I would like to begin a discussion on a proposed new Tier 7 addition to liquidity operations, which unlock a powerful feature of volume-dependent transaction fees that shareholders have not yet considered. Proposed definition:
This liquidity is unlocked through substantially increased transaction fees during periods of extreme crisis. It has zero maintenance costs but may impair the perceived quality of NuBits. When Tier 7 is used, Nu is in a state of “restricted network access”.
Before we look at this definition of Tier 7, it is important to point out there are three primary benefits of volume-dependent transaction fees for the Nu network relative to static transaction fees:
- Increased profitability of network operations
- Quicker reduction in circulating supply of NBT
- Better peg protection during extreme crisis scenarios
Shareholders have discussed the first two benefits at length in the draft motion thread. It is intuitive that higher NBT transaction fees will lead to greater profitability if the rates are set below competitor rates. This is especially true in comparison to the current static fee the network charges that does not allow effective price discrimination relative to transaction volume. As well, all shareholders agree that robust transaction fees help ensure the circulating supply of NBT is constantly decreasing - an advantage for minimizing network liabilities.
I would like to focus this discussion on the third point above, specifically the ability for volume-dependent transaction fees to protect NBT price pegs in times of extreme crisis. I define an extreme crisis as an event that threatens to permanently devalue the network assets – such as US-NBT – that shareholders issue.
Shareholders, through volume-dependent transaction fees, have a hidden mechanism to maintain perfect asset pegs through restricting network access during times of extreme crisis. It is powerful but likely controversial.
To begin, here is an example of an “extreme crisis”:
It is September 23, 2019. The NuBits network has been operating for five full years and has gained popularity across a wide variety of retail and banking users. Daily US-NBT transaction volume has exceeded Bitcoin, and the price peg of US-NBT has maintained a perfect $1.00 US. There are 100,000,000 US-NBT in circulation.
Sensing a threat from the growing popularity of US-NBT, regulators from a major world government declare US-NBT illegal on October 1, 2019. There is immediate market panic. NuShareholders predict that users may attempt to sell up to 50% (50,000,000 US-NBT) of all NuBits over the next few days, overwhelming the ability of Tier 5 (parking rates) or Tier 6 (NSR sales) liquidity to support the peg in the short-term.
Ordinarily there is only one course of action: if Tier 5 and Tier 6 liquidity are overwhelmed, the network has no choice but to wait for the peg to fall below $1.00 US, and then hope that speculators slowly purchase NBT at discounted prices until $1.00 US is again reached. These US-NBT discounted purchases may eventually restore the $1.00 US price, but US-NBT would have lost much of its credibility during that period. There is a chance the US-NBT price peg may be lost permanently.
Volume-dependent transaction fees provide shareholders with one final course of action through Tier 7 liquidity. After the major world government declared US-NBT illegal, shareholders realized that an extreme crisis is taking place. They immediately begin to vote for an emergency transaction fee proportionality constant that will significantly raise transaction fees at all volume levels. Within 1000 blocks, the transaction fee for a 1500 NBT transaction has increased from the standard 0.25% to a staggering 50%. Transferring 1500 NBT through the network will now cost (and destroy) 750 NBT. Over the following weeks, shareholders gradually reduce the proportionality constant until transaction fees are back to historical network norms.
This example demonstrates just how powerful volume-dependent transaction fees could be in maintaining asset pegs. During times of emergency, the network can differentiate among its users to prioritize those who are willing to pay the most to reduce the supply of NBT for us. Over time, shareholders would slowly vote the proportionality constant back to normal rates as the circulating supply of NBT reduces to match the decreased US-NBT demand. This is similar to parametric order books, a mechanism that penalizes users who quickly sell large amounts of NBT.
In theory, this Tier 7 mechanism will allow US-NBT to remain $1.00 US forever; users always control the US-NBT in their wallets through private keys and the network cannot seize those assets. However, during an extreme crisis only those users who are willing to pay a significant transaction fee to move their $1.00 US-NBT through the network will be using Nu’s fast and efficient blockchain.
It is likely that optimal proportionality constant rates will be determined in advance of emergencies through a set ratio of buy-side liquidity to sell-side liquidity. As a simple example, if buy-side liquidity fell below 10%, a recommended emergency proportionality constant of X would be voted for, whereas if buy-side liquidity fell below 5%, an increased recommended proportionality ratio of 2X would be voted for.
Shareholders would have complete control to vote according to prior recommendations, or, do nothing at all – just like all other tiers of liquidity. A fundamental principle of Nu is that external actors cannot coerce shareholders into making decisions that are contrary to their individual interests. Shareholders can choose not to set parking rates (Tier 5) or authorize NSR custodial grants (Tier 6) during times of crisis. Likewise, Tier 7 would only activate if a majority of shareholders support it.
Questions for NuShareholders:
Because shareholders should only consider this action after believing Tier 5 and Tier 6 liquidity will fail, should we classify this defense mechanism as Tier 7 liquidity, or as something else outside the liquidity operations framework? In my view this is an “active” tier that requires shareholder action, similar to Tiers 1 through 6.
How should the proportionality constant be set in regards to buy-side/sell-side liquidity ratios? I am interested in feedback from @woodstockmerkle, @nagalim, and others who took an interest in forecasting transaction fee rates in the volume-dependent transaction fee thread.
How should Nu categorize this mechanism? I have chosen to define it as a state of “restricted network access”. Users may still manually trade their NBT to other (very) trusted users through private keys, but our network would not facilitate the trade over the blockchain unless a premium is paid during the emergency period.
All feedback is welcome. In contrast to my discussion on Tier 0 liquidity, I am more convinced this belongs in the liquidity operations framework because of its requirements for explicit shareholder action.