I am working on an economic model of the nubits system.
I thought I would share my progress with the forum.
I’d like to know what parts of the document are hard to understand.
Where do you need more explanation?
What is not useful?
What are the questions you would like answered?
I’ve read through the paper once and am collecting my thoughts before responding. It’s greatly appreciated that you took the time to formulate an analysis using proper economic equations and theories @Benjamin, thank you.
Alright, here’s my first take on your analysis. I’m sure it will become obvious that economics isn’t my area of expertise. Hopefully my response will provoke a few questions that help the community understand your analysis better.
My first impressions are that much of your analysis has been covered in various threads here, albeit from a less technical viewpoint. It was certainly helpful to see the equations you generated and their underlying assumptions. I’ll choose to focus my response on your four ending implications:
The system can degenerate into an unrecoverable state if the reserve ratio falls to too low of a level. Interest rate changes become completely ineffective in this case.
As you state, your Equation 12 “implies that an increase in the interest rate can actually decrease demand for NuBits under certain circumstances. When the reserve ratio is very low, the perceived probability of collapse can be very sensitive to the interest rate. Due to the sensitivity, an increase in the interest rate could cause negative effects on expectations that outweigh the attraction of a higher interest rate”.
Have you given thought to how this reconciles with Jordan’s belief that “As this outcome (the collapse of the $1.00 US peg) approaches, NuBits will shift from the hands of ordinary businesses and people into the hands of speculators tolerant of high risk in exchange for possible high rewards”? Ie. Does your technical analysis assume that there are uniform expectations of NuBits’ future utility across all users? I believe you use the symbol p to quantify the risk of collapse; is it the same for all users?
Nubits should target an explicit healthy reserve ratio range. This is just as important to Nubits viability as maintaining USD parity. In fact it can be more important. A fall from USD parity would likely be a temporary situation. Once the reserve ratio falls to an excessively low level, it could be very difficult for nubits to recover.
This area of the paper (pages 6-7) I had a bit more difficulty following. In general I follow the logic of using “central bank assets’ and “central bank liabilities”. However, I’m not sure how the USD market capitalization of NSR factors in. I assume “central bank” in this case refers to the collective mindset of NSR holders as a homogeneous unit.
I’m having difficulty wrapping my head around the idea of NSR being an asset independent of the value of NBT. The future value of NSR should be defined as [(discounted flow of future dividends) + (intangible assets)], where intangible assets are whatever value an investor would place on the existing community, branding properties, websites, etc. In any adverse scenario where NuBits demand is expected to permanently decline, NSR should become worth only as much as the intangible assets present. This would imply a very low reserve ratio by default when NBT approach the end of its life, meaning the “bank” would not have the power to enact much change. This is the same concern I shared in the NSR-for-NBT Burning proposal presented to the community that is very similar to your proposed mechanism.
I’ve advocated in a separate thread an idea of maintaining close to 100% USD reserve ratio, with the only dividends paid out as funds that have been “lost forever” :
My summary point for this insight: isn’t it more appropriate to ignore the market capitalization of NSR, and instead simply mandate a close to 100% USD reserve ratio (minus whatever NBT are “lost”) that is aided by the currency-deflating power of variable transaction fees? In my example above the speculative risk is maintained with NSR holders.
Interest rates increases are most effective at supporting prices of nubits when the reserve ratio is quite high. You might want to use interest rates to offset a temporary shortfall in demand for nubits. Such a temporary shortfall would not have much effect on the price of nushares, but could lead to pressure for nubits to fall below parity. Interest rate increases are appropriate in this case.
Agreed, Jordan has said as much in his discussion on Price Stability (https://nubits.com/about/price-stability) that interest rates are most effective in offsetting a temporary (not permanent) demand in shortfall for NuBits.
Interest rates are also useful as a temporary incentive to get new users to try out nubits. Provided the reserve ratio is high enough to support this. A temporarily high level of interest on nubits might be a good means of expanding the user base. For example, when paypal first formed they offered new users 10 USD for free to expand market share. Nubits could achieve this by offering new users high interest rates as a temporary promotion. As long as high interest rates are temporary and the reserve ratio is monitored carefully, such an incentive would not compromise the sustainability of nubits.
Also agreed. We used this promotional interest strategy way back in September for a brief period, outlined here: Park Rate Voting.
My primary question for you after reading this analysis – assuming I’ve understood everything correctly – is what you feel needs to be modified in our current design?
From what I can tell, all your implications and recommendations are possible with a shareholder policy in our current design of:
A 100% reserve ratio rate of USD (side note: not sure why you say “maintenance of a large USD reserve is also unprofitable” - surely for a custodian holding NSR it increases the future projected value of their holdings if the network is more stable?)
Dividends only paid out from “permanently lost” NuBits
Funds lost to exchange default are covered from planned shareholder dividends, to properly penalize NSR holders for their poor choice of network exchange
Variable transaction fees to provide currency-deflating support for the 100% reserve ratio rate
Promotional interest rates in the beginning stages of the network
Parking rates as a short-term incentive to bolster demand in periods of modest demand contraction
My apologies if I’ve read anything incorrectly, it was a fairly technical paper to work through. I hope to read your analysis of the role of transaction fee policies in maintaining stability of the reserve ratio and exchange rate (as you note at the end of your paper) soon.
[quote]Nushares and USD held in reserves are very dierent in character. Essen-
tially, as long as 1 USD is held in reserve for every nubit, there is no risk of a
collapse in the system.[/quote]
It seems you agree that 100% reserve is strong enough.
[quote]Interest rates increases are most effective at supporting prices of nubits
when the reserve ratio is quite high.
Nubits should target an explicit healthy reserve ratio range. This is just
as important to Nubits viability as maintaining USD parity.
The system can degenerate into an unrecoverable state if the reserve ratio
falls to too low of a level. Interest rate changes become completely ineective
in this case.
Interest rates are also useful as a temporary incentive to get new users
to try out nubits. …As long as high interest rates are temporary and the reserve ratio is monitored carefully, such an incentive would not compromise the sustainability of nubits.
The expression above Equation 2 (line 2 of page 2) is not right. It is not equal to the expression in the line above it. Will this affect your conclusions?
It would make your paper easier to read if you give an intro section including relevant background, intention, and a summary of the overall structure of the paper, and define/expplain the symbols as they appear in the body.
oops. It is actually equation 1 that is wrong (missing a “1+”) on the lhs. The subsequent stuff from eq 2 onwards should be fine.
Thanks for the reminder about an introduction and relevant background. I always do that as a last step. Otherwise I don’t know exactly what I will be introducing. I will put in the definitions of terms.
I think we can close the discussion for the time being an reopen it when I complete the draft.
I will probably just post the completed draft in a new thread. Otherwise, accumulated comments get unmanageable.
Thanks for the comments everyone, very helpful.