not P(t)=$1, probably something involving stabilizing the price level, or (I would hope) stabilizing the level-path of a nominal aggregate like NGDP.


      • David Andolfatto

        Thanks, Ken. Well, I guess we'll soon hear what Kevin meant, I hope! 🙂

        • Kevin Dowd

          Appreciate the comments guys!

          As Ken points out, the P(t)=$1 peg was just an example to illustrate the mechanics of the system, and I am not advocating such a peg myself.

          The next step of the analysis is then to replace the $1 peg with some index (in terms of USD prices) and then finally (hopefully!) move on to an index specified in terms of Coin prices not USD prices.

    • George Selgin

      I understood Kevin's suggestion to be for a transitional period only, with stabilization of "Coin's" purchasing power in terms of goods taking its place once Coin's become sufficiently widely employed in exchange to make construction of a reasonably reliable Coin price index possible.

      • David Andolfatto

        Nice save, George. But I didn't interpret it that way.

        By the way, do you happen to know whether it is presently legal for people or firms to pay for things (goods and labor) in gold, silver, bitcoin, corporate bonds, equity shares, etc.?

        It is my impression (though I'm no lawyer) that it is indeed legal to pay for goods and services in what ever objects the two parties agree to.

        IF this is true, then in what sense is it true that the Fed has a "monopoly" on money (or base money)? They may have a monopoly on small denomination paper note issue, money in this form is increasingly irrelevant.

        I'd be interested to hear your thoughts on this.

        • MichaelM

          David, for the most part, parties may agree on what can be exchanged. They certainly may agree that silver or gold can be exchanged for something. If it's a present simultaneous exchange, no problem. If it's a contract for a later exchange, or a credit transaction (the silver or gold to be delivered later), then if the party to deliver the gold or silver defaults, the other party may sue, but (as in the vast majority of contract breach cases) is likely to get a money judgment (in the dollar value of the gold or silver to be delivered) not a judgment of "specific performance" (requiring the party to do exactly what they promised). Of course, the fact that something may be exchanged for something else does not mean that it is money. "Money" refers to a generally-accepted medium of exchange. But you are correct on your main point, that people have a lot more freedom to structure their transactions than many believe. One may refuse to sell his goods and services for dollars, accepting only gold or oil or anything he chooses. His only problem (relatively minor) would come if he accepted credit deals or formed contracts rather than have only present simultaneous exchanges (for the reason described above).

  • Nick Zbinden

    I actually came up with a system that would get you most of the properties of bitcoin and gives you stable demand. My system would opperate simularly to free banking with gold (usually I have to explain this, but not here). Gold would be replaced by bitcoin as a reserve currency. Then you would have private groupes issue bitcoin based IOU in a different crypto currency system, simular to ecash (basically cryptographically signing a token that says "We AltM-Bank will give 1 Bitcoin for this token".

    So the token circulate like banknotes. To any free banker this system makes instance sence.

    The money demand is counteracted by IOU issuers increasing or decreasing the reserve ratio.

    Sadly this system depends on the willingness for people to take IOUs. With gold and notes the advantage is quite clear, with bitcoin and ecash tokens, less so. However there actually are quite a few advantages. The tokens can live by themself, you don't need the hole blockchain on your device. Transaction cost is essentially zero (like sending somebody a textfile). If intrested I can mention some more.

    Another benefit is that the blockchain (a list of all bitcoin transaction ever) could be used like a clearing house. If you want to gain trust, you can publically associate yourself with your bitcoin address and show that you are not constantly lose bitcoin.

    Cryptographically this it is actually pretty sound, im a programmer by trade, and a montary economist by night.

    • Kevin Dowd

      We are polar opposites Nick: I am a monetary economist by day and a programmer by night.

      I don't see how your system ensures stable demand or a stable-priced monetary base, but it is a natural idea to think through and I would be interested to hear more.

      • Nick Zbinden

        Stable demand might be a bit much. But just as any free banking system there is a insentive to exand the amounts of notes in circulation, this would have the practical effect of increasing spending. That is if I understand Free Banking correctly.

        The value of bitcoin would still not be completly stable. Diffrent then gold, bitcoin can not be melted down and used in industry (or exported). Bitcoin would also net react to overall demand increase with a (slow) increasing in supply (insentive to mine more gold), but the growth function could be model more or less on the avg. growth in gold during the classical gold standard. In theory this should lead be pretty close to optimal.

        If you are intrested in the crypto/programming aspect, here are some resources:
        – E-Cash: https://en.wikipedia.org/wiki/Ecash

        – The princple crypt tool behind this is called "blind signatures" https://en.wikipedia.org/wiki/Blind_signature
        Some advantages of this
        – ECash-Bitcoin be transacted for esentially free
        – ECash-Bitcoin can be transacted and validated almost instantly
        – Good macro properties
        – Low transaction cost
        – With some tricks, it ccould be much better used for offline payment
        – The blockchain acts as a clearinghouse
        – ECash-Bitcoin is untracable, just like banknotes (the IOU is for any bitcoin not a fixed bitcoin of course)
        – Banks and in competition have stack in the currency and income to improve overall system (simular to the idea of Distributed Autonomous Company)
        – Easy to backup, copy, encrypt (just like any file)
        – Easy to make very thin client
        – Could be printed on paper (or small RFID chips) and be used that way

        – Banks need to be trusted, maybe they even know your identity (or at least bitcoin address), simular to many exchanges today.
        – Hard to desgin a system, that is simular to a emergent system such as free banking
        – To make this works the Banks need some way to invest to make the service worth it (this is a real problem many of these outbalancing systems will have) Im not sure how to solve this
        – Its based on the idea of Free Banking, and many people don't like that in general
        – Bank liquidation can not be done automatically, if a bank is insolvent it has to be resolved from external source (like MtGox). Thinking about a way to do this, maybe if you reserve currency is etherium one could build a solvency manager into the system somehow.

        Im very open to ideas or problems. I am currently not very hopeful that this will emerge, specially because of the investment problem. Maybe something like the Bitshares BitAsset system could be used, but thats not more then a vague idea.

        There is a open source version of ecash called lucre. Sadly ecash has still some patants on it (I think).

        • Kevin Dowd

          Thanks Nick!

  • TheLight

    The idea of a peg is a bad one and defeats the purpose of going to a cryptocurrency in the first place. The whole point of a cryptocurrency is to allow the market to determine the value, not the economic policies of any government. That the price of a Bitcoin can fluctuate wildly at times is just proof that the idea of letting the market determine the value is actually working.

    • Most people regard a wildly fluctuating price level as undesirable because it makes it much more difficult to conduct business. How often do I need to give my workers raises? Should I pay you 10 bitcoins per hour today, and 3 bitcoins per hour tomorrow? It's awfully convenient to negotiate long-term contracts fixed in nominal terms, but if the value of the currency swings all over the map, things get a lot harder for those of us who are more interested in being practical than maximizing "liberty".

  • Mike sproul

    the shares confuse me. You auction new coins and destroy the shares received. And then you create new shares to buy back refluxing coins. What are these shares? they are apparently not like the bonds the fed uses in open market operations, since those bonds are not created and destroyed by the fed at will.

    • Kevin Dowd

      The shares confuse me too, Mike. The problem seems to arise because they share – pardon the pun – a dual function: they serve as backing, but also they reflect future seigniorage revenues and I would argue that those functions conflict. I would then suggest that we need some way of 'backing' the Coins that is (a) robust and (b) unconflicted. I am working on this.

      • Mike sproul

        When I work on it, I come up with a system where the issuing bank backs its money with gold, bonds, etc, just like every modern bank does.

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  • blogospheroid

    The main concern of the decentralizing crowd is that the variable "Price" is dependent on an input from outside the blockchain aka an oracle. Centralization leads to central vulnerability : capturing the oracle would lead to an effective capture of the monetary policy of the coin.

    I think that for a purely decentralized proof of work currencies, there is really no alternative to minting a coin for a fixed number of hashes or a slow monotonously increasing number of hashes . There will be an initial volatility when the currency moves from mining on CPUs to GPUs to ASICs, after that, it will be a pure commodity market. Whenever it is easier to obtain the currency from trade, it will be obtained from trade and when it is too difficult to obtain by trade, it will be mined.

  • JP Koning


    Have you heard of Nubits? It's been running along these principles for eight or nine months. My understanding is that it has so far managed to maintain a peg to the US dollar.

    • Kevin Dowd

      Thanks JP: I hadn't come across NuBits. Having now checked it out, it does aim to peg to the USD but there is in fact some fluctuation against the dollar (see https://www.coingecko.com/en/price_charts/nubits/usd/90_days).

      Be that as it may, it broadly succeeds and would appear to demonstrate that a stable-price cryptocurrency is possible – and, moreover, that there is a demand for it too (apparently, mainly for international payments, which makes sense). This is definitely one to watch.

      • MasterOfDisaster

        NuBits indeed is an implementation that is matching the descripton of Seigniorage Shares.

        The Nu network has NuBits (NBT), the currency units pegged to USD and the shares (NuShares; NSR) that represent the corporation issuing the NuBits.

        Both tokens (NBT, NSR) can be created and destroyed by protocol.
        (Temporary) revenue from selling NBT gets invested in NSR buybacks.
        If NBT need to be removed from market, NSR can be created and sold for NBT.

        When looking at the NBT price take into regard that NBT/BTC is the major trading pair. BTC fluctuation sometimes makes it hard to determine an exact price.
        The NBT/USD on the exchange CCEDK is perfectly stable.

  • MichaelM

    I'm sorry for asking here, but I can't find any other place on this site to ask. I just replied to a comment below. I had been a participant in FreeBanking.org and had a user name there, MichaelM, the one I just used here. But in FreeBanking.org, I just logged in each time I visited and my user name would appear if I wrote a comment. Here, I was directed to Disqus, and was asked to sign up for ease in future logging in. I used my email address and password from FreeBanking.org, and that made progress to the next screen, but then It asked for my user name, and I entered MichaelM, and it said that is taken. It seems that Disqus is broader than just this site, and that someone else has that user name, or am I wrong? I then entered my whole name, with a space between, and it said it was not valid, without saying why not (though I see many here use names and have a space between the names). I removed the space, and it said that is taken. I don't want to create a new user name unnecessarily, but is that what I need to do to post here? Thanks, and sorry again.

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  • Justin Merrill


    I should alert you to my paper on a proposed elastic digital (but not crypto) currency that pays interest and maintains monetary equilibrium without pegging it to an outside money or commodity. It functions like an ETF that targets the NAV of the fund to adjust its supply and and interest rate parity will stabilize its value against other currencies.

    I might follow up with a way to have similar mechanics with a crypto-currency that would use futures markets and covered interest parity to adjust its supply through unit destruction and share dividends.


    • Kevin Dowd

      Thanks Justin! I have only had a quick glance at your WP but this is the kind of innovative thinking that we need and I shall read it with interest.

  • Aajaxx

    In more or less pegging to the dollar, can I assume that this means some constant dollar and not current dollars? And if so, how is the deflator to be determined?

    • Kevin Dowd

      Nice question Aajaxx! The short answer is no and yes.

      No in the first place: I used the $1 USD peg merely as an example to illustrate the mechanics of pegging. However, I am not advocating such a system.

      In later blogs, I DO intend to discuss constant dollar pegs (or more precisely, pegs involving price-indices) and can then address your (very difficult!) question of the deflator.

  • Any "price-pegging target" flies directly in the face of free banking and free market monetary principles. I'm afraid that Kevin Dowd is a faux "private money" advocate.

    • Justin Merrill

      Kevin said in the post that the pegging to the dollar was just an example and that other indices such as NGDP could be used.

      He also said here in the comments:
      "As Ken points out, the P(t)=$1 peg was just an example to illustrate the mechanics of the system, and I am not advocating such a peg myself.

      The next step of the analysis is then to replace the $1 peg with some index
      (in terms of USD prices) and then finally (hopefully!) move on to an
      index specified in terms of Coin prices not USD prices."

      His body of work proves that he is indeed a private money advocate, and has been long before crypto-currencies were around.

    • Kevin Dowd

      May I suggest that you read my work before condemning it, Jon.

      The main theme of my book "Competition and Finance"is to set out how a free banking system might operate based on a commodity-basket-based monetary standard that can be regarded as involving a price-index peg. The free banking system and the price-index are not mutually
      contradictory as you claim.

      Of course, one can also imagine free banking systems based on other ‘standards’, including a gold standard, a frozen monetary base etc. George and Larry especially have written extensively on these.

      • Eric Voskuil

        Defining a peg and enforcing a peg are two entirely different problems. The article doesn't account for the fact that for coins to have "price" a person needs to provide it this information. That makes the coin's inflation subject to arbitrary intervention. As such this differs little, if at all, from any government or other fiat currency scheme.

  • Experience w Bitcoin thus far pretty much explodes Milton Friedman's concept of a fixed increase 2 – 5% in money supply annually. No gold mine operator, or oil producer for that matter, would continue to pump out a certain percentage of production no matter what, and no issuer of currency should do so either. Assuming any digital currency is on the up and up, it appears to me a profit motive remains key.

  • martinbrock

    I haven't read Sams' proposal for Seigniorage Shares, but destroying shares after the creation of new coins seems incorrect. Destroying coins, when delta Q is negative and new shares are sold for coins, makes sense, but destroying shares when delta Q is positive is unnecessary and seems undesirable.

    With each new transaction block, the winner of the hash race, instead of creating a fixed quantity of new coins, creates delta Q coins. If delta Q is negative, the winner creates new shares, exchanges them for coins in an auction and destroys the coins. If delta Q is positive, the winner creates new coins, exchanges them for shares but doesn't destroy the shares. Presumably, the winning miner owns these shares as it owns newly created coins in existing schemes.

    If the winner destroys the shares, miners have no incentive to mine other than transaction fees. Maybe Sams' scheme finances mining only through transaction fees, but rewarding the hash race winner with the shares collected by decreasing the coin supply is more like existing schemes and poses no problem. If shares can only be exchanged for coins in these auctions, an increasing supply of shares is not a problem.