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Bitcoin and Blockchain Technology: Hayek Money

Bitcoin and Blockchain Technology: Hayek Money

Sixth lesson for the Bitcoin and Blockchain Technology course of Milano Bicocca University (2017)

Video (in Italian) available at https://goo.gl/g65Nzp

Ferdinando M. Ametrano

June 12, 2017
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  1. Bitcoin and Blockchain Technology
    The Cryptocurrency Frontier in Commodity Monetary Standard
    [email protected]
    https://github.com/fametrano
    https://twitter.com/Ferdinando1970
    https://speakerdeck.com/nando1970
    https://www.reddit.com/user/Nando1970/
    https://www.slideshare.net/Ferdinando1970
    https://it.linkedin.com/in/ferdinandoametrano
    https://www.youtube.com/c/FerdinandoMAmetrano

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  2. Table of Contents
    1. Bitcoin, Money, and Gold
    2. Hayek Money
    3. Dual Asset Ledger & Reserve Asset Bank
    Ferdinando Ametrano 2017 2/55

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  3. Understanding Lags Well Behind the Hype
    Understanding of the technology however lags well
    behind the hype, amongst practitioners, policy makers
    and industry commentators alike. ‘Blockchain’
    technology seems to promise major change for capital
    markets and other financial services – some say it may
    ultimately prove to be as important an innovation as the
    internet itself – but few can say exactly how or why.
    Michael Mainelli, Alistair Milne (2016)
    The Impact and Potential of Blockchain on the Securities Transaction Lifecycle
    http://ssrn.com/abstract=2777404
    Ferdinando Ametrano 2017 3/55

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  4. Why Bitcoin Is Hard to Understand
    At the crossroads of:
    1. Cryptography
    2. Distributed systems (networking and data transmission)
    3. Game theory
    4. Economic and monetary theory
    Mainly not a technology,
    a cultural paradigm shift instead
    Ferdinando Ametrano 2017 4/55

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  5. • Decentralized digital currency
    • Not backed by any government or organization
    • Instantaneous peer-to-peer transactions
    • No need for trusted third party
    • Cryptographic security
    • Synergic economic incentives
    • Efficient low-cost banking for everybody everywhere
    https://bitcoin.org/en/faq
    http://www.coindesk.com/information/
    Ferdinando Ametrano 2017 5/55

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  6. The Information Economy
    • Data is transferred with zero marginal cost
    • Why pay a fee to move bytes representing wealth?
    • Why only 9-5, Monday-Friday, two days settlement?
    • Who (and when) will gift humanity with a global
    instantaneous free p2p payment network?
    BANK
    Ferdinando Ametrano 2017 6/55

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  7. Bitcoin
    • Decentralized: no central authority, no intermediaries
    • Permissionless: no regulator
    • Censorship resistant: no frozen funds
    • Open-access: no discrimination, no amount limits, 24/7, 365 days
    • Free: negligible transaction costs
    • Borderless: no geographic limits
    • Transnational: no specific jurisdiction applies
    • Secure: non falsifiable, non repudiable transactions
    • Resilient: nothing has been able to stop it or break it
    Ferdinando Ametrano 2017 7/55

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  8. A Bitcoin Transaction
    https://blockchain.info/tx/8f1d3a8ef6b2d4a25d2f499279e01518b4770819ccbc39a765c4c326170c61b3
    About $83M transacted with $0.04 fee
    Ferdinando Ametrano 2017 8/55

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  9. BTC/USD Exchange Rate
    http://bitcoincharts.com/charts/bitstampUSD#tgWzm1g10zm2g25
    • BTC Market Cap: about $50B (USD M0 1959-2017 average has been $680B)
    Ferdinando Ametrano 2017 9/55

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  10. Double Spending Problem
    • To securely transfer value using digital means has
    been possible for decades
    • In digital cash schemes, a single digital token,
    being just a file that can be duplicated, can be
    spent twice
    • A centralized trusted party has always been
    required to prevent double spending
    Ferdinando Ametrano 2017 10/55

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  11. Mining
    • All bitcoin network nodes validate and propagate transactions
    • Transactions are cleared in blocks, thus a blockchain: the nodes
    providing computational power for clearing are called miners
    • Miners compete to validate a new block of transactions: the winner
    providing proof-of-work is rewarded with the issue of new bitcoins in
    a special coinbase transaction included in the block
    • Miners solve the double spending problem:
    – conflicting transactions spending the same coins would invalidate the block
    – an invalid block would be rejected from the network
    – the bitcoin reward would be removed from transaction history
    – miner would have wasted his work
    Ferdinando Ametrano 2017 11/55

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  12. Distributed Consensus
    • How do miners reach consensus on the
    transaction history?
    • Consensus in an asynchronous network with faulty
    (or malicious) nodes is proved to be impossible
    • A problem known as Byzantine General Problem
    Ferdinando Ametrano 2017 12/55

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  13. Nakamoto Consensus
    • Nakamoto achieves Practical Byzantine Fault Tolerant consensus
    using (game theory) economic incentive for the mining nodes to be
    honest. Bitcoin
    – solves double spending without a central trusted party
    – can resist attacks of malicious agents, as long as they do not control
    network majority
    • Miners are compensated for their proof-of-work using seigniorage
    revenues, i.e. with issuance of new bitcoins
    • Seigniorage revenues subsidize the network, making transaction
    almost free
    Ferdinando Ametrano 2017 13/55

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  14. Network Costs Covered By Seigniorage Revenues
    • 144 blocks per day, 365 days per year
    • 12.5 BTC per block, $6,000 per BTC
    Currently about $4 billions per year (as of November 2017)
    Ferdinando Ametrano 2017 14/55

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  15. Virtuous Cycle
    Hashing
    Power
    Bitcoin
    Security
    Bitcoin
    Price
    Mining
    Reward
    Ferdinando Ametrano 2017 15/55

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  16. Validation Process: Block Generation
    The proof-of-work difficulty is adapted to the overall available computing
    power to ensure an average of one block every ten minutes
    Ferdinando Ametrano 2017 16/55

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  17. Bitcoin Monetary Rule
    • 2009: 50BTC per block, every 10 minutes
    –halving every 4Y
    • This is the only way new bitcoins are released
    • It is called mining because of its similarity with the
    progressive scarcity of gold extraction
    • Supply free of discretionary intervention
    Ferdinando Ametrano 2017 17/55

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  18. Bitcoin Inelastic Supply:
    Deterministic Decreasing Rate
    chart
    2029: 96.88% of
    all BTC issued
    2141: last satoshi
    (0.00000001 BTC)
    will be issued
    Ferdinando Ametrano 2017 18/55

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  19. What after 2141?
    • We are all dead ;-)
    • Gradually switch over to a fee-based system: as block space is
    limited, market is already requiring a growing satoshi/byte fee
    to be included into a block
    • Switch to a different paradigm? We have about 120 years to
    come up with a solution
    Ferdinando Ametrano 2017 19/55

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  20. What Makes Bitcoin Special?
    • Digital and scriptural: it only exists as validated transaction
    • Asset, not liability
    • Bearer instrument
    • It can be transferred but not duplicated
    (i.e. it can be spent, but not double-spent)
    • Scarce in digital realm, as nothing else before
    • Mimicking gold monetary policy
    • More a crypto-commodity then a cryptocurrency
    Bitcoin is digital gold
    this is the brilliant groundbreaking achievement by Satoshi Nakamoto
    Ferdinando Ametrano 2017 20/55

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  21. Trade Economy
    From Gold Standard to Fiat Money
    • Gold: the commodity money standard
    – scarce
    – pleasant color, i.e. resistant to corrosion and oxidation
    – high malleability
    – relative easiness of its purity assessment
    • Gold purity certification
    • Representative money
    • Fractional receipt money
    • Fiat money and legal tender
    Ferdinando Ametrano 2017 21/55

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  22. Money As A Social Relation Instrument
    1. Human beings are born into a gift economy
    2. Enlarged relationship circle requires exchange
    economy
    3. Barter economy: coincidence of wants
    4. Trade economy: money as medium of exchange
    5. Global information economy: supranational digital
    money
    Ferdinando Ametrano 2017 22/55

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  23. Friedrich August von Hayek
    Denationalisation of Money
    • history of coinage is an almost uninterrupted story of debasements;
    history is largely a history of inflation engineered by governments for
    their gain
    • why government monopoly of the provision of money is regarded as
    indispensable? It deprived public of the opportunity to discover and use
    a better reliable money
    Blessed will be the day when it will no longer be from the benevolence of
    the government that we expect good money but from the regard of the
    banks for their own interest
    A Free-Market Monetary System, Gold and Monetary Conference, New Orleans, Nov. 1977, https://mises.org/daily/3204
    Hayek, F. A., Denationalisation of Money, The Institute of Economic Affairs, http://www.mises.org/books/denationalisation.pdf
    Ferdinando Ametrano 2017 23/55

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  24. Permissionless Innovation
    Fast and Effective
    • No centralized security mechanism, no barrier to
    enter, no editorial control
    –Email has not been designed by a consortium of postal
    agencies
    –Internet has not been developed by a consortium of telcos
    • Will a decentralized transactional economy be shaped
    by a consortium of banks?
    Ferdinando Ametrano 2017 24/55

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  25. Explain Money to an Alien
    fiat money
    • No intrinsic value (legal
    tender, social contract)
    • Currency based on paper/ink
    security
    • Discretionary governance
    • Wicksellian interest-rate
    approach
    bitcoin
    • No intrinsic value (digital
    gold)
    • Currency based on
    math/cryptographic security
    • Algorithmic governance
    • Deterministic supply
    Ferdinando Ametrano 2017 25/55

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  26. Bitcoin as (Digital) Gold
    in the History of (Crypto)Money
    gold
    • Its adoption was not centrally
    planned
    • For centuries it has been the most
    successful form of money
    • It has bootstrapped all monetary
    systems we know of
    • It has been surpassed by other kind
    of money without becoming
    obsolete
    bitcoin
    • Its adoption has not been centrally
    planned
    • It is the most successful form of
    cryptocurrency
    • It will bootstrap new monetary
    systems
    • It might be surpassed by more
    advanced type of cryptocurrencies
    without becoming obsolete
    Ferdinando Ametrano 2017 26/55

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  27. Table of Contents
    1. Bitcoin, Money, and Gold
    2. Hayek Money
    3. Dual Asset Ledger & Reserve Asset Bank
    Ferdinando Ametrano 2017 27/55

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  28. Unit of Account: Money as Numeraire
    • Money is the unit of account against which the value of
    every other good is measured
    • The price system measures the value of goods relative
    to the value of money
    Good money should provide stable prices to best perform
    its role as unit of account
    Ferdinando Ametrano 2017 28/55

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  29. Money Comparison
    Medium of Exchange Store of Constant Value Unit of Account
    Live cattle
    Diamonds
    Gold
    Fiat coins and notes
    Bitcoin
    • swappable
    • fungible
    • portable
    • divisible
    • recognizable
    • resistant to
    counterfeiting
    • reliably saved, stored,
    and retrieved
    • retain usefulness over
    time
    • Maintain its storage
    properties
    • non-perishable or with
    low preservation cost
    • relative worth unit of
    measure
    • stable value for stable
    price comparison
    • supply must be
    controlled in some
    way
    Ferdinando Ametrano 2017 29/55

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  30. The Holy Grail of Stable Prices
    • Gold standard, bimetallism, symmetallism
    • Fixed value of bullion (Aneurin Williams 1892)
    • Compensated dollar (1911-20 Irving Fisher)
    • Commodity Reserve Currency (1932 J. Goudriaan, 1937-44 B.
    Graham, 1942 F. Graham, 1951 M. Friedman)
    • ANCAP basket (1982 Robert Hall)
    • Futures contracts (1984 Miles, 1989-95 Sumner)
    • Quasi-futures contract (1994 Kevin Dowd)
    • Price index option (2000 Kevin Dowd)
    Ferdinando Ametrano 2017 30/55

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  31. Bitcoin is Digital Gold
    Not a Good Unit of Account
    • no salaries, no
    mortgages, no stable
    purchasing power
    • successful at getting rid
    of a centralized
    monetary authority, it
    has given up the
    flexibility of an elastic
    supply of money
    Ferdinando Ametrano 2017 31/55

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  32. Hayek Money
    • The cryptocurrency monetary standard of elastic
    non-discretionary supply
    • Price stability paradigm with respect to a given
    reference basket
    • Concurrent cryptocurrencies will compete in
    monetary policy definition and reference basket
    choices
    Ferdinando Ametrano 2017 32/55

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  33. Fixed USD Exchange Rate
    • USD/BTC: 15-Apr-11 1.0, 29-Mar-14 500.0
    • x500 increase for BTC demand relative to USD
    • 29-March-14: 12.5M bitcoins in circulation
    • Inflate their number 500 times to 6250M
    • On 29-Mar-14 it would have been equivalent
    –to own BTC1 worth $500
    –or (rebased) RBTC500 each worth $1
    Ferdinando Ametrano 2017 33/55

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  34. USD-Parity (Daily) Rebased Bitcoin
    • Adopting the USD Consumer Price Index
    • 6% inflation in the period March 2011-2014
    Ferdinando Ametrano 2017 34/55
    1.06

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  35. Avoid USD Monetary Policy:
    Brent-Wheat Commodity Price Index
    Ferdinando Ametrano 2017 35/55

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  36. Brent-Wheat Commodity Price Index
    Rebased Bitcoin
    Ferdinando Ametrano 2017 36/55

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  37. Brent-Wheat Commodity Price Index
    Ferdinando Ametrano 2017 37/55

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  38. Rebasing Bitcoin?
    No, not really!
    • Bitcoin has been used for the sake of discussion,
    basically to leverage its historic price time series
    • Bitcoin is good as it is: more of a cryptocommodity
    than a cryptocurrency, bitcoin is digital gold
    Ferdinando Ametrano 2017 38/55

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  39. Hayek Money
    This First Simplistic Implementation
    • Results:
    – Price stability
    – Salaries, mortgages, forward payments are now possible
    • Problems:
    – Number of coins in a wallet changes without direct in/out flows
    – Purchasing power of a given wallet is not stable
    – Coins still have speculative investment appeal and so enjoy limited
    transaction usage
    Ferdinando Ametrano 2017 39/55

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  40. Table of Contents
    1. Bitcoin, Money, and Gold
    2. Hayek Money
    3. Dual Asset Ledger & Reserve Asset Bank
    Ferdinando Ametrano 2017 40/55

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  41. Hayek Money Implemented as
    Dual Asset Ledger
    Split transactional and speculative money demand with
    two non-fungible assets:
    • (stable) transactional coins
    • (unstable) speculative shares
    Blockchain technology tracks ownership and transactions
    for both: dual asset ledger
    Ferdinando Ametrano 2017 41/55

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  42. Reserve Asset Bank IPO
    • Raise bitcoins as reserve asset in quantity
    Better to avoid non-crypto reserve assets: a custodian legal entity would
    be required, re-introducing centralization
    • Issue coins and shares
    Monetary base is backed by :

    + ∙
    =
    Ferdinando Ametrano 2017 42/55

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  43. Monetary Policy Target
    Coin is pegged to a given reference basket for price parity:

    ≅ 1, allowing for a corridor, e.g. 0.95 <
    < 1.05
    • Must be ≪ at IPO
    • Hopefully < any time later on
    The Reserve Asset Bank (even as Decentralized Autonomous
    Organization) enforces price boundaries by market operations using
    reserve assets
    Ferdinando Ametrano 2017 43/55

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  44. Monetary Phases
    Expansionary monetary phases (when
    ↑ 1.05):
    • new coins are minted by the Reserve Asset Bank and sold for
    1.05 in exchange for bitcoin (increasing reserves)
    Contractionary monetary phases (when
    ↓ 0.95):
    • existing coins are bought at 0.95 (and destroyed) by the
    Reserve Asset Bank using bitcoin (until reserves are depleted)
    Ferdinando Ametrano 2017 44/55

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  45. Reserve Asset Bank: Stable Coins
    • When
    ≅ 1, coins give up any speculative value
    • Money velocity and transaction volume increase
    =
    M is the money supply (total amount of money in circulation;
    V is the velocity of money for all transactions in a given time frame;
    P is the price level;
    T is the aggregate real value of transactions in a given time frame.
    • Coins should not be inflated/deflated arbitrarily
    • Transaction validation must be rewarded with the
    issuance of new shares, not coins
    Ferdinando Ametrano 2017 45/55

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  46. Reserve Asset Bank: Seigniorage Shares
    Seigniorage: profit made by a currency issuer, especially the difference between the face value of coins
    and notes and their production costs
    • Shares are never burned/destroyed
    • Shareholders are in charge of reference basket maintenance
    • The share price is free to float: shareholders absorb all monetary
    policy’s costs and benefits, shielding coin holders from volatility
    • Share value = assets - liabilities

    = − ∙ 0.95
    Ferdinando Ametrano 2017 46/55

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  47. ↓ 0.95: Losses for Shareholders

    = − ∙ 0.95
    • If
    ↓ 0.95 and < ∙ 0.95:
    coin is dead, Reserve Bank defaulted,
    = 0
    • If
    ↓ 0.95 and > ∙ 0.95:
    coin is dead, Reserve Bank has not defaulted,
    > 0
    (no interest for stable coins, shares are the equivalent
    of bitcoins)
    Ferdinando Ametrano 2017 47/55

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  48. ↑ 1.05: Profits for Shareholders
    • fresh new coins are minted and sold in exchange for
    reserve assets pushing
    down to parity
    • Reserve assets increase by 1.05
    • Coin liabilities increase by 0.95
    • Net effect:

    Ferdinando Ametrano 2017 48/55

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  49. Leverage Bitcoin As Reserve Asset
    • Bitcoin is the first and most successful instance of an intrinsically
    scarce digital asset: it’s digital gold
    • When used as reserve asset, its qualities are magnified!
    • Its limits are lessened. No more need to:
    – scale to huge (cash + bank accounts + credit cards) number of transactions
    – support economically inefficient micropayments
    – lower confirmation time
    • The Reserve Bank IPO raises bitcoins, issues seigniorage shares and
    stable coins
    Ferdinando Ametrano 2017 49/55

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  50. The Ultimate Fate of Bitcoin:
    To Serve as a Reserve Currency
    https://bitcointalk.org/index.php?topic=2500.msg34211#msg34211
    Hal Finney (1956–2014) was a noted cryptographic activist. He was the second PGP Corporation developer hired after Phil
    Zimmermann. He created the first reusable proof-of-work. He was an early bitcoin user and received the first bitcoin
    transaction from bitcoin's creator Satoshi Nakamoto.
    Ferdinando Ametrano 2017 50/55

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  51. Transaction Validation
    Proof-of-Payment
    • Instead of the hardware and electric power expenses of proof-of-
    work, bitcoins are irrevocably paid to the Reserve Asset Bank by
    validating nodes (proof-of-payment)
    • Chances of being appointed for the next block generation are
    proportional to the overall submitted payments, i.e. to the
    accumulated proof-of-payment
    • When a node is picked up for block generation its proof-of-
    payment resets to zero
    • Even if a node is not picked up, its payments are never reimbursed
    Ferdinando Ametrano 2017 51/55

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  52. Transaction Validation
    Proof-of-Payment
    • Block generation is rewarded with the issuance of a new
    share
    • Since
    = − ∙ 0.95 , that should be the
    price a rational agent is willing to commit as payment
    • Share price estimation in bitcoin is obtained as by-product
    • Existing shareholders are not really diluted: for the issuance
    of each new share, increases accordingly
    Ferdinando Ametrano 2017 52/55

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  53. Bibliography
    • Ametrano F., Hayek Money: the Cryptocurrency Price Stability Solution,
    http://ssrn.com/abstract=2425270
    • Morini M., Inv/Sav Wallets and the Role of Financial Intermediaries in a
    Digital Currency, http://ssrn.com/abstract=2458890
    • Sams R., A Note on Cryptocurrency Stabilisation: Seigniorage Shares,
    https://github.com/rmsams/stablecoins/blob/master/00-main.pdf
    • Buterin V., The Search for a Stable Cryptocurrency,
    https://blog.ethereum.org/2014/11/11/search-stable-cryptocurrency/
    • Ametrano F., Cryptocurrency Price Stability With Seigniorage Shares And
    Reserve Bank, http://ssrn.com/abstract=2508296
    Ferdinando Ametrano 2017 53/55

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  54. Bibliography
    F. Ametrano, Bitcoin, Blockchain and Distributed Ledger
    Technology: Hype or Reality? (2017)
    https://goo.gl/Z9OeHt
    Bitcoin and Blockchain Technology videos (ITA):
    • Introduzione
    https://www.youtube.com/watch?v=Ef3d1N4Ogxw&list=PLrVvuryXHYTdzvtpzrj4wvYEhCwF6G82b&index=1
    • Hayek Money
    https://www.youtube.com/watch?v=Wu_7RVwoV84&list=PLrVvuryXHYTdzvtpzrj4wvYEhCwF6G82b&index=2
    • Distributed Ledger Technology
    https://www.youtube.com/watch?v=ByzoYHx7eTc&list=PLrVvuryXHYTdzvtpzrj4wvYEhCwF6G82b&index=3
    Ferdinando Ametrano 2017 54/55

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  55. Conclusions
    1. Bitcoin solves the double spending problem relying on seigniorage
    revenues
    2. Bitcoin is a scarce digital asset, i.e. the digital equivalent of gold
    3. Hayek Money is the price stability paradigm of elastic non-
    discretionary money supply
    4. Coin/share dual asset ledger can decouple transactional and
    speculative money demand
    5. Bitcoin can be used as reserve asset by a decentralized Reserve
    Asset Bank (DAO) to stabilize the coin
    6. Proof-of-Payment leverages bitcoin as off-chain resource to be
    consumed in order to receive seigniorage revenues
    Ferdinando Ametrano 2017 55/55

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