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Author Topic: Thought experiment. Coding a stable exchange rate.  (Read 2242 times)
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June 27, 2011, 06:40:28 PM

Trying to maintain a peg by changing the rate of creation of BTC can only maintain the peg in one direction.  If BTC rises relative to USD or whatever else, the increase in supply will bring it down, but if BTC falls relative to USD, you can only change the creation rate to zero, you can't withdraw currency.
Yes, I did think of this. I partly agree with you, but suspect that dropping the creation rate to zero may be good enough, since currency is continually being lost. This shrinkage in the money supply may be small, but in the absence of fundamental security concerns with the currency, given enough time it will bring the value back to the targeted level. The expectation that the currency will eventually return to its targeted value becomes a self fulfilling prophecy as some traders are always to keen to buy below this value. This means that the value bounces a lot sooner than what would otherwise have been the case.

Of course if there are fundamental concerns with the security of the currency (i.e. someone may be able to create more currency at will, break private keys gaining control over the funds of others or double spend) then no "long term" peg will save it, since traders don't expect that there will be a long term.

It's easy to confuse supply as rate of money creation with supply as amount of money outstanding, and I think this is the error you have made.  You have complete control of the former, but the latter can only be expanded/inflated.

If retailers decide to withdraw from the BTC world and people decide to shed their holdings because of the falling value, there is nothing to stop it from falling to near zero.  Some miners may quit and the security might weaken, which could further weaken confidence.

Your last sentence here raises a very important point that I have not considered. If a drop in the value of the currency, is accompanied by a drop in the supply rate as is proposed here, miners are hit with a double whammy. If enough miners withdraw, the reduction in difficulty may lead to security concerns, leading to a further reduction in value and a nasty positive feedback loop ensues that drives the value to zero.

The solution to this, is that it is critical that it must be possible to cross-mine this currency with other crypto-currencies. Withdrawing from a cross mined currency only makes sense if the sum of currency mined from all mined currencies falls to below the miner's running costs. Therefore as long as one or more of the other crypto-currencies is going strong, miners will not withdraw.
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