Intro to Economics Behind Nubits System

[Benjamin]

I have had a chance to resume work on my nubits analysis today. I find that I have much too much to write, so I prefer to break it into chunks.
This is a nontechnical introduction to Nubits that doesn’t use any equations, but covers some very important points.
I look forward to comments and discussion.

http://www.slideshare.net/benjamin_bit/analysis-of-custodial-system-introduction

[sportscliche]

This wasn’t the easiest essay to read and perhaps I’m missing something. Is the author assuming/claiming that the price of NuBits is largely backed by and/or linked to the price of NuShares? The liquidity provider custodians operating on the exchanges are backing NuBits with real fiat, not NuShares. If NuBits were indeed backed primarily by NuShares (a volatile crypto-currency), you’d have a system closely resembling Bitshares. De-coupling NuShares from NuBits is a central tenet of Jordan Lee’s white paper.

[Benjamin]

Yes, I am definitely claiming that nubits are ultimately backed by nushares.

USD reserves originate from sales of nubits and nushares by custodians.
The USD reserves are depleted through dividends less txn fees, interest paid on nubits, fees paid to custodians,
and potentially misappropriation by custodians.

If you look forward into the future, capacity to repay USD debt (nubits)
ultimately depends on whether

1. USD reserves could be replenished through sale of new issues of nushares.
2. nushares holders are willing to replenish USD reserves through sale of new issues of nushares.

If these conditions break down, the only source of funds available to repay nubits depositors
is money coming in from other depositers. In other words, the system becomes a textbook ponzi scheme.

It worries me quite a bit that this is not explicitly acknowledged in the Nubits white paper.
The fact that we would even need to debate this point is alarming.

[Sabreiib]

100% reserve and elastic NSR supply.

BTW, your article is quite long, can you summarize it?

[DavidMc0]

I’ll have to look at all this when I have some more time, but I don’t see how a currency peg, even if weak, could be described as a ‘textbook ponzi scheme’.

What textbook ponzi schemes aim to create a currency peg?

What textbook ponzi schemes promise stable value instead of market-beating returns?

However, I’ve not considered this on near the same level as you Benjamin, and I think it’s great to have very well thought through scrutiny, so I really appreciate what you’re doing & look forward to trying to use my limited time & brainpower to contribute to the debate.

As long as we’re all willing to be flexible in our understanding of the economics of NuBits, this kind of scrutiny & debate can lead to the strengthening of the system design.

[Raythma]

100% reserve and elastic NSR supply.

100% Reserve looks so secure, as long as we believe in USD $ purchase power sustainability, but many of us don’t.
Reserve scheme means moving the peg to other currency or basket of goods is practicaly impossible in case of emergency like hyper inflation crisis which may be near in the future.

[sportscliche]

Still not clear as to why it’s an obvious ponzi scheme. The point of NuBits is not to provide profit opportunity for early investors. Their sole function is to always and only equal 1 USD.

Is the existence of a fractional reserve the issue here? Does the presence of any unbacked NuBits qualify it as a ponzi? Certainly the system is vulnerable to a bank run if every holder simultaneously wants to convert back to fiat. In the early phase of implementation as we are in now, having a large liquidity reserve is very important. But as the system matures and the market gains confidence in the peg, the role of the custodians and exchanges should greatly diminish. Users will transact entirely in NuBits, secure in the belief that they can redeem their NuBits for fiat currency at an exchange if they deem it necessary. But will that be necessary? If NuBits gain wide acceptance for everyday commerce, the overwhelming majority of users will treat them as USD cash equivalent. It’s essentially the same goal that Bitcoin is moving toward (trusted currency for daily commerce), except this currency is tied to a value entity people can immediately grasp today – the USD.

In your earlier thread on the potential of a speculative attack on the Nu network, @tomjoad pointed out that NuBits are not backed by NuShares yet you continue to make this assertion. I copied this directly from the first page of the whitepaper:

“The solution is a network with two types of units which are not fungible: shares and currency. Shares represent ownership of the network and their quantity should not change to accommodate changes in the level of demand for them. If demand increases, the price should rise proportionately.”

[Benjamin]

ponzi scheme - an investment swindle in which some early investors are paid off with money put up by later ones in order to encourage more and bigger risks
http://www.merriam-webster.com/dictionary/ponzi%20scheme

The substance of the definition here is that early investors are paid off solely through money put in by later investors. As you describe above…

I had thought that implementation of nubits burning was on the agenda. If so, nsr could be used to pay off early investors in lieu of your proposed ponzi arrangement.
Burning addresses the system’s lack of long term sustainability, a problem openly acknowledged in the white paper.
Is burning still controversial? Is there a camp that favors a rigid supply of nsr?

[Ben]

Is burning still controversial? Is there a camp that favors a rigid supply of nsr?

I’m not aware of any faction within the community that has been vocal regarding an immutable supply of NSR. I expect it’s still on the table–at least, it is in my mind.

[woodstockmerkle]

I had thought that implementation of nushares burning was on the agenda. If so, nsr could be used to pay off early investors in lieu of your proposed ponzi arrangement.

The case for burning NuBits was framed as a way to reduce supply, to create scarcity, which in theory would drive prices higher.

What was the use case, benefit, and method for for burning NuShares? And what would the mechanism to decide which NuShares to burn? NuBits could be easy – shareholders would vote for a custodian to burn them.

[Benjamin]

sorry, loose language. You don’t need to burn nsr, just nubits. For nsr, burning is a substitute for dividends. Dividends work just as well. For nubits you absolutely need burning.

To be clear you need to issue new nsr to the custodian. The custodian then sells the nsr for nubits. And burns the nubits.
If you do this, nsr become backing for nubits. In central bank language, this is called an open market operation.

As long as you issue nubits in conservative quantities and burn liberally when the price of nsr falls, a peg could be sustained indefinitely.

[henry]

What a great article to read!. Thank you so much @Benjamin

I strongly support the role of burn nubits custodian, who is granted with NSR , buy and burn NBT.
I think it will be not so difficult to implement in Nu’s protocol.

one Question: 1. how to apply negative interest rate in current parking function. I think it should be compulsory, otherwise no one will park NBT to get punished by interest rate.

[dongshan]

I agree Hong Kong Monetary Authority is someone we can learn from.

http://www.hkma.gov.hk/eng/key-functions/monetary-stability/linked-exchange-rate-system.shtml

What about inflation-adjusted US dollar in future. It would be better to have investment profit on the foreign exchange reserve to cover the inflation rate.

[Benjamin]

Yes, I planned to write about the parking system later, but since you ask I’ll just cover it here.
In my view, interest rates should be universal across nubits. The parking system destabilizes nubits, serves no useful purpose, and should be abolished.
Parking creates a form of asset-liability mismatch, known as maturity mismatch or term mismatch. Term mismatch plays an important role in the collapse of fixed exchange rate regimes, e.g. the Asian Financial Crisis.

The value of assets in the nubits system are predictable in the short-term, but highly unpredictable over a longer time horizon. The debt structure of Nubits should match its asset structure.
Nubits should only issue short-term debt. The option of purchasing long-term debt by parking nubits should be taken off the table.

Since negative interest rates encourage Nubits holders to sell their Nubits for USD at parity now, they effectively allow shareholders to exercise a call option on short-term debt commitments. Prudent exercise of this call option would prevent the system from ever becoming overleveraged. The parking system allows Nubits holders to evade the call option. If a significant fraction of Nubits are parked, nushares holders could lose control of the debt to equity ratio in the system. In the face of an adverse price shock, this may lead to insolvency and a collapse of the peg.
http://en.wikipedia.org/wiki/Asset%E2%80%93liability_mismatch
http://en.wikipedia.org/wiki/Call_option

[Benjamin]

I don’t think issuance of an inflation-adjusted currency makes sense. In order for the Nubits system to be profitable for shareholders, we need a high velocity of txns in Nubits that can be milked for txn fee income. In short, we want to attract spenders to Nubits not savers. Ideally, savers should invest in nushares as part of a diversified portfolio.

It makes much more business sense to issue a currency with a relatively high inflation rate like the Chinese Yuan. Inflation means seignorage revenue for shareholders. This is the other possible source of income besides txn fees.

[tomjoad]

I don’t think issuance of an inflation-adjusted currency makes sense. In order for the Nubits system to be profitable for shareholders, we need a high velocity of txns in Nubits that can be milked for txn fee income. In short, we want to attract spenders to Nubits not savers. Ideally, savers should invest in nushares as part of a diversified portfolio

Agreed. I also think another important behavior of the “savers” target demographic is the establishment of a cryptoeconomy that promotes lending. I shared my thoughts in another thread here: Inflation-Protected Asset vs. Anti-Inflation Parking

Inflation-Protected Asset vs. Anti-Inflation Parking

The US government doesn’t offer “inflation-resistant USD” anymore, and neither should we. I’m not opposed to a secondary product being introduced that attempts something novel, but it should never replace the core product NuBits product we’re building. An “inflation-resistant” product would not strengthen the brand image as you suggest, nor is there any evidence whatsoever that market demand would increase.

Introducing an “inflation-resistant” product as our sole offering would confuse the market, kill the point-of-sale simplicity that we’re marketing ourselves on (1.00 NBT = $1.00 US), and complicate the process of using NuBits. It is a much less simple solution.

Inflation-Protected Asset vs. Anti-Inflation Parking

I am much more in favor of continuing to develop the Nu ecosystem to the point (in a few years, likely) where lending is possible through projects like the Cryptocurrency Bank (https://www.cryptocurrency-bank.com/). A moderate 1-3% inflation rate is already present in NuBits because it is tied to US federal monetary policy. If you want to avoid that inflation, you should be investing in projects that offer a return on capital above that rate. Trying to build it into the protocol is artificial and inefficient.

In short, we should not be artificially deflating our product 1-3% per year. We should be encouraging the establishment of formal, legitimate institutions (such as cryptobanks, or DAC’s that offer corporate bonds) that will pay users that 1-3% (or likely higher) interest in exchange for their funds. That is how a cryptoeconomy with an active money supply is built; users should be forced to avoid inflation by active investing, not passive hoarding.

[tomjoad]

To be clear you need to issue new nsr to the custodian. The custodian then sells the nsr for nubits. And burns the nubits.If you do this, nsr become backing for nubits. In central bank language, this is called an open market operation.

How do you see this solution improving on the current NBT-for-NSR burning proposal offered by Jordan, where burn rates are voted on by shareholders? Isn’t the final outcome essentially the same (increased NSR, decreased NBT), except with Jordan’s proposal the solution is built directly into the protocol (as opposed to trusting a custodian to burn the required amount of NBT)?

[mhps]

Excellent discussion. My confidence in Nu community increases as a result.

[Sabreiib]

In short, we should not be artificially deflating our product 1-3% per year. We should be encouraging the establishment of formal, legitimate institutions (such as cryptobanks, or DAC’s that offer corporate bonds) that will pay users that 1-3% (or likely higher) interest in exchange for their funds. That is how a cryptoeconomy with an active money supply is built; users should be forced to avoid inflation by active investing, not passive hoarding.

I disagree. When I deposit my money with 1-3% interest, I can’t use it at my will until I take it back.
This is meaningless, what I want is a good money which is of constant buy power and ready for spend at any time. Who gives “ Federal Reserve” the power to dilute my money? I get my salary because my hard work in the past, my work was worthy of a certain buying power, if I just hoard my money, its value should neither increase nor decrease. I do nothing, so nothing should happen to my money, why should I get punished when I do nothing?

[sportscliche]

In my view, interest rates should be universal across nubits. The parking system destabilizes nubits, serves no useful purpose, and should be abolished.

By universal do you mean fixed? If so, then this creates the Impossible Trilemma that prevents a currency from simultaneously achieving a peg to a second currency (in this case the USD), free capital flow, and fixed interest rates (monetary policy). The Nu network must have the ability to dynamically adjust parking rates in response to changing external conditions. Far from serving no useful purpose, parking is essential for Nubits’ survival.