[Discussion] Tier 7 liquidity: Volume-dependent transaction fees and "Restricted Network Access" status

Liquidity Pools
#1

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:

Tier 7
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:

  1. Increased profitability of network operations
  2. Quicker reduction in circulating supply of NBT
  3. 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:

  1. 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.

  2. 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.

  3. 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.

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[Withdrawn] Motion to create a new Tier 6 (Restricted Network Access) of liquidity
#2

This was a great read and I agree that it’s likely to be controversial among shareholders as well as users of our network or people outside of it. I would lean toward supporting this motion with the hope that it never actually has to be used. If we are in an extreme crisis situation though and there isn’t a shadow of doubt among shareholders that tiers 1 through 6 will all fail, we will be lucky we had something like this to fall back on. Not only would it be devastating to shareholders, but all the users of the network if the peg was permanently lost. Anybody willing to transact in such a crisis scenario would be doing so voluntarily. Their voluntary sacrifice of NuBits would help in normalizing the network.

I believe that this could be considered tier 7. Would we need to vote on each Nu currency separately or would one vote raise the fees on all of them at the same time? I’m interested in hearing what others think and if there is any way for shareholders to abuse such a mechanism.

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#3

I will be worried if I know it is possible that 1 Nubit in my wallet is $0.7 if I spend it. I feel such mechanism will just set off panic sell earlier when people know that a haircut against moving funds is going to happen.

Plus, didn’t we find a lot of problems when tx fee is changed a few months ago when we tried it?

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#4

Tier 7 is already possible with our current variable transaction fees. All that is required is enough shareholders deciding to use it. Volume-dependent transaction fees will be no different.

I was careful to note that no “haircut” necessarily needs to happen. If NBT users held their funds through the extreme crisis period, it would be expected that transaction fees gradually lower to historical (normal) levels. Tier 7 requires NBT users to pay a premium for immediate access to the network during a period of uncertainty.

The variable transaction fee works perfectly. The only issues were with an external service (NuDroid) where further development was needed to align it with the current code. I would expect that volume-dependent fees would present the same issues.

#5

It’s a double edged sword.

I know. But many will read that way. Your intention is good and the proposed solution has neat aspects. What I am saying is that from an outsider’s point of view it might look like a convenient way for the network to seize money.

Exchanges had issues, too. Withdrawal transactions wouldn’t go through. NuDroid had a centralized solution. I prefer to see technical problems properly worked out before pushing variable fee further.

#6

The time-locking that is a feature of the NBT interest rates is a very powerful concept, and perhaps it can play a part of additional methods of mitigating attacks or in this elevated fee scenario.

Someone who is more schooled in economics could help the discussion by explaining the impact of velocity and a central bank slowing it down. I’ll assume for the moment that slowing velocity can help mitigate a crisis.

i.e.: if you need to transact right now, perhaps having a method for exorbitant fees may be a powerful method to preserve the peg. But at the same time, perhaps a user can opt for a low-fee transaction, but it is time-locked. So from a marketing standpoint, you end up paying more for fast delivery, but there does (and forever) exist a conduit for low-fee transaction.

And to poke holes in that idea, time-locked NBT could be a problem for a merchant, since purchasers may settle with either time-locked or not time-locked NBT. Then again perhaps there are different NBT addresses indicating if it can receive time-locked, non-time-locked, or either.

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#7

@woodstockmerkle’s post made me think about this topic more, and I’m now convinced that Tier 7 is a new form of capital control for digital currencies that hasn’t been discussed among cryptocurrency communities, as far as I’m aware. I know shareholders are busy with finalizing FLOT and liquidity operations, but this topic needs to be addressed in the coming months.

The definition: > Capital controls are residency-based measures such as transaction taxes…

So, the Nu network should realize it has already inadvertently pioneered yet another form of digital monetary policy (the ability to institute capital controls) through variable or volume-dependent transaction fees. This is a topic that needs to be addressed eventually, because it has the possibility of alienating hardcore cryptocurrency enthusiasts. The Nu network should either pass a motion declaring that it will never use Tier 7, or else begin to formulate the conditions under which Tier 7 could be applied. To choose the first option would be to increase the odds of permanent peg collapse however, and so I favor the second option for the reasons that follow.

The International Monetary Fund (IMF) has published an extensive series of articles and papers on capital inflows and outflows. In the case of Nu, our largest risk comes from capital outflows (ie. NBT being sold for fiat). One excellent IMF paper that is relevant to our network is here: http://www.imf.org/external/np/pp/eng/2012/111412.pdf beginning on page 25.

  1. Capital outflows that are large, sustained, or sudden can pose significant policy challenges. Some capital outflows are a natural consequence of openness, as foreign investors recoup their investments and domestic investors diversify their portfolios and expand business operations abroad. Outflows can, however, become disruptive in some circumstances, which are usually associated with economic crises. Such disruptive outflows can be driven by domestic factors but they can also be driven by international factors such as global risk appetite, liquidity, interest rates, and global growth, and by contagion effects through trade and financial linkages and investor confidence. **Disruptive outflows can lead to reserve depletion, currency collapse, financial system stress, and output losses. Even short of crisis, large or sustained outflows can pose challenges through their effects on exchange rates, availability of financing, and interest rates.**

  1. In crisis situations, or **when a crisis may be imminent, there could be a temporary role for the introduction of Capital Flow Management Measures (CFMs) on outflows**. For example, when countries face domestic or external shocks that are large relative to the ability of macroeconomic adjustment or financial sector policies alone to handle, or when the size or duration of the shocks are highly uncertain, CFMs may help to prevent a free fall of the exchange rate and depletion of international reserves. When a crisis is considered imminent, CFMs may be desirable if they can help to prevent a full-blown crisis.

In this case, our primary CFM would be Tier 7 transaction fees.

  1. **CFMs in response to disruptive outflows, while they need to be comprehensive, should be temporary.** The right time to lift outflow CFMs will depend on specific country circumstances. In general, outflow CFMs should be lifted when macroeconomic stability, particularly with respect to the exchange rate, debt sustainability, and financial stability are restored, confidence is regained in domestic assets, access is resumed to international capital markets, and foreign reserves climb above critical levels

This supports my assertion in the OP that transaction fee hikes should only be in place until equilibrium is restored.

Overall, I think there is a place for Tier 7 liquidity as a last line of defense against currency collapse. The IMF report seems to support limited use of CFM’s like Tier 7 when necessary. Shareholders should begin to discuss under what circumstances other CFM’s may be applied, according to IMF (or other economic expert) guidelines.

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#8

It’s rational to have insurance for raining days. But it’s like talking about a baby’s unemployment plan – it’s applicable time is so far in the future that no one for sure knows what the baby will have grown up to before the time comes.

#9

In 14 months of the network we’ve already accessed Tier 6 once during a crisis. It’s not unrealistic that Tier 7 could be required in our next year of operations if an exchange like Poloniex failed.

It’s also possible that shareholders may even prefer Tier 7 over Tier 6 in some circumstances, because it preserves the rarity of their shares. We should consider this topic while we are experiencing success, rather than waiting for a crisis to emerge.

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#10

Must consider, the more the baby, the more experience not from the wind and waves, the crisis appear at any time. Not only to consider, in order to anchor the $1, should be in the 7 set a lot of money.

#11

I am not sure which is better, a broken peg or a unbroken peg that costs an arm and a leg to use. The free market would prefer the former. Mental experiment -

If I know T7 is going to be used what if I offer a crypto token that is pegged to 1 NBT, backed by 100% NBT reserve (proceeds from selling the token), and only cost 1/5 or 1/2 T7 fee ?

#12

This is what I hope more shareholders will discuss here, and I plan on keeping this discussion bumped until more input is provided.

Tier 7’s definition could have an impact on other tiers as well. I’ve always thought Tier 6 is inherently flawed, because we will be attempting to sell an asset (NSR) that derives the majority of its value from the performance of another asset (NBT) when that secondary asset (NBT) is failing. It will lead to a tremendous amount of NSR dilution if the emergency is severe enough. That makes the asset (NSR) undesirable to many people for long-term speculation.

With Tier 7, we impose capital controls on the network for a brief period of time. Our shares retain their scarcity, which should make them much more valuable in the long-run. One of Peercoin’s problems from a marketing perspective is that there is no cap on the number of PPC that can be in circulation. I remember many Bitcoin purists disregarding Peercoin for that reason.

I would even go so far as to say that if the network eliminated Tier 6 and replaced it with this “restricted network access” concept that our NSR would immediately become more valuable. There is always a looming threat that NSR will be diluted in an emergency; with Tier 7, we can have a constantly decreasing supply of NSR forever. That would be very attractive to speculators.

Tier 7 makes more sense to me than Tier 6. In retrospect, I’ve felt this way since the beginning, as shown in a quote from the original NBT burning discussion thread:

Tier 6 is flawed but easy to digest. Tier 7 requires us to think of Nu as a true currency that uses the same tools (capital controls) all real currencies do in times of crisis. I think we should eliminate Tier 6 because it will require mass dilutions at large enough scales, and because it will make NuShares worth much more if there is no possibility of dilution.

What do other people think? I may introduce a motion because I feel very strongly that Tier 7 is a more effective economic tool than Tier 6.

3 Likes
#13

I basically agree with you as far as T6>T4 has been implemented (using BTC as a middle man). However, true T6 should be implemented more in a way like seeded auctions, where we trade NSR for NBT directly. In that case, you can see that a failing NBT actually causes the NSR/NBT price to go up rather than down (anti-blackswan). Still, you make a very good point that a dropping NSR/BTC price is indicative of failure in the long term and will force Nu to go through some bloody shrinking of operations. T7, as you put it, is the cure by providing real long-term profits to keep people’s spirits up.

#14

I’ve largely avoided commenting on seeded auctions because I don’t understand this logic. Could you explain further? That statement would appear to be in direct opposition to my statement:

In a scenario where demand is decreasing and is forecasted to never again reach a new peak, the value of NuShares should be equal to its intangible assets (whatever the intrinsic value of its branding elements, the number of existing users as defined by Metcalfe’s Law, etc.). There shouldn’t be any additional value present in the price because future dividends would be expected to be zero.

If it is common knowledge the price of NuShares will benefit from increased NuBits demand, I don’t see how decreased NBT demand can also increase the price of NSR. A failing NBT peg would cause the NSR/NBT price to go up if, and only if, the valuation from NuShares was independent of NuBits demand. You cannot reliably back an asset with a derivative of itself.

Tier 7 has nothing to do with profits. It is a form of capital control that organizations like the IMF recommend using to mitigate currency collapses in times of demand decrease. Normal volume-dependent transaction fees (say 1%) are a form of profits; Tier 7 would exist when those fees are pushed to an extreme level that make transactions undesirable for a portion of users.

#15

There are two scales to consider, the short term and the long term. On the short term what we have to be concerned with is an NBT peg break causing an NSR black swan event. From the perspective of the auction, both the NBT and the NSR price would dive at the same time, meaning the NSR/NBT ratio would stay the same, or at least be higher than the NSR/USD ratio. On the long term we regain the peg but put continual stress on NSR and everything you say is true. However, in the long term our system is able to pass motions and adjust the Txn fee accordingly.

I’m confused by what you mean by capital controls other than volume-dependent transaction fees (which you say are profits and therefore not T7). Can you give an example?

#16

Volume-dependent (or any variable) transaction fees can be used as a tool for profit (at perhaps 1% Tx fee per transaction) or extended to a form of capital control (at 20%, 40%, 50% Tx fee per transaction). The percentage transaction fee that regular profits turn into capital controls is a matter of opinion, but you could perhaps argue that capital controls are in place once our transaction fee is set above our competitors.

This is why I am so enthusiastic about this concept:

Tier 6 requires us to sell an asset (NSR) at the bottom of its valuation to support NBT, requiring greater dilution. It requires us to trust a multisig group. It may require multiple auctions and multiple custodial grants to “mop up” all the excess NBT in a severe crisis, creating a disincentive to purchase NSR when the crisis first begins. Even in good times, Tier 6 threatens the perceived scarcity of NuShares because any investor knows the NSR supply could quadruple overnight. It is slow, it is centralized, and it is inefficient.

Tier 7 can be applied in whatever block duration it takes to adjust a transaction fee. It has no scalability limits, in that we could set up to a 100% transaction fee if needed. It requires no centralized trust of a multisig group. It improves the perceived scarcity of NuShares, which will increase the number of users advocating for our network. And, it is a tried and tested macroeconomic tool for currencies, just as interest rates (Tier 5) are. It is fast, it is decentralized, and it is efficient.

Unless I hear a compelling reason I will be introducing a motion soon to re-define Tier 6 as the application of “restricted network access” status through increased transaction fees. The motion will call for the burning of all NSR held by FLOT. The old Tier 6 has served its purpose as a final peg defense, but I believe a superior option is now available to our network.

#17

So you propose to increase our static fee in response to a peg break scenario? The response to our product losing value is to reduce its utility? That seems like a death sentence. To burn our NSR to try to achieve this is a step backwards from overall confidence in the peg. There is no way I would vote for such a motion given the details in this thread.

#18

As is your right, of course. Major changes are always controversial.

I would be interested in hearing more logic-based arguments against the case I’ve presented however, as I suspect you’re glossing over the materials I’ve introduced in favor of an emotional defense. What I’m proposing is exactly what professional economists would recommend if they ran a digital currency.

What specifically do you disagree with in my quote below? I’m interested in understanding your objections better.

#19

Sorry I have so many objections I’m having a hard time articulating.

  1. We aren’t ready. Static txn fees simply cannot make us the $$ we need. You’ll need to see fees like 100 nbt, long passing the point of being able to buy coffee with what we are calling a currency.

  2. It breaks some things. I’ll give you the fact that pools can burn as much nbt as they want in operation without significantly affecting the reward system (I.e. Nu can just give more nbt to the operator). However, the trusted address holders would have a much larger risk if they needed to hold a vastly larger amount of funds to do their job.

  3. Transactions on the blockchain are not transactions on exchange. If I can’t withdraw my nbt without paying a huge fee, you know what I’ll do? Sell it.

  4. Anonymity and security pays a huge price when you can’t freely move outputs around.

  5. Maybe I’m confused. If we spiked the fee to 100%, wouldn’t nbt (and therefore nsr) become worthless?

[Withdrawn] Motion to create a new Tier 6 (Restricted Network Access) of liquidity
#20

  1. Had to think about it. The tier model confused me at times as it consists of funds and mechanisms/policies. I had to readjust my view of it to make sense of it. The tier model is really a peg defense mechanism. In that context tier 7 as the ultimate mechanism makes sense.

  2. Refrain from answering this on. Don’t have a strong view and there are others who have a better understanding and more experience with this.

  3. I wouldn’t call it restricted access, capital control as you mention later is better. We should live in a free world, however scarcity always comes at a premium price. The proposal to slow velocity as capital control appears to be widely adopted in the financial world. The 100%+ reserve model is too expensive and involves a lot of ‘dead’ capital. I think the tier 7 policy should go together with say a 33%-50% reserve model (in tier 4 or 6?) to be able to manage the smaller bumps in the road without pain. Application of tier 7 will hurt (and cost) and therefore should only be used for the serious potholes in the road which threatens to stop the network in its tracks (losing the peg) when the reserves (shock absorbers) can’t take any more.

I don’t think it is too early to think about it as @MHPS raised and start preparing for it, see reasons below. We have seen a sudden increase in demand, it is not unusual that this temporarily turns around again. The market may test the peg sustainability before taking stronger positions.

I’ve seen the same turmoil. It was certainly not only NuDroid. The CoinOmi App and exchanges also had problems. Exchanges mostly work with fixed fees. When the fee is changing often exchanges won’t be happy as they would loose money or users won’t be happy because of excess fees until the exchanges have changed their process/wallets. We need to make sure the Apps, community/exchanges are prepared and take into account that funds and time may be required to implement this.

Selling NSR when it is not in demand is also a death sentence. We are talking about already having a serious problem and trying to come up with the best solution given the circumstances. I tend to prefer the capital control model. The challenge is to have adequate reserves. The tier 7 policy should only be executed to cover those unknown risks. The other tiers should cover the known risk to an affordable extent.

The fees should be adjusted to the amount. Exchanging 1 NBT might only cost 0.25 in a crises, but exchanging 10,000 NBT might cost 2,500 NBT and increasing exponentially.

Eventually we will be paying for going cheap on risks in the short term.

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