Hi!
Below is a personnal idea i had about creating a currency that could drastically reduce the problem of volatility and price manipulation, which i personally believe to be the main issue preventing crypto adoption as a currency instead of a vehicle for speculators.
Having no technical knowledge myself about cryptography, i decided to post this concept in the unlikely case that more technically inclined people would find this idea worth experimenting with, and posting it here on this forum seemed to be appropriate.
If some people do find this interesting, please do not hesitate to contact me in PM, i would be really interested to make it an experimental prototype of it.
All discussion about this concept is also welcome of course.
This is just a draft idea and in no way pretends to be a full working solution.
Also, english is not my native language, so apologies for mistakes.A prosposal for a volatility-resistant cryptocurrency
or
How to improve price discovery by having the total supply back the currency's valuation at all times
The paper below describes an idea. It is not the purpose of this paper to argue about the technical feasability of this idea.
Currently, I beleive the biggest issue preventing adoption of Cryptocurrencies is volatility.
It undermines the credibility of all cryptos as a currency, and makes them labbeled as "backed by nothing but speculation".
Noone is willing to use Bitcoin -or any other crypto- as a currency when it can lose or gain 90% of its value in a few months, appart from idealists, speculators, and traders.
That is still a lot of people worldwide, but adoption as a currency remains nearly inexistant because people willing to use it as an actual currency have little to no interest in it.
The common counter argument to this issue is to say that volatility is temporary and that it would decrease with adoption, as liquidity would improve as well.
Not only is there no sign of this so far, with volatility being overall the same today as it was 10 years ago despite more adoption, but most of all it creates a chicken & egg problem as adoption will not happen in the first place because of high volatility.
Additionnally, one could argue that for every new mediatized crash or bull run, the idea of it being only good for gambling and speculation spreads more into the public, undermining its credibility as a new potential currency.The radicalism of BitcoinWe all know that bitcoin was born in reaction to the last economic crisis of 2008, to take a stand against the corruption of the current banking system.
As the inflation process and central banks couldn't be trusted to act in the best interest of people, it offered a radical solution: creating a deflationnary currency of limited supply (with a built-in non-adjustable mechanism of inflation).
However, for reasons i will not dwell on here, it is an opinion shared by many economists that a deflationnary currency is equally as bad for the economy, and leads to more instability and more volatility.
It is of no suprise that in the crypto community deflation is seen as a good thing in majority, as it is sadly mostly composed of speculators looking for "get rich quick" schemes instead of people interested in it as an actual currency.
So on one hand we have traditionnal currencies with non-trustless central banks, and on the other we have cryptocurrencies with no central banks at all, most of them deflationnary for the interests of speculators, and each one with its own baked monetary policy unable to adapt to the present circumstances to provide stability.
Therefore what i propose is to find a middle ground between these 2 models: creating a crypto currency working in pair with trustless 'central bank', which could be much more resistant to volatility than the currently existing cryptos.
Vulnerability to low volumeOne agraving factor for price volatility is the dependency to volume: the lower it gets, the more volatility and the less trust there is in the resulting price, leading to more instability and creating a viscious circle that can take a very long time to settle down.
Lets say that at a given point, we have the situation of a coin that has 1% of its supply active on exchanges (to trade vs USD or other currencies) with a very low volume, while the 99% of the rest is circulating between users or simply held into various accounts.
At this given time, the price discovery is therefore backed only by 1% of the supply and their holders, and it can easily be dropped by any massive sell order from a 'whale'.
Surely, it can be argued that the other 99% still counts in the price discovery process, as their holders would in turn react to the initial price change event and make a decision to buy more or sell more in consequence.
But there is one big issue with this: by definition the reaction of the 99% has to happen after the initial price changing event.
Sadly, instead of dampening the price change 'decided' by the 1%, it usually tends to do the opposite and to amplify it, increasing volatility further more. My theory is that this is caused by 2 factors:
- First there is inertia. It takes time for an event to spread and for people to react to it. An insignificant trigger-event can create a wave that will spread and amplify, increasing volatility, in the same way that "traffic waves" can create huge traffic jams and speed irregularities on a road with alternating segments of stopped and moving cars (see
http://trafficwaves.org for example).
- Then we have to consider the nature of human psychology: the simple fact that this reaction will happen AFTER means it will be influenced by it and people will tend to follow it -by fear or by greed- wich will contribute into amplifying the price movement further more instead of dampening it.
A proposed compromiseTaking inspiration from the mechanisms used by stable coins, i propose to create a non-stable coin resistant to volatility.
One one side we have non-stable coins plagued with too much volatility and too much greed, decredibilising them as a currency and thus preventing their adoption.
On the other we have stable coins used only as a tool for trading, which wont be adopted either for anything else as their 1:1 pegging to FIAT make them useless as a new currency, but also voids the driving force of adoption that is human greed.
There are multiple projects of stable coins relying on smart contracts and game theory to achieve automatic price stability, using a system of collaterals.
Inspired by these systems, i propose to create a coin linked to a smart contract that i will here call the Smart Reserve (SR).
The SR's main role would be to act as a trustless source of price discovery, stabilizing the currency from day 1 against volality and price swings.
The SR would be able to control the emission and destruction of coins while keeping FIAT currencies as collateral (through stable coins?).
The objective of the SR is not to create a stable coin pegged to a specific currency, nor a coin that would make the impossible promise of only apreciating in value, but rather to create a coin ensuring a more rational pricing by limiting its vulnerablity to price manipulation, panicks, and greed.
Basically, the idea is that what plagues cryto is the process of price discovery and that the SR will improve that by helping the price discovery instead of leaving it to entirely to the free market.
The SR principle solves the issues of volatility by cancelling their root cause: because there is no longer causality between a trigger-event and a reaction to it.
- Inertia is cancelled because the SR can compensate in realtime preventing the price change to become effective in the first place by using its full reserve to buy or sell coins. Thus providing maximal liquidity.
- Human exuberance is cancelled out by the knowledge of an official public price backed by the SR, increasing trust in the current price to be reliable and pertinent.
Reference Unit of ValuationUsed for its other calculations, the Smart Reserve would rely on the calculation of a reference unit of valuation (RUV). This unit role would be to measure value in better way than simply using a single existing FIAT unit (such as USD) as a reference, as it could be prone to fluctuations, inflation, and volatility of its own.
The RUV unit could be based on an average based on the valuations of the all the main world currencies (USD, EUR, YEN... ) , the price of gold, and other units measuring the real purchasing power of these currencies.
The reserveThe SR would keep assets in a main reserve, as collaterals backing up the value of the coins and used to purchase them back when needed.
In the best case scenario it would be actual FIAT, but as this would be technically hard or impossible, in a more reastic way it could hold one or more stable coins to begin with.
Each sold coin by the SR would add to this reserve, and each purchase would destroy the coin and use that reserve to buy it back.
Whenever funds are added or removed from it, the SR would also update a different variable: the target RUV reserve, adding/substracting the RUV value of the funds at the time that they were added/removed. This would give us the amount of actual wealth that should be in the reserve, in RUV, at any given time.
If the assets actually in the reserve remain stable, their RUV value should remain mostly the same as the calculated RUV target.
The SR would also have a seconday reserve, the "failsafe reserve", required to face extraordinary situations explained later on.
Reference priceThe reference price is calculated from the RUV unit.
It is the result of a sigma sum of 1/(n+1), with n going from 0 to the total existing supply of coins. This means that for every new coin sold by the SR, reference price in RUV increases by 1/(nb of existing coins+1), and for every coin bought it is reduced by the same amount.
Selling priceThe effective buying and selling prices of the SR in FIAT units (ex USD) are then calculated based on the reference price.
The selling price is based on the RUV reference price simply converted into USD at its current RUV to USD exchange rate.
Example: if 1RUV = 1.2USD, then the selling price will be equal to: reference price *1.2 USD.
The SR would also add to this price an additionnal margin (of dynamic rate, for ex 1%). The funds earned from this additionnal margin wouldnt go into the main reserve of the SR, but in the secondary one.
Example: If 1 coin = 1 RUV, then final price = 1.2 + 0.012 = 1.212 USD for user, 1.2 going into the main reserve and 0.012 going into the failsafe reserve.
Buying priceThe buying price is calculated in a silghtly different way: the same reference price (without the margin) is then factored by the ratio of current RUV value of the reserve / target RUV value of the reserve, maxed at 1. What this means is that if the funds in the reserve have lost for example 40% of their value (in RUV), the reference price will be factored by 0.6 , decreasing the buying price proportionnally.
Then, in the same way as the buying price, that RUV price is converted into the actual desired FIAT unit (USD), at the current exchanged rate calculated by the SR.
In normal situations where the collaterals RUV value is stable, buying and selling prices are nearly identical as that ratio would remain equal to 1, but this mechanism is required to face extraordinary situations.
Extraordinary situation: the RUV value of the reserve decreasesThe stability of this currency could be threatened mostly by one scenario: a devaluation of the assets held in its reserve.To face this situation, 2 mechanisms exist.
The first mechanism uses the failsafe reserve to compensate for any loss of value from the main reserve, which would iron out every minor variations of it.
The margin rate of the SR selling price could then be dynamically increased of a few percents to replainish the failsafe reserve.
If a major devaluation happens that the failsafe reserve cannot compensate for, a second mechanism enters in play: buying and selling prices by the SR will start to differ proportionally.
In such situation a critical decision must be made: should the currency follow the devaluated asset (USD) as well, or should it retain its original value and therefore increase its USD price accordingly.
This decision cannot be made by the SR, and has to be decided by the market.
This opportunity is given as the prices will differ, each one representing one choice: selling price remains pegged to true value while buying price remains pegged to the devaluated asset's value.
As an example, let's assume here that the reserve is exclusively made of USD and that the USD (or USD stable coin) has devaluated by 40%.
- the buying price remains unchanged in RUV. However because of USD devaluation, USD buying price will increase accordingly.
- the buying price remains unchanged in USD: indeed, the reserve being composed mostly of USD, its total RUV value decreases by 40%, while the reserve's target RUV value remains unchanged. This will result in a RUV price factoring of 0.6, cancelling out the price increase from the RUV to USD exchange rate.
This means the market price will become free to vary between these 2, effectively leaving it to the free market to decide which way the price of the currency should go.
The free market decides to follow the devaluated asset
If the markets decide that the currency should devaluate as well, it means the SR will no longer sell any new coins as the market price will be below it. The SR will only be buying back coins.
This is not such a problematic situation as in this case, the chosen market price of the currency is still fully backed by the SR.
The circulating supply of the currency would not increase until organic price growth eventually reaches the selling price again.
The free market decides to follow the true value
If the market decides that the currency should retain its true value (RUV), then the buying price will be below market price and the SR will only be selling new coins.
This case is more problematic, as it means the reserve in the SR no longer backs the full market value of the currency.
In this case, the margin rate added to the selling price is increased to a maximum, so that any new coin sold will not only be backed at its new RUV value, but also to participate into replentishing the reserve so that it slowly grows back to match its target RUV value, reducing the price gap between buying and selling prices.
Extraordinary situation: the RUV value of the reserve increasesThis does not affect the currency nor the SR's behavior: the reserve's ratio of current RUV value to target RUV value being above 1 is ignored and remains maxxed at 1 for practical purposes.
In contrary it benefits it, adding an extra safeguard in case of future variations of the reserve's RUV value.
Volatility resistanceWhile bitcoin's price is only as strong as the current volume backing it, the price of an SR backed currency would be backed by the full circulating supply at ANY time.
This would make it immune to any manipulation attempts taking advantage of low volume oppotunities.
While with most cryptocurrencies a tiny fraction of the total supply can significantly crash or pump the prices by overloading the available liquidity, the SR backed currency would remain almost unaffected.
RUV price formula
A default formula for the RUV price could be:
Σ[n 0 to s] 1/(n+1), where s = total supply.
This would result in the following price evolution as circulating supply grows:
10 coins = 2.02 RUV
100 coins = 4.19 RUV
1000 coins = 6.48 RUV
10,000 coins = 8.78 RUV
100,000 coins = 11.09 RUV
1,000,000 coins = 13.39 RUV
10,000,000 coins = 15.69 RUV
At 10,000,000 circulating coins, selling 1,000,000 coins would drop the price from 15.69 to 15.59.
Selling instantly 10% of the supply would only drops the price of about 1%, when a traditionnal cryptocurrency such as bitcoin would see its price absolutely detroyed from such an event.
For perspecitve the Mt gox trustee sold about 24,000 bitcoins in multiple times during early 2018, which is around 0.15% of the bitcoin circulating supply.
This is so extreme that a more agressive formula could be worked on with a faster price growth, while retaining a very good resistance to volatility and price manipulation.
I beleive the solution lies in finding the right balance between volatility resistance and price growth, as speculators are still needed to motivate initial adoption and usage.
Working a formula where selling 1% of the circulating supply leads to no more than a 1% price drop would seem to better compromise.
Properties of the currency- high manipulation and volatility resistance: the whole circulating supply acts as liquidity through a "smart reserve", meaning that even massive selloffs overcoming the daily volume cannot affect the price in any major way.
- provides a better way to assess the value backing the currency than the traditionnally used "market cap", as the funds held by the smart reserve would show the exact amount invested.
- dynamic circulating supply, neither inflationary nor deflationary, avoiding the issues of both systems.
- later adopters cannot be held hostage by early adopters holding too much power over them.
- no mining
- no initial distribution process. noone can get coins for free or at discount prices.
Technical realizationI would intuitively imagine using the something like the NANO protocol for the currency itself, binded with a smart contract on ethereum for the reserve mechanisms.
