This was from a few months ago (28th of september 2015), when there was some sell pressure on Cryptsy.
Ok - my updater "unstuck" itself....here it is. My interpretation of the Cryptsy wall, why price didn't go up when masternode count did, a breakdown of how Dash's economic model behaves under adverse perturbations and some other stuff I discovered on the way
Supporting Trading Price vs Achieving Full Coin Deployment as a Monetary Objective
If you’re an investor in cryptocurrencies, it’s normal in this business to be checking “the price” umpteen times a day to see how your coin’s doing. But if your job is to build a new monetary medium (as in construct a house or a car), then maybe there are times when maximising the valuation isn’t the appropriate objective or when it conflicts with other, more immediate priorities.
If you put your architect’s hard hat on, and see this from the point of view of a construction project rather than an investment one, then what would the priority be ? Surely it would be to acheive FULL COIN DEPLOYMENT - i.e. the entire current coin supply deployed in a monetary role. As far as money goes, there are really only two roles available:
[1] - as a means of payment for goods or services
[2] - as a store of value (and if it’s a currency, that means earning interest to compensate for inflation)
That’s it !
TerminologyFor handiness, we can refer to these two monetary roles as the
reserve role and the
currency role respectively. Correspondingly, the market for interest bearing capital then becomes the
reserve market while the market which requires trading liquidity is the
currency market. Finally, those markets are addressed by their respective portions of the coin supply, i.e. the
reserve supply and the
currency supply.
Straight away we can see problems for a brand new monetary medium. In the case of [1] (the reserve ,market) there are no cryptocurrency banks yet, ergo no interest, ergo no store of value. In the case of [2] (the currency market) the demand for payment method liquidity is not anticipated till quite some time in the future. Right now the only significant source of currency demand comes from exchanges who’s function is to provide liquidity for speculative trading.
The result of this absence of “front loading” of monetary demand is that a standard valuation profile emerges whereby a currency reaches a high speculative peak, followed by a long slow drift down - sometimes all the way to zero.
What Dash has done to address the need to ‘front load’ the monentary demand curve is to create two markets instead of one and make them compliment each other so that the entire coin supply is deployed in both the fundamental monetary roles and therefore can address both currency and reserve markets right from the start.
Recent Market Activity and Masternode GrowthThis afternoon, I noticed a sudden growth of supply on exchanges (the “Cryptsy wall”). But on checking the masternode count, it was steady at around its high watermark of 3220 nodes. This is an immediate clue as to from which of Dash’s 2 monetary markets the new supply precipitated - in this case the currency market (see blue sector in the diagram below). It’s reasonable to conclude that over the last year, much of the coin supply going to masternode collateral has come from existing held funds redeployed (i.e. moving from the dark blue sector in the illustration below into the orange one without passing through markets). The growth in masternodes therefore hasn’t had much impact on price because an internal re-assignment of coin holdings has occurred initially to populate the network.
However, at some point this flow will stop. There will inevitably be some holders who have no intention of deploying masternodes for whatever reason - they want to keep their holdings available for trading, they want to play Satoshi Dice, they want to buy a case of Dry Muscat from the
Misconduct Wine Company etc.
Returning now to our money architecting perspective of “full monetary deployment”, we need to add a third category for completeness. That is the balance of the coin supply which is redundant and not deployed in either of the two active roles meeting market demand (neither interest bearing reserve nor currency). If the balance is non-zero, this is the supply that finds its way to markets and is traded. (Note: not the amount sitting in order books, but the amount actually changing hands and moving the price), or put another way, the amount sitting on order books that matches the next bid price. What happens then is that the coin supply changes hands, the price moves and the redundant supply is eliminated (the light blue gap gets fully closed). When the price stabilises, then the supply is fully deployed again in a heterogeneous market.
Don’t All Cryptos Support this Model in Some Form ?Yes - all crypto’s clearly exhibit some aspect of this monetary model but here’s the distinction.
a) in the case of non interest-bearing proof of work coins, the ENTIRE supply is in the blue zone. This clearly places too much commercial loading on an immature currency market which leads to an inevitable long term value depletion in the absence of major speculative price support. It’s a case of ‘keep pumping and hope to hell that people hodl’.
b) in the case of interest bearing proof-of-stake (POS) coins, the interest bearing feature applies across the entire coin supply with the result that heterogeneity is lost. Those two markets are not distinctly addressed which precludes them from complimenting each other in an optimal way. For example the trading sector still pays interest even though investors have a different financial priority. That then depletes the attractiveness of the high earning cold wallets. Conversely, the portion of the supply that is meeting the reserve requirement cannot be specifically targeted for rewards-based service loading as Dash’s is.
The Dash Economic Model: How are its Dual Markets Complimentary and What are the Mechanics of Stabilisation ?
Lets take each one in turn with reference to the colour-coded illustration and see how this model continuously brings the coin supply back into full deployment. (Note, the priority is full deployment, not price support. The assumption is that if full deployment is sustained in both commercial sectors, then we have the highest chance of a long term favourable revaluation).
FOR A GIVEN SIZE OF CURRENCY MARKET - DOLLAR EQUIVALENT LIQUIDITY REQUIREMENT (Blue side fixed)
[1] - if masternode count decreases (holders want to trade their masternode collateral for another coin and exit Dash)
a) - the gap will open and redundant (Sr) coin supply goes positive
b) - this will go to markets as excess supply and move the price down
c) - masternode revenue goes UP (due to fewer masternodes), masternode price goes DOWN (due to b)
d) - the effect of c is to attract demand from BOTH the currency sector of the existing investor community (the blue band) AND from markets
e) - the redundant supply gap (Sr) is closed, the masternode count stabilises and full coin deployment is restored
[2] - if masternode count increases (demand rises from the fixed income commercial market sector)
a) - the redundant coin supply term (Sr) goes negative
b) - a negative Sr term due to masternode shortfall can only be cleared by moving coins from the blue to the orange sector which can happen in two ways: an existing holder re-deploys their holdings as masternode collateral OR a new holder does by way of the coins passing through markets first and changing hands
c) - the price rises to maintain the liquidity requirement for the currency market (blue zone)
d) - the negative redundant coin supply term (Sr) is eliminated and full coin deployment is restored
FOR A GIVEN MASTERNODE COUNT (Orange side fixed)
[3] - if the size of the currency market decreasesa) - the gap will open and redundant (Sr) coin supply goes positive
b) - price will fall to close the gap
c) - the redundant supply gap (Sr) is closed, the masternode count stabilises and full coin deployment is restored
[4] - if the size of the currency market increasesa) - the redundant coin supply term (Sr) goes negative since there is a liquidity shortfall
b) - by definition, demand has exceeded supply on markets so price rises to meet the liquidity requirement for the currency market (blue zone)
d) - the negative redundant coin supply term (Sr) is eliminated and full coin deployment is restored
What are the Complimentary/Secondary Effects ?
We’ve discussed on an ongoing basis the huge technical gains to be had from a logically articulated network. (That’s to say, where the protocol for any given node can operate in either a client mode or a service mode while remaining decentralised). So in this section we’ll stick to the economics of the two distinct commercial markets that Dash serves.
To do this we just have to connect up an adverse perturbation in one of the two markets above, directly to its corresponding step in the other market. For example, to observe the primary and secondary impact of a decrease in size of the currency market, it’s knock-on impact on masternode count and subsequent tertiary effect on valuation, we can do this:
Start at [3] and note the primary effect of a market shrinkage (it’s a price decline at [3]b)
Next to go to the two sections governing masternode dynamics ([1] and [2]) and see which one contains the price decline - its [1]b
Now note the conclusion of those steps. From that we can see that the shrinkage in the currency market was balanced by an expansion in the revenue-earning investment sector (masternode count) and full monetary deployment was restored.
We can use this type of ‘jump across’ analysis to model the secondary effects for any perturbation - increase in masternode count, decrease in masternode count, shrinkage in currency market or expansion of currency market (e.g. widening retail adoption). To know the starting point, we need two data points:
- the market movement direction (is it a price increase or a decrease)
- the change in masternode count
So today, we had supply coming onto the market, but it doesn’t yet count as a perturbation till it moves the price (which as I write it still hasn’t). Lets say it did though and the price tanked. The masternode count remained steady, so our entry point in the model is [3]a.
Implications for Trading Technicals and Long Term Market Split
From the previous example, an interesting phenomenon occurs which theoretically has a favourable influence on trading technicals. We saw that successive shrinkages in the currency market has the effect of “pushing” coin supply from the blue sector to into the orange sector on the illustration. In trading technicals, a resistance area is often defined to exist at the end of a large selloff. However, if we look at this from the perspective of the dual market economic model that Dash now serves, it’s possible that this resistance will be substantially mitigated by reduction in coin supply in the blue zone, since much of the supply that would otherwise be sitting on the order book - underwater waiting to be rescued - has gone off to find a new home as masternode collateral (Orange zone).
So this heterogeneous market makes it much easier for Dash to recover marketcap after a selloff, whereas when you have no ‘front loading’, the market has it all to do. A mountain to climb.
Note that Evan sees the blue sector as being ultimately very small - a good deal smaller than I have drawn it. (I drew the relative split according to today's masternode count). Having thought things through for the purpose of this post, I now realise why. Lets see how the model affects relative spread between the two market sectors in the case of a liquidity decrease and increase respectively:
a) - in a decrease (price decline for fixed masternode count) as we’ve seen, we should loose some net supply from the currency sector to the masternode sector
b) - in the increase, we should not necessarily regain that full loss (in other words, some of the coin supply that moved from the blue to the orange sector in a price crash will ‘stick’ and not return to the blue sector. That then requires a price rise to a higher original value just to regain the same dollar liquidity level
Industrial Precedents for This Approach - A Case Study: Electricity Generation
The reason I’m so confident that this is not only a sound strategy for a fledgling cryptocurrency but an essential one, is that there exists an fascinatingly close parallel in heavy industry which faced almost identical growth challenges and successfully deployed a similar dual-market strategy to meet those challenges.
Iceland in the 1960’s had a population of about 200,000 people and growing. The government embarked on an ambitious long term plan to build new hydro-electric stations, the first of which would be the largest ever to date. Here’s the problem - once completed, the full generating capacity would be online decades before the demand was projected to rise enough to absorb it. The question was, what to do with the spare capacity ?
The answer they came up with was to build an aluminium smelter. Aluminium requires huge amounts of cheap electricity while at the same time provided exposure to a completely independent market from the consumer one which would take years to evolve. The same product was supplied to both markets (so the 'coin supply' is continuous), but the markets had distinct properties which complemented each other in the way Dash's do.
This gave the generating capacity a dual market with appropriately favourable dynamics, where one is capable of taking up slack in the other and supporting its growth. So in conclusion, what we saw today in the Cryptsy order book was possibly the ‘flab’ on the blue strip that was about to be absorbed by the aluminium smelter (thankfully, Dash has one now
)
How is Bitcoin Doing It ?
Finally, lets consider how these two distinct markets are addressed in bitcoin. As far as the currency side goes (the blue sector), there is little difference economically between any crypto because they all inherit the principle characteristics of bitcoin (POW, inflationary to some degree etc). However, it's in the auxiliary capital investment market (the orange sector) that the challenge lies - particularly now that we've seen this is key to supporting long term growth of the currency by front-loading excess supply.
Bitcoin does not support any protocol based reward for proof of network service other than mining. Full nodes, for example, are not incentivised and this has led to a steady decline in their population as SPV wallets start to dominate. We'll consider 2 significant examples of how the bitcoin economy intends to address this market:
[1] - Sidechains
[2] - ETF's
SidechainsThe idea here is to be able to introduce new protocols to the bitcoin economy without the need for hardforking the bitcoin protocol itself. So this is a potential area where ideas like incentivised nodes or proof of service could be introduced. The problem, however, is that sidechains drives a horse and coaches through bitcoin's fungibility. You have to sacrifice entire sections of the coin supply to 'morph' them into the sidechain currency. It also carries the problem of pegging the sidechain's coin value to bitcoin's (the designers actually think thats a good thing believe it or not), thereby transmitting undesired volatility from one market sector to another that would otherwise be served by distinct currencies isolated from each other with a commercial firewall.
Technically - as an API interface - this is a potentially attractive idea. Monetarily it's a non-starter according to any accepted definition of ideal monetary properties.
ETF'sThe eventual emergence of a Bitcoin ETF-like product would directly address the demand for investment capital as distinct from trading liquidity. However, here the solution is also incomplete because ETFs are in principle a risk asset - not a fixed income one - and rely on the underlying commodity accruing in value to deliver a return. So we're back to square one with the blue sector accounting for the whole coin supply. We still have no 'auxiliary market' to front load our supply. [
To illustrate the difference between a risk asset and a fixed income one, consider you had $1000 to invest. You can either invest it in stocks or bonds. If you invest in stocks, you may end up with less than $1000 dollars or you may end up with more. With bonds which pay a fixed interest in the same currency as the capital sum, you'll always end up with more than $1000. You may loose out in other ways (e.g. the $ may devalue against gold) but you'll at least have more dollars than you invested. This is the market that Dash's 'Orange sector' is supporting). ].
How does Dash Do It ?How does Dash avoid the two cul-de-sacs above ? In the first case, it addresses the two monetary roles distinctly but ENHANCES fungibility instead of destroying it. It can do this because the capital and currency markets are supported without having to recast sections of the coin supply with a different identity as sidechains do.
In the second case, it supports a protocol level reward for proof of service, thereby providing a basis for fixed income investments that pay out in the SAME currency as the capital sum. (The risk-asset market is supported by default, whether your funds are serving as masternode collateral or not).
As these two examples illustrate, the problem bitcoin has is the same one that keeps recurring everywhere else - from fungibility to scaleability to governance and that is: If you want to service this 2-tier market, you need a 2-tier protocol !
Simple as that
