I have a much improved white paper published on google-doc available for viewing:
https://docs.google.com/document/d/1FqDgA7J_O2hufetbNY51xue7yE57Euk2_nTa5IOhnJA/edit?usp=sharingGranted it is still in draft, unformatted form but it takes a lot of effort to explain complex economic relationships in understandable and 'provable' terms. The reality is it gets simpler the more I explain it.
Proposal:In this paper I present a new crypto-currency with aim of supporting the creation of many sub-currencies that closely track the value of any other item in the market without the need to any issuers. An analogy can be made to a distributed peer-to-peer bank that accepts and pays interest on deposits in any currency. This bank operates without counterparty-risk or IOUs.
This currency will have the following Properties:
- The native currency will be called a share and is mined into existence on the same schedule as Bitcoin.
- Shares will pay dividends from half of the mining fees and rewards
- Users may issue new sub-currencies by ‘shorting the sub currency’ and backing the short position with dividend payments from a defined number of their Shares.
- Owners of sub-currencies will receive the dividends from the all Shares used to create them proportional to their balances.
- Short positions can only be redeemed by the issuer.
- Users will be able to trade among all shares and currencies and via a built-in exchange.
- All shares and sub-currencies will have the same transaction properties as bitcoins.
Economic Effects of this new Currency: 1. Shares derive their value from the same sources as Bitcoins.
2. Because shares pay dividends the shorts effectively pay interest to the longs. This interest payment is what regulates the supply and demand for deposits and withdraws and ultimately maintains price parity.
How does crypto-USD get created?
Someone must go short crypto-USD and back their short position with interest bearing BitShares.
Does it cost them anything to maintain a short position?
Yes, the act of going short causes the interest rate of crypto-USD to go up relative to the interest rate of Bitshares AND the individual who is short crypto-USD forgoes interest payments on their Bitshares.
Why does the interest rate of crypto-USD go up relative to the interest rate of Bitshares when someone shorts?
Because the individual short-selling crypto-USD is taking an exchange rate risk, he is unlikely to do so at the current market price. After all, he will have to buy back crypto-USD in order to recover his bitshares (which he expects to go up in value). So, he only goes short at a strike-price below the current exchange rate with enough margin to cover his risks. If USD goes up then it will be more costly to cover his short position and he will lose money. The risk of USD going up is equal to the risk of BitShares going down.
Because the exchange occurred at below market rates, the dividend payments which are in Bitshares are necessarily valued at ‘above market rates’. In other words, the percent gain in interest rates is proportional to the margin built into the short position.
What impact does the change in relative interest rates have on the market?
Higher interest rates always attract more depositors which will drive up the price of crypto-USD. This works against the short-seller who needs the price of crypto-USD to go down relative to Bitshares or else he will make a loss. This is part of the reason the individual short crypto-USD must maintain margin.
Higher interest rates also trigger other Bitshare holders to consider selling their Bitshares for crypto-USD. By swapping their savings they may yield a higher return. This also serves to drive up the price of crypto-USD (and discourage the short-seller and necessitates caution when issuing new crypto-USD).
If the change in interest rates brings in more depositors AND causes existing bitshare holders to switch to crypto-USD for savings, what market forces bring the price of crypto-USD back down? Holders of crypto-USD may see the potential for equity gains in bitshares outweigh the difference in interest rate. In this case they would take the same position as the short-seller in believing bitshares will appreciate.
Holders of crypto-USD may wish to withdraw their money into paper-USD.
What happens if there is a run on the bank and everyone wants to redeem their crypto-USD?
If Bitshares lose all value, then crypto-USD no longer pays interest of any value whatsoever and the short-seller has nothing to gain. Everyone involved would lose everything they deposited with the bank. This scenario is unlikely so long as bitshares continue to provide a valuable service as a medium of exchange and the underlying cryptography, internet, and power systems remain available *somewhere* in the world. Thus any depositor who puts money into crypto-USD is implicitly trusting that the underlying Backing of crypto-USD (bitshare dividends) will not go to 0.
Assuming bitshare do to not go to 0, then crypto-USD will have value to all short-sellers. crypto-USD will also have value to anyone who expects the bank-run to pass and for depositors to return at some point in the future. In this case, speculators will start buying up crypto-USD at below face value prices and short-sellers will start covering their positions taking crypto-USD out of circulation. These factors will conspire to provide support to the crypto-USD price.
In a panic the rush to withdraw will push the paper-USD to crypto-USD price down which is economically identical to increasing the interest rate paid to new depositors in crypto-USD. The increased interest rate will cause cash to flood into the system to meet the demand for withdrawals.
The depressed paper-USD to crypto-USD price will also discourage many people from trying to withdraw during the run. They decided to ride out the storm rather than take a loss in a panic.
So the question becomes what would trigger a run on the bank? Because there are no IOUs involved and all crypto-USD are backed by real value that does not have counterparty-risk (bitshares) then it is unclear what could cause such a rush short of something threatening the very infrastructure (internet/power) that the system is built on.
What happens if someone dies before they close out a short position?Then there will be a permanent bias in interest rate in favor of owning crypto-USD over bitshares.
What happens if Bitshares fall in value by 99%?Assuming the 99% fall in value is not part of a complete crash to 0 which I have already covered, then I will assume that the Bitshares found support at 1% of their high.
Then the value of interest payments paid to holders of crypto-USD will fall by 99% while the interest rate paid to holders of Bitshares will remain at 10%. As a result those who are seeking a 10% return will sell their crypto-USD and buy bitshares. This will depress the price of crypto-USD and help support the price of Bitshares. Short-sellers (crypto-USD issuers) would be taking it in the shorts so they would be actively redeeming as much crypto-USD as possible as soon as possible to cut their losses.
Some short sellers may not be able to redeem their positions. In which case the effect would be the same as if the short seller had died and there would be a permanent interest rate bias in favor of owning crypto-USD vs owning bitshares. Once Bitshares reach a new equilibrium after the market adjustment, then this interest-rate bias will encourage others to redeem the crypto-USD for paper-USD.
How will the block-chain algorithm determine what exchange rates to use when issuing Crypto-USD?
The blockchain will not have to decide, market participants will estimate the risks of going short to acquire crypto-USD. Therefore the price will be decided by the user in an intentional act to issue Crypto-USD. Likewise, these same participants will decide at what price it makes sense to cover their position.
How do you prevent abusing short positions to manipulate the market?Taking out a short position requires capital of equal value and incurs opportunity cost in foregone interest payments. These forgone interest payments are what back the value of the short position. Therefore there are no naked shorts and the shorts have no more power in the market than the longs.
What prevents people from creating a million different currency types?First of all, creating a currency type means taking out a short position in that currency which means it incurs a transaction cost. Second, others must understand and have consensus about the meaning / relationship of that currency type to Bitshares for it to have any value. Third, the short position must accurately reflect market prices or the issuer will take losses. If the price too low, the the market will push the price up causing them to lose money on the short position. If they price it too high, then they will only ever be able to redeem it with themselves and thus would incur 2 transaction fees for wasting everyone’s time.
