Speculative Attack on Nubits

[Benjamin]

Nushares/Nubits is vulnerable to speculative attack.

Currently, there are about US$2 million worth of nushares outstanding and US$2 million of nubits outstanding. This is alarming.

To see why, suppose that I am a rich guy (or group of guys) with $4 million in BTC at my disposal.
I decide to make some bank by bankrupting the nubits system. Easy. Here’s how.

1. I put up a request to borrow up to 1 million nubits at a 50% annual interest rate. To back up my loan with collateral, I put up $2 in BTC at current prices for every $1 in nubits I borrow. If I don’t send $1.50 in nubits within the space of a year, my BTC collateral reverts to the creditor. Think of this as some type of smart contract enfoced through cross-chain trading.

2. Nubits holders takes me up on my offer en masse fulfilling my order for a loan of 1 million nubits. If I pay my debt back, then they convert 1 Nubit this year into 1.5 nubits next year. If I default, they convert 1 Nubit this year into $2 worth of BTC next year ($2 refers to the value of BTC at current prices). This is a win-win for an individual Nubits holder. Collectively, however, we will see that things turn out bad for nubits holders.

3. I sell the 1 million nubits I borrowed for USD. Dumping this many nubits on the market will break the peg, Is there a credible way for nushares holders to defend the peg?

4. The only ways of supporting the price of nubits are
   a) beating my offer of 50% interest by offering more than 50% to people who park nubits.
   This is not a credible long-run defense. If everyone expects the peg to hold after the interest rate increase, I could respond by simply parking my nubits and paying back my creditors at a profit. The nubits system, on the other hand, would get screwed. Next year we would have $3 million in nubits outstanding instead of $2 million. The system would be on even shakier ground than it is already. The next guy who attempted to bankrupt the nubits system would have an easier go of it. Hell, that would likely be me trying again next year. Eventually, I or someone else would succeed.

b) ‘burning nubits’ by allowing holders to convert them into nushares
This could be a credible defense, if the nubits central bank was run-well. But as things stand now, it is being run blindly. The ratio of value in nubits to value in nushares is much too high to be sustainable. Nushares holders would have to burn $1 million worth of nushares to offset all of the 1 million nubits I put up for sale. Selling this many nushares on the market at once would severely depress the price of nushares. There is no way one could obtain $1 million worth of revenue from burning nushares all at once.

5. Since both defenses are not credible, I will not be able to sell all of my 1 million nubits at a price of $1. Instead, the price of nubits will drop well below $1 due to the selling pressure I generate.

6. Once nubits have fallen off the peg for a sustained period, their price will go into a downward spiral. Since I began selling nubits at parity, the USD revenue I net from sales will greatly exceed the new market cap of nubits. I will use some of my USD revenue to buy up 1.5 million of the now nearly worthless nubits. I use these worthless nubits to repay my debts. The rest of my USD revenue I get to keep. They are my reward for breaking the nubits bank.

Solution: Target a long-run sustainable ratio of value held in nubits to value held in nushares. Something like 1 to 20, 1 to 10, or 1 to 5 seems appropriate to me. Maintain this ratio by issuing nubits when there is too little value in nubits and burning nubits when there is too much value in nubits. If the nubits price falls below parity or rises above parity at the target ratio, adjust the price by changing the interest rate on nubits. The necessary interest rate could potentially be negative in theory (but would likely always be positive in practice). Offer interest not just on parked nubits, but all nubits. Do away with this idea of parking nubits altogether (it creates debt overhang making the system unstable).

I have said my piece. I will only communicate further via private communication with the head developer Jordan Lee I believe. For personal reasons that I prefer to keep private, I cannot enter into any further public discussion about this. If the developers choose to sit on their hands on this, that is up to them.

[masterOfDisaster]

ad 3)
selling NBT for less than 1 USD in a higher amount than the buy walls can eat, might endanger or even break the peg - but only the sell side!
This will lead a self-regulating situation. NuBits users already know that buying 1 NBT for less than 1 USD is a winning trade, because they can immediately sell them to the buy walls which are not affected by this attack. The price is expected to stabilize (or even stay stable) at 1USD.
Maybe I missed something or this attack is not very dangerous at all.

[mhps]

3. I sell the 1 million nubits I borrowed for USD. Dumping this many nubits on the market will break the peg
   …
4. Once nubits have fallen off the peg for a sustained period, their price will go into a downward spiral.

For every Nubits in circulation there is ~$1 in NuNet, which was paid by the initial buyer of that Nubits to the Nu bot. The only outstanding NuBits that are not backed by USD are some development fund, payment to custodians for their services, and park interest. These funds are relatively small. You will have to sell, I guess, 96-98% of all NuBits in cirulation to sustainablly break the peg. Everyone who realizes how hard this is will buy up NuBits at bargain prices when you break the peg at one of the bots, where the peg will go up again inevitablly (and quickly, depending how quickly the LPC and arbitrageurs reacts).
The net effect is that your selling will enrich the buying Nu believers, arbitrageurs and speculators, and you will exhaust your fund and lose your collaterals.

[tomjoad]

To see why, suppose that I am a rich guy (or group of guys) with $4 million in BTC at my disposal.I decide to make some bank by bankrupting the nubits system. Easy. Here’s how.

It’s always a red flag to me when someone labels a financial attack as “easy” but yet nobody has tried it. But let’s play through your scenario for academic purposes.

1. I put up a request to borrow up to 1 million nubits at a 50% annual interest rate. To back up my loan with collateral, I put up $2 in BTC at current prices for every $1 in nubits I borrow. If I don’t send $1.50 in nubits within the space of a year, my BTC collateral reverts to the creditor. Think of this as some type of smart contract enfoced through cross-chain trading.

Sure, let’s pretend this agreement has been made.

2. Nubits holders takes me up on my offer en masse fulfilling my order for a loan of 1 million nubits. If I pay my debt back, then they convert 1 Nubit this year into 1.5 nubits next year. If I default, they convert 1 Nubit this year into $2 worth of BTC next year ($2 refers to the value of BTC at current prices). This is a win-win for an individual Nubits holder. Collectively, however, we will see that things turn out bad for nubits holders.

3. I sell the 1 million nubits I borrowed for USD. Dumping this many nubits on the market will break the peg, Is there a credible way for nushares holders to defend the peg?

Right now there’s somewhere between 100K - 200K of active NBT in circulation. Maybe more, maybe less; the custodians would have a better idea. 2M is the amount of the first custodial grants given to KTm and Jordan Lee.

If NuBits holders take you up on this 1M loan offer, that means 800K - 900K of new NBT are entering circulation after being purchased by users. These new NBT are paid for with USD funds that are now held by a custodian.

When you try and immediately sell 1M NBT, two things happen:

1. The custodial buy wall eats up the majority of it. After all, 90% of funds are being held by @KTm for buy support right now.
2. The remaining 100K are bought up by other NuBits users at discounted prices, as long as they believe that a new demand peak will occur in the future. Hint: most do since we’re still only in the first quarter of operations.

The fact that NuShareholders have chosen to make very conservative dividend payments for the time being makes the cost of the attack increase substantially. And as the Nu network grows, the cost of attempting this attack increases significantly as well.

4. The only ways of supporting the price of nubits are

Not addressing this as my response to your third point negates this section. Which leads us to…

5. Since both defenses are not credible, I will not be able to sell all of my 1 million nubits at a price of $1. Instead, the price of nubits will drop well below $1 due to the selling pressure I generate.

The price of NuBits will drop temporarily below $1.00 if you sell more than the buy wall can support, and permanently if users do not expect a new aggregate demand high to occur. This is true, but…

6. Once nubits have fallen off the peg for a sustained period, their price will go into a downward spiral. Since I began selling nubits at parity, the USD revenue I net from sales will greatly exceed the new market cap of nubits. I will use some of my USD revenue to buy up 1.5 million of the now nearly worthless nubits. I use these worthless nubits to repay my debts. The rest of my USD revenue I get to keep. They are my reward for breaking the nubits bank.

This is untrue. Once you begin purchasing NBT at the lower prices, it’s a signal to the market that demand is picking up again, and thus prices will increase. If I sell 50,000 BTC right now to drop the price from $400 US to $350 US, I can’t immediately purchase 50,000 BTC at $350 US. The price will increase.

Whether or not the peg rebounded from this type of attack would depend on if Nu users believed that a new all-time aggregate demand peak would occur beyond the amount the attacker sold. If this belief existed, users would buy the cheap NBT and the attack would be unsuccessful. If this belief did not exist, the peg would be broken.

Either way, the real question I have for you is why would anyone would spend $1 million to carry out this attack. I’ve shown in my response to your sixth point that this attack would only harm the attacker’s own financial self-interest with no value or benefit provided if the peg is maintained, which it is likely to be with the current custodial buy walls. There would be a very real possibility that the attacker loses a substantial amount of money.

EDIT: @Benjamin We enjoy these types of debate. Our team can help you with improving your anonymity if you would like to continue contributing to our forum. Glad to have the discussion.

[Benjamin]

This is a video explaining speculative attacks. A speculative attack is possible for any asset backed by a fractional reserve. That is, unless there is 1 USD backing every single Nubit out there, then Nubits will be potentially exposed to speculative attack.

[https://www.khanacademy.org/economics-finance-domain/macroeconomics/forex-trade-topic/currency-reserves/v/speculative-attack-on-a-currency][1]
[1]: https://www.khanacademy.org/economics-finance-domain/macroeconomics/forex-trade-topic/currency-reserves/v/speculative-attack-on-a-currency

Regarding my privacy, my writing style could expose my identity regardless of what measures I adopt. This approach has been used to identify me in the past and it caused serious personal difficulties for me. I’m not kidding. For this reason, I can only communicate in private. I would like to open a channel to do this.

[tomjoad]

Regarding my privacy, my writing style could expose my identity regardless of what measures I adopt. This approach has been used to identify me in the past and it caused serious personal difficulties for me. I’m not kidding. For this reason, I can only communicate in private. I would like to open a channel to do this.

If you’re open to using BitMessage, most of the Nu dev team has BM addresses. Send me a note at BM-NBQwATfqG9tBoVRJGAJzLuwhfBj22aEw.

Nothing I saw in your post was revealing in any way though, so I hope you continue to consider improving the privacy tools you use to interact in public forums. The solutions the Nu network generates will be stronger with public discussion and debate.

[desrever]

Hi @Benjamin, at least 50% of the things happening in that video are not possible within the Nu ecosystem.

If you are worried that someone could interfere with you by analysing your writing style, you should not have written that very long post to start with. For next post try to pass your text into google translator to a foreign language and then back to english. Will be a lot worse to read but could help you.

If you prefer bitmessage to communicate with the dev team, we do understand it, and we can open that channel. However it is not very clear what you will try to achieve on private channels. You either have a solution for it, or it sounds like a bit threatening/trolling risky .

I d rather keep the discussion here and have large number of eyeballs review these scenarios.

Let us know.

[tomjoad]

This is a video explaining speculative attacks. A speculative attack is possible for any asset backed by a fractional reserve. That is, unless there is 1 USD backing every single Nubit out there, then Nubits will be potentially exposed to speculative attack.

Yes, absolutely. I addresses this in my response to your second and third points, namely that a 90% effective reserve ratio (as currently exists) makes the cost of an attack prohibitively high (not impossible, but very unlikely).

I would actually be interested in seeing a quantitative model developed for the cost of a successful attack being executed based on anticipated future aggregate demand. I suspect that the risk/reward of a speculative attack at these reserve levels makes it improbable that anyone would attempt this, but interested to hear if you think that may not be the case (not in an academic way, but in a truly real-world possibility way).

I also gave my opinion that reserve ratios should stay high, and that transaction fees should be used more prominently in a post here as well.

[Benjamin]

I don’t think reverse translation will work. It would be too easy to guess who I am just based on my opinions. I will try the bitmessage route this weekend.

[Benjamin]

Ugh, a little bit more for the public record. What do you mean by effective reserve ratio? Will 90% of USD from nubits sales always be set aside in custodial accounts forever? If so, then I agree with you. However, I’d worry about the high degree of trust placed in custodians in this case.

My understanding was that nubits are backed by nushares. I do not see how one can simultaneously

1. keep a 90% reserve in USD at all times
2. pay dividends to holders of nushares
3. AND pay interest to people who park nubits
   Where does the revenue come from?

If we have a 90% reserve in terms of the USD value of nushares, then a speculative attack is definitely possible. The value of nushares could fall substantially in the face of an attempted speculative attack on nubits. To be safe, you would need something more like a 500% reserve in my opinion. I don’t see the benefit in testing the limits here and would prefer something more conservative than 500%.

And yes, I have a solution.

[tomjoad]

What do you mean by effective reserve ratio? Will 90% of USD from nubits sales always be set aside in custodial accounts forever? If so, then I agree with you. However, I’d worry about the high degree of trust placed in custodians in this case.

It’s up to NuShareholders to decide what percentage of NuBit sales should be distributed as dividends, set aside for development costs, or held in buy-walls. If a compelling case can be made that higher ratios will make the $1.00 US peg demonstrably stronger, NuShareholders will vote for it because it is assumed that potential future network value is maximized when the peg is most stable. In my personal opinion I think we’ll continue to see very high reserve ratios in the short term to ensure protection for the network while it is still getting established. Ultimately the majority of shareholder votes will decide.

However, I’d worry about the high degree of trust placed in custodians in this case.

The custodial system does have its limitations, you’re right. That’s why we’re always in search of better solutions. Perhaps the future will allow us to have automated custodians or better forms of trustless reputation systems that don’t require custodians to reveal their identity. For the time being there has been no indication that our current custodians have acted improperly though. Full accounting has been provided by @KTm in her grant reports for example.

My understanding was that nubits are backed by nushares. I do not see how one can simultaneously1) keep a 90% reserve in USD at all times2) pay dividends to holders of nushares3) AND pay interest to people who park nubitsWhere does the revenue come from?

NuBits are not backed by NuShares in any way right now. NuShareholders vote for custodians who say they will perform certain actions. One of these actions might be (in the case of KTm’s proposal) to sell NuBits, where 90% of proceeds are recycled back into the buy wall, and 10% are distributed as dividends. As mentioned above, shareholders are voting for this conservative reserve ratio because they want to make sure the peg can handle large volatility that might occur from an individual buyer or seller of NuBits.

In this case “revenue” comes from any surplus NBT that are sold by custodians to handle increased demand for NBT. If aggregate demand is 100 NBT and the supply is 100 NBT the system can continue on indefinitely with no “revenues” coming in to the system. If aggregate demand increases to 105 NBT, a custodial grant for 5 NBT will occur (increasing the supply to 105 NBT) and the 5 NBT will be sold for USD. The 5 USD will then be used for dividends, operations, buy-wall support, or anything else shareholders decide.

A discussion on price stability mechanisms in Nu (including parking interest rates) are located here on the website: https://nubits.com/about/price-stability

Two discussions are underway to supplement the parking feature in NuBits: NSR-for-NBT currency burning and variable transaction fees. Variable transaction fees would allow the supply of NBT to gradually diminish if no new custodial funds are granted.

[sportscliche]

This is the same strategy George Soros used to successfully attack the GBP on 16 Sep 1992, now known as Black Wednesday.

[mhps]

Where does the revenue come from?

You are welcome to contribute to http://discuss.nubits.com/t/where-do-dividends-network-revenue-come-from

[Sabreiib]

1）One thing Benjamin is right, the borrowed NBTs have no USD backing.

If attackers borrow NBT from ordinary NBT holders, those NBT backed by USD in Kiara’s hand, but if attackers borrow from protocol or kiara, no backing at all.

2. if we run loan business in future, the bitcoin should be rejected as a collateral. Because not only trans blockchain smart contract is difficult but also the Nu protocol can’t control asset like BTC ie sell BTC for fiat or buy NBT with BTC which only performed by people.

You can only pledge your NSR to borrow NBT, if you attack, you lose money/NSR price drop due to peg failure.

3)Now we have partial reserve ratio such as 90% 80% etc, however, we probably find a good way to make profit by charge transaction fee, set up our own open transaction exchange and nubitmessage. In such ways we may get 100% even 120% reserve ratio and make NBT (or a new unit) anti-inflation.

[Benjamin]

I found this response on Quora which articulates the same concern about a speculative attack. The author has a solid background in quantitative finance. See his website. He also has done research on bitcoin. See this paper. He also does bitcoin arbitrage for a living, so this is the kind of speculator who would participate in/organize a consortium to conduct attacks like this. If he isn’t a credible source for you yet, then see his bitcoin talk on youtube. Finally, I am not this guy, so don’t get any ideas about that!

I am reposting it here for people too lazy to follow the link. I think he is entirely correct in suggesting that systems such as nubits (or bitshares for that matter) would be prone to collapse through speculative attack. I also am confident that the problem can be solved, but my solution requires quite aggressive modifications to nubits design.

It is a nice idea, but you will run into problems if you try.  Countries have tried doing this and you end up with some standard problems.  If you have all your cash in reserve, this will work (i.e. Hong Kong or casino chips) but you then run into regulatory hell, and one problem is that even if you are keeping a 100% reserve, people might not believe you.  

Now if you don't keep a 100% reserve, then you are just painting a target on you and daring traders to break the bank.  What people will do is if you guarantee 1:1 exchange, but you don't have reserves, is that they will borrow peg-coin, sell it to you, get the dollars, and try to force you to run out of money.  Once you run out of money, at that point the trader will buy peg-coin very cheap and pay off the loan.

Now remember that people have successfully preformed the strategy against entire *countries* including the United States in 1971 and the United Kingdom in the early-1990's.  If you try this, it will be amusing to watch the outcome (google for Bambi meets Godzilla).

[desrever]

I found this response on Quora

link

[Benjamin]

fixed in the previous post
here it is again
http://www.quora.com/Is-it-counterintuitive-to-peg-a-cryptocurrency-to-the-value-of-the-dollar-and-simply-use-it-as-a-means-to-efficiently-send-money

[mhps]

The full-reserve and revenue issues have never stopped being brought up in the forums, your posts being just an example. That is a sign that the issue will be solved or contained and Nu will be run in a much more prudent way than how the listed countries in the link had financed themselves.