Balance Sheet Attacks

NuBits
#1

Alright, so I guess we start simple. What is a balance sheet attack?
A Balance Sheet Attack (BSA) is an attempt to profit off of the logic of passed motions or fabricating situations that force shareholders to pass certain motions that can be profited off of. There are only three ways to defend against a BSA:

  1. Make the attack very expensive
  2. Make the attack require extremely large amounts of liquidity (preferably invested in the system)
  3. Make the attacker take on an extremely large risk

I think I will move away from the general now and right in to a specific, textbook case:

The Buy Slow Sell Fast (BSSF) Attack
This classic example uses the basic asymmetry of the peg against itself. The backing concept here is that shareholders have control over only one side of the peg in an NBT/BTC pair. Interestingly enough, the concept seems to disappear when NBT/NSR is considered, but in reality the risk has simply been spread out throughout the network. So in the case of an infinitely liquid NSR/USD price, this attack is equivalent to a well known PoS attack of simply buying a large portion of the network and holding stake.

So, the BSSF attack is therefore a figment of an illiquid NBT/NSR gateway as long as the NSR marketcap greatly exceeds the NBT marketcap. Still, we must consider the attack and the consequences. Let us examine it in chronological order by the attacker:

  1. Step 1 must be buy NBT. Because the network needs time to create and release more NBT, it will be assumed that this will happen over time. The speed of purchase should be enough to keep Nu doing buybacks semi-continually and increasing the price over time.

  2. Now that the attacker has a large percentage of the NBT in existence, when they sell they will smash safeguards and potentially promote either a long term breaking of the peg or forcing shareholders to go through messy illiquid NBT/NSR gateways quickly. The strategy here is to sell at a price just low enough to cause a panic and dump the peg (something like $0.95 or $0.9)

Profit Strategy: The purchase pressure of buying NBT at $1 will be symmetric with buying $1 of shares. Similarly, the sell pressure will apply direct market pressure. The basic statement is that buying at open market prices over time allows for a lot more liquidity than selling in a short period of time. The price could easily spike lower than it rises, assuming the buyback and dilution amount in $$ is the same. The attacker can certainly participate in the dilution and buy shares at a greatly reduced price. Or, the price could bottom out and the peg could fail indefinitely, thereby removing Nu as a competitor.

How the shareholders respond currently:

  1. The response to a slow buy is to store the purchased liquidity in T1-3 first and use them as feedback sensors for T4, where the purchased liquidity is used to buyback NSR. Because this occurs over time, the NSR price trends upward and Nu enters a period of prosperity.

  2. Step 2 is where it gets interesting. The sell walls would most likely happen on a number of different exchanges essentially at once, and after a day or two almost all T1-3 would get dumped, triggering T4 which would also get dumped. This leaves NSR sales, a messy business.

Liquidity required = ($0.95)*(Desired effect on NSR market) + T1-3 buy + T4 buy + market forces to keep peg at $0.95 > $200k

Cost = 0.05 * Desired effect on NSR market + Network Spread * Tiered liquidity
(i.e. act on NSR market with 20:1 leverage after tiers are depleted)

Clearly, this attack already requires a lot of liquidity. However, when Nu is a lot more valuable, will this liquidity requirement be enough? The T1-3 term will grow, as will the market forces and the desired effect on NSR. It makes logical sense that we make T4 also grow with the network. One of the most direct ways to do this is to tie it directly to the NBT supply. Under that logic, I will be introducing a motion to turn T4 buy threshold into a function of the NBT supply.

The Threshold Attack
The idea here is to take the BSSF to the next step and prey on the particular motion thresholds that have been implemented.
~~~Work in progress~

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[Poll] When do you think the next NSR buyback will occur?
[Withdrawn] Motion to prohibit Tier 6 NSR sales above a total 1,000,000,000 NSR supply
Lack of commitment to liquidity is our biggest threat now
Transferring all Nu assets to B&C? - Liquidating or 'archiving' or mini-Nu?
[Passed] T4 Circulating NBT Threshold
#2

Basic frontrun:
Requires Nu to be at or above equilibrium.

  1. Buy y NSR
  2. Buy x NBT
  3. Wait for Nu to equilibrate, pumping NSR by $0.5x
  4. Sell y NSR
  5. Sell x NBT
    This attack results in Nu selling more NSR than it buys due to the frontrun, giving the attacker the difference. This is an extremely low difficulty attack, as it can be done with any amount of liquidity. All it requires is Nu to be at equilibrium or in a buyback phase.

Collapsing NBT:
Assume there are x circulating NBT.

  1. Buy (x+y) NBT.
  2. Wait for Nu to equilibrate, leaving the reserves at $(x+y/2).
  3. Sell (x+y/2) NBT, thereby breaking the peg.
  4. Use your y/2 uncollateralized NBT to make the market panic at will.
    This requires a lot of liquidity (at least equal to the number of circulating NBT) but as the NBT is sold at the same price it is bought at, the actual costs are very very low (y/2 times the desired reduction in NBT price). The time it takes Nu to restabilize is given by the dilution velocity.

The main difference between these attacks and the OP is lack of decentralized liquidity.

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#3

I have recently described this potential exploit here.

While there are risks to shareholders in the hypothetical scenario, I explained why I believe an attempt to employ the techniques you describe is likely to result in overall benefits to NuShare holders, even though some likely costs can be identified.

I hope someone does it, partly because I believe chances are it will benefit the network and quite frankly, it would be a fun game to play as Chief of Liquidity Operations. Remember, I can change liquidity policy without advanced notice, including increasing the reserve level. While I will change liquidity policy to benefit NuShare holders, I won’t advocate burning or quarantining any NuBits or NSR suspected or confirmed to be part of an attempt to employ the possible exploit. All NSR holders deserve to have me protect their collective interests, including anyone who tries to make money using the technique @Nagalim and I have outlined.

#4

So the only defense against breaking the peg is to micromanage not only the reserve target but also blackballing addresses on the blockchain. So customers should always be concerned the will be blackballed for no other reason than that they want to sell their nbt. This is even more of a customer risk than the possibility of USDT blackballing an address because there is no legal recourse for a customer of Nu. Kinda makes NBT useless if you have to worry your address will be blackballed if you try to sell, no? Also, it assumes that the chief of operations is outsmarting and forking against every potential attacker. Quite a task for any human.

The front run attack stands. The only defense against the front run attack as described without decentralized liquidity is to keep the system perpetually in a state of dilution.

So, to summarize, the solutions to these attacks are to ensure NBT is useless as a store of value and NSR is permanently in a dilution phase. Got it.

1 Like
#5

That should increase the overall confidence in Nu, knowing that a single anonymous person can do that.

Who judges this? You?
Based on what? Your feeling?
As the mitigation of attacks relies on you changing policies I understand that you can’t follow a policy changing the policy :wink:

You can’t be taken serious if you don’t have the decency to publish state how many NSR you lost.
Or do you think that not writing about it makes people forget that?

I will remind people of how transparent you can be if it’s about you losing millions upon millions of NSR from shareholder funds.
So please tell us, @Phoenix: how many NSR did you lose?

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#6

Phoenix just specifically said he wouldn’t do that:

I agree that an anonymous person micromanaging reserve targets is not ideal. The reserve ratio should be discussed and voted upon by a number of individuals, or NSR holders in general.

3 Likes
#7

Count how many people are contributing to this these days.
Do you think it might be related to the fact that @Phoenix has de facto majority control over the voting?

How do you know which addresses have been blackballed? I mean, the addresses are known, but besides that all you know is that @Phoenix claimed they were part of a theft.
Is that the case? Where’s the proof?

Am I the only person being uncomfortable with @Phoenix attempting to sit out question for the amount of NSR he lost and how?

Is this the person you are comfortable with being at the head of this project?
I call it project, because it’s for sure no corporation. It lacks basic functions of a corporation.

#8

Ah, cool, ok so both attacks stand then. If i buy enough nbt over time, wait for it to equilibrate, then sell all at once I can shatter the peg (as long as reserve ratio is <100%). Great.

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#9

I’ve seen that before. It was that event that brought my attention closer to Nu.
From all that was done and not done I can only deduce that Nu doesn’t want to learn and adjust.If you are a critic you are offended or your questions are being sit out (sometimes both).

I’d make such an attack myself. It would be a nice way to make a gain. Not very ethical, but if you are offered free money… :wink:
But @Phoenix who can adjust policies as he sees fit introduces uncertainty. That makes @Phoenix the only person who is able to launch an attack with foreseeable consequences. That’s great as well! @Phoenix got on the gravy train! Did he really lose the NSR? Weren’t lots of NBT sold recently? When’s the next NSR buyback? And how soon after it will lots of NBT be sold? Time for even cheaper NSR then?
Is here anybody remembering George Soros attacking the UK Treasury?

Regarding uncertainty: single people being able to adjust policies after their fancy makes me shy away from using/holding NBT and in the end I consider fiat at exchanges to hedge BTC volatility more reliable and trustworthy.
Can’t wait to have crypto coin funds to hedge.

#10

What you described is the common way to attack a partial reserve pegging system, this is well demonstrated by George Soros in South East Asia financial crisis in 1990s and UK attacking.

This is related to impossible trinity.

BTW, this community is full of economics laymen. Most of them believe/dream they can invent a successful system quite different from Satoshi’s fixed supply model, however, their economics knowledge is high school level.:grinning:

So they are and will be in trouble, unless they follow a decent powerful theory. But, they are too boastful to realize it.

In my thread of “Plan B for Nu”. The Hayek’s short-term lending model can avoid this kind of attack as long as NSR is accepted as the sole collateral (BTC not accepted）.

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#11

As stated by Paul Krugman in 1999:[9]

“ The point is that you can’t have it all: A country must pick two out of three. It can fix its exchange rate without emasculating its central bank, but only by maintaining controls on capital flows (like China today); it can leave capital movement free but retain monetary autonomy, but only by letting the exchange rate fluctuate (like Britain – or Canada); or it can choose to leave capital free and stabilize the currency, but only by abandoning any ability to adjust interest rates to fight inflation or recession (like Argentina today,[10] or for that matter most of Europe).

When Jordan designed Nu, he wanted the 3 goals simultaneously：

  1. fixed exchange rate: 1NBT= 1USD
  2. fre e capital flow: people can buy and sell as they wish
  3. independent monetary policy: parking rate determined by shareholders not FED.

So we know Jordan has bad economics background, he may be an excellent IT expert, but this cannot guarantee success. We are playing financial game indeed.

Now Phoenix tends to capital control: to punish those bad guys’ NBT/BKS addresses.

Well, watching some laymen struggling with basic economics rules is also a funny thing. They believe they’ve mastered C++ so they can control economics, what a joke!

Impossible trinity stands in real world, because governments cannot shrink domestic currencies in short term. While with Hayek’s model, we can shrink total NBT in circulation to Zero within short term.

A master is a master, the real Nobel Prize Winner.

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#12

I believe this risk has been raised a couple of times. The only defence is indeed 100% or more reserves.
The challenge is in how Nu can recognise someone taking a major position over time and still have a fractional reserve. This will be a hard nut to crack I believe when it is done over a longer period of time. Therefore I suggested earlier that we should explore how we best can hold those (100%) reserves and make some money out of it e.g. as peer-to-peer short to mid term loans.

Not sure if I agree with Phoenix about managing the level of reserves manually without having good and reliable indicators when an attack is imminent. It may be an interesting play to have with potential short term gains, but when one of the parties blinks one time too much they will loose. Interesting to play such a game maybe, but the risk are major loses for Nu. Not an attractive play from an economic perspective imo.

Agree

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#13

Name just one game Nu plays, in which it is not at the wrong end of the stick from an economic perspective.
I’m not asking about a future vision. I’m asking about the games Nu plays or has played so far.

#14

I was referring to the game of someone “attacking” Nu and buying a significant number of NuBits, with that pump the shareprice and dump the coins once the reserves are relatively low. Phoenix said that he would be prepared to play that game, but I believe you may win that over a short time period by holding more reserves (resulting in less pumping) but for attacks over a longer period it would be hard to win unless maintaining a close to 100% reserve in BTC or fiat.
That’s why we shouldn’t make profits which pump the shares directly but indirectly my making profits out of the reserves (future vision).

1 Like
#15

Yah, we all should rely on this single, wise, and never failing protector of the peg.
At the moment and looking at the situation of Nu regarding control it looks more centralized than Tether. At least there you have bank accounts involved and if a person gets hit by the bus, the funds aren’t lost.

You can’t hold a 100% reserve in BTC unless you continue selling NSR.
Exchange trading at close spread drains funds from Nu.
I believe, it’s the only reason why the NAV from trading doesn’t get published. It would look devastating. The liquidity officials can prove me wrong if they like. I’ve explained more than once why my claim is rational.

That leaves you with a 100% reserve in fiat, USD for US-NBT, which poses other challenges and threats.At least it would be compliant with the design to trade US-NBT/USD and not US-NBT/BTC.

One solution was proposed by @Sabreiib (pledging NSR to receive NBT) and NBT/NSR swapping in seeded auctions was proposed by @Nagalim. There have been some more ideas to mitigate reserve risks. NuSafe was another.
It’s not that there are no people understanding the problem and proposing solutions.
If you don’t want to change anything, another easy way out is to increase the spread. If you can’t sell you product then, you have no market in which you can prevail. In a nutshell it’s as simple as that.

@Phoenix is good with bold claims, rhetorics and accusations.
He stays silent, if proposals that reform Nu, but take away direct control from him are the matter or when questions about the “attacks” on Nu funds under his control or how many NSR he lost are asked.

Agree:

If you manage to lend money (NBT) at a fee and do something useful with the collateral, you can make double profit.

#16

It’s Hayek’s mechanism, not mine.

Satoshi gives up “fixed exchange rate” then BTC has other two:

  1. independent monetary policy: 21M total and reward halves per 4 years.
  2. Free capital flow: anyone can buy/sell BTC as they wish, no worries about being filtered out with their addresses.

Nu’s trouble is to challenge the impossible trinity, although Nu tries to shrink NBT in circulation by raising parking rate(independent policy), the free market doesn’t like it.

Impossible trinity’s principle is well demonstrated below:

Assume that world interest rate is at 5%. If the home central bank tries to set domestic interest rate at a rate lower than 5%, for example at 2%, there will be a depreciation pressure on the home currency, because investors would want to sell their low yielding domestic currency and buy higher yielding foreign currency. If the central bank also wants to have free capital flows, the only way the central bank could prevent depreciation of the home currency is to sell its foreign currency reserves. Since foreign currency reserves of a central bank are limited, once the reserves are depleted, the domestic currency will depreciate.

Hence, all three of the policy objectives mentioned above cannot be pursued simultaneously. A central bank has to forgo one of the three objectives. Therefore, a central bank has three policy combination options.

This is exactly what’s Nu’s crisis. For some reasons, investors want to sell your currency for another high liquidity currency, such as in 1997 south east Asia’s hot money wanted to leave and transferred for USD, or in 2016, when BTC price went up so investors wanted to sell NBT for BTC.

After the limited (partial) reserve is depleted, the peg failed.

So Nu’s crisis is just another typical “financial crisis” like The Mexican peso crisis (1994–1995), the 1997 Asian financial crisis (1997–1998), and the Argentinean financial collapse (2001–2002).

@Phoenix If you cannot shrink your money in circulation effectively, you cannot challenge the “impossible trinity”. Nu’s fate depends on whether you can find the way, while Hayek’s mechanism is a good option.

#17

In 2016, we did in fact reduce circulating US-NBT supply from 821,000 to 133,000. That was a rapid 84% reduction in the circulating supply. Nu has amply proven its capacity to shrink the supply of NuBits.

#18

Liquidity engine is proven to be a not-so-good method to shrink your money supply because it takes one year to recover from the crisis. I believe with Hayek’s, you can shrink effectively within 1-2 month.

#19

This is not true. There was ample reserve available at the time of peg failure, and plenty of capacity available from park rates and NSR sales. In the most direct and brazen violation of Nu contracts that could be possible, multisig signers decided to lock all funds down and cease operations. This decision, and this decision alone, was the SOLE cause of the temporary peg failure. There was no financial component or deficit involved.

Nu clearly had all the funds it needed to keep the peg, but some unsteady authoritarians opposed to the rule of law refused to use them for reasons that are not clear, but it appears to be due to the tendency authoritarians have to “hunker down” and change all the rules when they feel fear. Nu has learned its lesson about how damaging authoritarian signers can be.

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#20

FLOT’s failure is just one factor, if they follows your plan, the more NBT selling order will continue until FLOT’s 16 BTC is completely consumed and NSR price dropping a lot.

Your accusing to FLOT reminds me of “Captain Sally” , if Sally immediately flies his plane to airport after bird strike, he can land safely on the ground. But you “extract all the humanity out of the cockpit”, human beings are not machine. I strongly suggest you watch “Captain Sally” movie again, then rethink your attitude to FLOT.

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