I’ve been watching NuBits closely and I do not fully understand how interest rates are supposed to keep demand for NuBits high enough to keep the price at $1. I get the idea, but according to my analysis it cannot be effective.
First of all, let’s take a look on a price above $1. The answer to this is: expand supply and sell at $1. Well, great, so far no problem – this is a hard cap and will work beyond doubt.
But below $1 things get tricky. There is no hard cap, someone buying unlimited NuBits to get the price back up at $1. Instead, there is only a soft floor by offering interest (in NuBits) in order to reduce supply and attract buyers. This should in theory get the price up to $1 and then interest rates will drop. In other words, there is asymmetry around the price of $1 and the solution to falling prices is: expanding the supply through interest. But wait, where did we see that before? Wasn’t the solution to an increasing price already expanding the supply?
So where does this lead? Well, first of all the asymmetry causes downward pressure on the price level. If you sell at $1 you will always have a winning trade. You face unlimited supply if prices move higher, but not unlimited demand if prices move down. You do not have to be a speculator to figure out you should sell at $1, it’s the only rational thing to do. It’s like buying a stock at $0, you cannot lose. A little below $1 this can still be an interesting investment, because demand will fluctuate and cause prices to go below $1.
So okay, there will be periods of less demand and this will just enforce falling prices during this period (it could also trigger the imbalance), it’s not the end of the world – that’s what interest rates are for, right? To get demand and the price back up. Well, that’s where things are starting to go wrong. Again, interest expands the supply, and expanding the supply/sell side to get demand back up? Hmm…
Let’s take a very extreme example to check how this is going to work out just to check the general concept. Take 100% interest on just a single day. If I am not in any way interested in NuBits, that is indeed interesting! Suppose the price of one NuBit is at 90 cents. I’ll buy 1000 at 90 cents for $900 and expect to sell 2000 tomorrow at $1, so I get $1100 for free. Realistic? How about no. First of all, the demand drops again when interest rates drop back to 0% when the price is at $1. Then all that newly created money through interest has to go somewhere, which will be dumped on the market. Because I now have 2000 NuBits, I can put a ridiculously low price of $0.45 per coin in order to break even again. If I sell anywhere above this price, I make a profit. So, the price was at 90 cent, and because of the interest it’s now about to crash. There has been a temporary increase on the demand side, but the most serious effect is on the supply/sell side and the only way to fix it is by adding yet even more supply (via interest).
So this was an extreme example, but this starts happening even when rates are low as it’s the same mechanisms. In the about section https://nubits.com/about/price-stability prices are said to go to zero if the coin has failed, what I am saying is that due to this mechanism the coin is designed to fail. There will be imbalances, at the very least due the fact that there is only a soft floor at and a hard cap at $1. Once you start fixing this by expanding the supply things will just go downhill. This has little to do with speculators, as my examples show it’s just the result rational behavior.
The question: Is this indeed a critical flaw in the design of NuBits, or am I overlooking something here? Please comment below