Some Suggestions To Eliminate Peg Maintenance Expenditures

[tomjoad]

I see several potential problems that perhaps you can answer or clarify.

What happens when demand for NuBits decreases by more than 1% in a 24 hour period? Unless I’m mistaken we could see NuBits lose its peg by a large percentage for days or weeks at a time in the event of a demand collapse like we saw in February with the exchange hackings. This would ruin our perceived product quality, and negate one of our primary competitive advantages over competitors like BitUSD. This approach also reduces the flexibility of the network to quickly respond to serious demand shocks because of the 1% limitation. An automated auction solution should be able to respond flexibly to varying degrees of demand variance.

What happens to users who are working or unavailable to participate during the auction period because of the time zone they live in?

More broadly speaking, do shareholders have the attention span to monitor daily auctions? What happens on holidays or periods of lower shareholder participation? This requirement to be at your computer every single day would be a negative utility for NuShareholders, and would negatively impact share price. Yes, users would not have to participate in the auctions, but most would realize that their share of equity will tend to decrease over time if they are not acquiring NuShares on days where the auction price is below the market value.

What does “1% of the outstanding NuBits supply” mean? How is this reliably measured? Would this be all NuBits in existence, minus those held by custodians? Wouldn’t there be a serious possibility that custodians could game the auction by reporting their totals inaccurately?

I’m concerned this approach turns NuBits into an inflexible derivative of NuShares that will damage the perceived quality of our product by allowing long periods of time with no peg maintained. I’m also concerned that it would damage the value of NuShares.

I’m still in favor of an automated burning auction solution, but I don’t think this is the correct approach. Burning as designed within our network is a last line of defense against the collapse of a currency, not a daily tool for us to use in liquidity operations.

Slightly off-topic but relevant: I would love to see us design tools and programs that monetize Metcalfe’s Law, such as the network being paid for advertising. For example, if nubits.com or this forum ran commercial advertisements in the future, that revenue could be placed directly into liquidity support. The more users we have on our websites, the higher the liquidity subsidization that could occur. A perfect future would be one where the collective attention span of our users is monetized in ways that continually support our liquidity operations. YouTube and Facebook have realized that free products attract users, and the attention of those users is immensely valuable to advertisers. It’s only a matter of time before a cryptocurrency project figures that out.

[Nagalim]

Many powerful concerns, now we’re talking.

What happens to users who are working or unavailable to participate during the auction period because of the time zone they live in?

per week? The auction period takes place over the entire week so timezone and weekly flows are irrelevant (Just send whatever funds you want to participate to a certain address, could even be a burn address honestly).

What happens when demand for NuBits decreases by more than 1% in a 24 hour period?

If no one submits anything to the auction, everything gets burned.

(Sold + Seeded Nubits) / (Sold + Seeded Nushares)

not a daily tool for us to use in liquidity operations.

Burning is now a weekly thing we do, we already passed that motion.

lose its peg

Keep tllp’s. I see this as a way to balance the market, not provide liquidity. However, interesting point about attention spans, we clearly need projects like @henry’s at this stage.

What does “1% of the outstanding NuBits supply” mean?

We can just use “in existance” and decrease the percentage (like 0.1%?)

the 1% limitation

The interesting point here is that the NSR auction seed is determined by the previous auction. The first auction we would have to set the price, but that’s a triviality in my opinion. The 1% limit prevents the NSR price from moving quickly in a demand shock, so I agree we should be careful about getting zealous with it.

0.1% of NBT is: $889.096
We would auction off $889.096 of NBT or NSR per week (+user funds). That seems reasonable to me.

[Benjamin]

Okay, here is a response to at least this question. I think I’ll need a new post for the other ones.
.

What happens when demand for NuBits decreases by more than 1% in a 24 hour period?

First, let’s describe the mathematics behind the system. Assuming that supply fully responds to demand eventually, market incentives will set a floor on the Nubits price.

To show how this works, let’s first break down demand for Nubits into two components.

Demand for Nubits = Demand for Txn Purposes + Investment Demand

In the long-run, we would like to achieve:

Supply of Nubits = Demand for Txn Purposes
Investment Demand = 0

In the medium-term, investment demand comes in to absorb excess nubits supply. The interest parity condition describes an equilibrium price, where investment demand = investment supply.

To set up the interest parity equation, let’s assume the following:

a) speculators demand a risk-adjusted return of R% per month for holding Nubits
b) park rates are I% per month (where I < R)
c) Supply exceeds txn demand. It will take approximately T months of daily nubits burning to reach the long-run supply necessary for exact parity.

Under these assumptions, if the current market price of nubits is P, the expected rate of Nubits appreciation will be (1/P)^(1/T)-1. This is a source of returns for investors.

Investors will also get a monthly return I from the park rate, so that the total rate of return from investing in Nubits will be I + (1/P)^(1/T)-1
(Note: This is actually an approximation.)

The current equilibrium price, P, sets the sum of these two returns equal to R and is given by the following equation:

R = I + (1/P)^(1/T) - 1

Solving for P yields:

P = (1+ R - I)^(-T)

So P is decreasing in T. All else equal, the longer it takes to adjust supply, the lower the current market price will be.

P is also decreasing in R. All else equal, the larger the risk premium on Nubits, the slower investors will be to respond to a deviation from parity.

P is increasing in I. Note that the park rate, I, compensates investors for risk. The system achieves an better and better parity as I approaches R and perfect parity if I = R.

Okay, now let’s think about some implications of this:

1. We don’t necessarily need to respond immediately to demand fluctuations immediately to maintain parity. There is always have some floor on the equilibrium price.

2. If deviations from parity are unacceptably large, we can address this by adjusting the park rate.

3. 1% a day is quite an extreme change in demand. If we see changes like this, I think it indicates excess other problems that we should try an address directly (e.g. hacked exchange risk is a consequence of the existing custodial system, volatile demand from BTC speculators is due to a costly attempt to maintain BTC liquidity). If we were actually serving a demand for consumer txns and payments, we would almost never see demand movements in excess of 1% day.

4. The design is compatible with ongoing use of liquidity custodians should they prove necessary. That is, one could still intervene using existing mechanisms in the event of a large deviation from parity. The effectiveness of the design increases as R falls and is accordingly likely to improve as Nubits gains more traction.

[Sabreiib]

What benjamin suggest is to let NSR holders provide liquidity by NSR/BTC dual direction auction, I like this direction of NSR do the work by ourselves. But some qeustion about the implement:

1. auction is risky, I may lose a lot due to the uncertian of price. What if only few NSR involved in this auction? Would you put yourself in risk to save the NSR public? tragedy of the commons

2)auction is late. Agree with the tomjoad that the auction is the last resort. When NBT is obviously higher/lower than 1 dollar.(0.9 or1.1) Our reputation ruined, the system failure probility is very high because we mantain strict peg, if NBT reach 0.9 USD, we have not enough reinforcement. The NSR is the most unreliable asset when peg in danger, the more you need it desperately, the lower of its price.

People will shout with panic"the bank cannot aford our deposite, they are liars, fraud, let’s bank run!"

And you say to them"hey, our bank share is wealthy, would you transfer your FIAT into our share?"

…

[Benjamin]

What happens to users who are working or unavailable to participate during the auction period because of the time zone they live in?
More broadly speaking, do shareholders have the attention span to monitor daily auctions? What happens on holidays or periods of lower shareholder participation?

These concerns are kind of odd. If there are very few participants, these lucky few will be able to pick up free money. If there are many participants, returns from participation will fall to zero.

This requirement to be at your computer every single day would be a negative utility for NuShareholders, and would negatively impact share price. Yes, users would not have to participate in the auctions, but most would realize that their share of equity will tend to decrease over time if they are not acquiring NuShares on days where the auction price is below the market value.

Again, this seems quite odd to me. Not everyone needs to do this, just a limited group of people who enjoy day-trading. To me this seems like an excellent way to attract a new group of Nubits enthusiasts.

In regards to inflexibility of supply adjustments, this is intentional. If you hold an auction every day using consistent rules, then a stable community of participants will develop. This will help develop a consistent level of liquidity in the nushares market.

If you instead try to sell large amounts at irregular intervals, you will exhaust nushares liquidity and cause the price to tank. That’s really bad for two reasons. Firstly, it undermines the effectives of the burning system. Secondly, it imposes financial losses on shareholders.

A third reason why rapid responses do not make any sense is due to lags in the response of price to money supply changes. The market does not know exactly how much of a supply change is needed and needs time to sort this out. Reacting too rapidly will lead to excessively large supply adjustments and oscillation of market prices. An analogy is control of a car using a steering wheel. Move the wheel too rapidly and you lose control of the car.

What does “1% of the outstanding NuBits supply” mean? How is this reliably measured? Would this be all NuBits in existence, minus those held by custodians? Wouldn’t there be a serious possibility that custodians could game the auction by reporting their totals inaccurately?

1% of all the Nubits in existence, including those held by custodians.

I’m concerned this approach turns NuBits into an inflexible derivative of NuShares that will damage the perceived quality of our product by allowing long periods of time with no peg maintained. I’m also concerned that it would damage the value of NuShares.

I’m still in favor of an automated burning auction solution, but I don’t think this is the correct approach. Burning as designed within our network is a last line of defense against the collapse of a currency, not a daily tool for us to use in liquidity operations

Hmm, that’s discouraging. Wouldn’t it make sense to discuss this more thoroughly before coming to such a firm conclusion? For the most part, your concerns don’t make much sense to me. In particular, given that the existing system could still exist along side this, your argument that adoption of this mechanism would pose an unacceptable risk is not at all persuasive. Even if it fails completely, custodians could still support the peg using existing tools.

[Benjamin]

I think describing a timeline will help clear things up participation concerns.

Day Before Auction

0:00 - 23:00 Voting on whether Nubits or Nushares will be seeded in the auction held on the following day.
23:00 - 24:00 Participants observe vote outcomes and learn the type of asset that will be seeded in the auction.

Day of Auction
0:00 - 23:00 Participants can submit Nushares and Nubits for sale in the auction. These submissions are included in blocks mined between 0:00 and 23:00
23:00 Final Auction Block is mined. Auction sales close. Nushares and Nubits are returned to auction participants. Nubits/Nushares accruing to seeded assets are burned.

Optimal Strategy:
You can actually solve for exactly what should happen in each auction block if market participants play the game optimally. It’s a bit messy, so I’m not going to do that here. Instead I’ll focus on two things:

1. a safe strategy for playing the game if you are not a miner
2. the optimal strategy for the miner of the final block

If you are not a miner, then you don’t know if your txn will get included in a block. You can potentially get taken advantage of if both of the following are true.
a) You submit a nushares/nubits to the auction too late, allowing an individual miner or group of miners to control whether these are included in the auction.
AND
b) The proportion of nubits and nushares you submit differs from the current market price.

A safe strategy is therefore too:

1. Observe the current market price of Nushares in terms of Nubits, call this p_0.

2. Submit np_0 Nubits and n Nushares to the auction in a single txn.
   Suppose the closing price of the auction is P. Using this strategy, you will end up with np*(P/p_0) nubits and n*(p_0/P) nushares.

3. Now consider the final miner. He can control the closing price of the auction by submitting the final sales. Suppose that the final miner observes a market price of nushares, p_1, and that the total qty of seeded+sold NSR and NBT in prior block are S and B, respectively.

If the final miner sells x_S NSR and x_B NBT, then his total expenditure in terms of NBT is x_Sp_1+x_b.
His revenue from the auction is
x_S(B+x_B)/(S+x_S)+x_Bp_1(B+x_B)/(S+x_S)
Therefore his profit function is
x_S*(B+x_B)/(S+x_S)+x_Bp_1(S+x_S)/(B+x_B) - x_S*p_1+x_B

You can maximize this expression to see what he will do, I’ll fill in that later because I need to put this aside for now.

The miner in the second to last block will use this equation to guess what the last miner will do. This will cause him to participate, capturing some of the profit.

The miner in the third to last block will predict what the last two miners will do allowing him to capture some of the profit.

Continuing this recursion allows you to solve for optimal behavior of every single miner.

Anyways, the broader implications of this are as follows:

1. There are strong economic incentives to participate if the auction price deviates from the true market price.
2. Participation causes the auction price to move progressively closer to the true market price.

[mhps]

Even if it fails completely, custodians could still support the peg using existing tools.

1. There are strong economic incentives to participate if the auction price deviates from the true market price.

If custodians work as planned, wouldn’t the auction be profitless therefore attracts few participants ? If true, the auction will only be meaningful when custodians’ peg fail, so it becomes an automatic safety net for LPCs. This is interesting. It is a stand-by tier of liquidity even we don’t give up shareholder-funded market makers (LPCs).

[Benjamin]

Sigh… no. Entering the auction is always profitable. I don’t understand why you would expect the peg or the existing custodial system to be relevant to auction profits in any way.

I envision it the other way around by the way. The price band used in the existing custodial system would be widened to say 0.98 - 1.02. The auction would be used to ensure that the average price is 1 USD.

[Nagalim]

If we add custodians in, we really want to talk about equilibrium from the perspective of the custodian. In this perspective, there is a risk of not getting compensated in the dutch auction (more compensation than park rates). If the buy and sell targets are equal, the risk is something like buy side liquidity / sell side liquidity. This creates a virtual price for custodians that has all the properties mentioned for a real NBT price. The auction volume will be dominated by NSR speculators and NBT custodians, and will help custodians directly hold the peg by leveraging NSR speculation.

[Benjamin]

Why would you want custodians to participate in the auction? What function would this serve?

[Nagalim]

If a custodian has too much sell side liquidity and not enough buy side liquidity, what should they do? Their actions reflect on the network. If they send NBT to the auction and the network is also feeling like NBT should be burnt, they will be given NSR based on both a seed and market factors. This seems to me like a great method of providing what’s essentially a decentralized burn grant for Nu-aware daily traders that make use of the liquidity pools.

[masterOfDisaster]

I like your way of thinking, but my understanding is that it wouldn’t work with TLLP pools, because the pool operator has no access to the funds. And @Henry’s NuLagoon pool is designed to manage funds, but participants receive the type of fund back they deposited.
This design would work well with liquidity providing by the Nu network directly (with Nu funded liquidity) which for good reasons Nu wants to get rid of.

I think @Henry might be able to offer a pool where participants need to provide an NBT address as well as an NSR address and agree to receive either NBT or NSR.
It would be up to NuLagoon to participate in auctions.
In this pool participants wouldn’t know what they receive when they want to withdraw funds, but they could make guesses based on the liquidity situation.
Effectively such a pool would provide the market with a NBT-to-NSR conversion mechanism.
I don’t know to what level this would be used (considering the incalculable outcome) though.
In difference to participating in auctions it would be a convenient way - just like the overall experience with NuLagoon.

[mhps]

@Nagalim and @masterOfDisaster explained what I had in mind. I see @Benjamin’s proposal as a protocol-facilitated dual-directional transfer of NBT and NSR value to maintain the peg. The traditional LPCs will be among the most active auction participants since they are the first to know the health of NBT peg.

Without LPCs and pools, NBT peg solely supported by auction will be like bitUSD, not very useable as a currency due to shallow liquidity arround the peg price. Therefore I don’t think LPCs and pools will disappear before NBT adoption brings organic deep liquidity to the exchanges.

[Benjamin]

Still confused. Couldn’t custodians just as easily trade NBT and NSR on traditional exchanges? Regardless of whether trades happen in the auction or on a centralized exchange, the outcome is exactly the same.

Support for the peg here comes from seeding the appropriate currency based on the voting outcome. The people who need to be informed about what to do are the miners. Everything else and everyone else is more or less irrelevant.

[masterOfDisaster]

Support for the peg here comes from seeding the appropriate currency based on the voting outcome. The people who need to be informed about what to do are the miners. Everything else and everyone else is more or less irrelevant.

That’s the beauty of this proposal.
It’s creating a much more direct link between the real-world and Nu.
It’s providing the required information to obtain the exchange rate.
It will allow (on protocol level!) to define the exchange rate for converting NBT to NSR or NSR to NBT depending on the market / peg situation.

[Nagalim]

The people who need to be informed about what to do are the miners

Tllp participants are just Nu-aware day traders in my mind. We don’t need to inform them, they will inform themselves and will act as free market agents in this auction. I am not proposing any actual changes, I’m simply saying that the peg balancing concept of this auction works even without a real price fluctuation in time because of the virtual price imposed by having targets on our tllp’s.

the pool operator has no access to the funds

Huh? The pool operator isn’t participating in the auction, the individual tllp participants are, at their own will and leisure.

Couldn’t custodians just as easily trade NBT and NSR on traditional exchanges?

There is no NSR/NBT market with real liquidity. There are barely any NSR markets with real liquidity. The point is that most people in the open market don’t know about the things Nu has to offer, like auctions and tllp’s. “Custodians” are simply people that are aware of the tools of peg balancing Nu has to offer and utilize them to keep the peg and make a profit doing it. Let the normal, Nu-naive trader simply speculate on NSR/NBT on the market, while the custodian speculates on auction outcomes and liquidity provision rates.

It will allow (on protocol level!) to define the exchange rate for converting NBT to NSR or NSR to NBT depending on the market / peg situation.

This is my understanding of why this auction concept is so useful. Note that we can use this daily exchange rate definition in future grant proposals to give a dynamic way of valuing NSR in terms of NBT.

[Nagalim]

Thought experiment assumptions:
A) There is only one exchange with one nsr/nbt pair on it.
B) The tllp there has a 10 nbt dual side target and 0.1%/day compensation
C) Lucy is the only person who uses tllp, and she is providing dual side support of 10 nbt to each side.
D) Market demand for nsr is exactly $0.1.
E) Nu prints $0.1 nbt daily and there are 100 nbt in existence, 80 of which are in the hands of trusted people (not including Lucy)
F) There is 0 market demand for nbt.

Every day, people will submit to the auction with a 10:1 ratio of NSR:NBT. This is because market demand is exactly $0.1 and nbt is pegged to $1, so if the auction price deviates from $0.1 at all and you submitted 10:1, then you win.

People sell some NBT to lucy for her NSR, but they sell it onto her wall, so she gets the NBT cheap from her spread. So let’s say she lost 10 of her 100 NSR and gets 1.01 NBT in return. She now puts that 1.01 NBT up to auction.

So now the auction, feeling the low NBT demand, seeds 10 NSR. People submit let’s say 30 NSR and 3 NBT. Lucy submits 1.01 NBT. The auction closing price is: 4.01/40 = $0.10025. Lucy receives 9.97 NSR which she puts back up on the buy wall. As long as this only happens every 3 days, she makes money off this process via the custodial grant.

The result of this is that Nu gets to sell its NSR directly to Lucy for relevant prices without having to trust Lucy at all. This is exactly the intent of our current weekly auctions. Here it works beautifully and uses the tllp incentive as a direct financial consequence of not using the auction to balance the peg.

[Benjamin]

There are barely any NSR markets with real liquidity

Didn’t realize things were this bad and now I think I see your point. That greatly strengthens the case for this proposal. Liquid NSR markets are necessary for any form of NSR burning to work well.

The proposal would create a liquid NSR market.

[mhps]

@Nagalim
There are barely any NSR markets with real liquidity

Didn’t realize things were this bad

It’s a side effect of voting-by-minting, dividends, and perceived appreciation potential.

[Sentinelrv]

Didn’t realize things were this bad and now I think I see your point. That greatly strengthens the case for this proposal. Liquid NSR markets are necessary for any form of NSR burning to work well.

The proposal would create a liquid NSR market.

I read a recent quote by @JordanLee that the parametric order book update in NuBot will help increase liquidity for NuShares.

Edit: Here is the quote from bitcointalk on May 13th…

Parametric order books are being implemented in NuBot right now, and when it is released I expect we will bring liquidity to NSR/NBT pairs. It won’t be deep liquidity at first, but it will be an improvement.