On a cryptocurrency of dynamic supply

The main idea: two joint cryptocurrencies are programmed such that one can be exchanged for the other as long as their product remains constant, thus tracking the minimal necessary volume of circulation required by a growing economy in a decentralized fashion. 

0. Posts on this blog are ranked in decreasing order of likeability to myself. This entry was originally posted on 30.09.2021, and the current version may have been updated several times from its original form. 

1 Setting the stage

1.1 The economy under the division of labour is a massive and massively complex system with immense degrees of freedom. Commie silliness notwithstanding, only money, an emergent computer of comparable capability, is equal to the task of daily optimising resources such as to fulfill demand to the greatest degree possible. Money alone can run such calculations at any reasonable speed.

1.2 Calculations need to be run in the moment as well as in time, hence the true and core function of money as a unit of account. Medium of exchange kind of follows but may be in principle separated, while store of value can be entirely separated at no cost to anyone.

1.3 It is extremely hard not to mess monetary calculations in time, but accounting relies on this being the case to an acceptable degree. Was value created or destroyed? Need a true standard in time to answer that.

1.4 The price of money is not the interest rate, but its purchasing power: how much “stuff” does a unit of currency buy you. When this price falls with time, you have inflation. If it increases with time, deflation.

1.5 A deflationary monetary standard makes it look as if companies lose money where they may not have: it sets a hurdle over which folks have to jump before they are allowed to see a nominal monetary gain. An inflationary standard, on the other hand, makes it look as if firms make money while sitting on ass.

1.6 True profit and loss accounting requires a stable standard, one that neither inflates nor deflates. Such a standard lets you know who is really adding value and who isn’t, so you can deal with the latter. Also, long-term planning and all that.

1.7 Hence, the optimal monetary standard is that which delivers a stable purchasing power, facilitating calculations in space and time.

1.8 Normal supply and demand interplay works for money just as well, but it is impossible to express the price of money in succinct terms (how to quantify the value of everything a unit of money buys?) so actual measurement is tricky.

1.9 Hence, ensuring a stable price of money in practice translates into ensuring every change in demand is met by an appropriate change in supply.

1.10 The only credible challenger to the current system of a centralised issuer of currency would be a decentralised system under the auspices of cryptocurrency. Alas, most of the time, the designers of these ingenuous tool just went with “fixed supply is good enough” and left it at that, making cryptocurrency a great store of value, but a shonky unit of account. How much worse this issue becomes when the user base is growing faster than the global economy (which of course it does).

1.11 Here’s how you fix this: you set up a savings pot and spending pot, and exchange between the two by conserving percentage of change, instead of total sum of the pots. In other words, use Gresham's Law to isolate the two functions. 

 

2 The Design

2.1 The new cryptocurrency is issued as two linked coins: the RedLek and the BlackLek. The issue of each is fixed at the start and no new units will ever be created exogenously (making allowances for technical needs of proof, such as they are).

2.2 You can only get more RedLeks by converting BlackLeks, and you can only get more BlackLeks by converting RedLeks. Such conversion can only be done within the portfolio, by the algorithm consulting the blockchain to calculate how many of either are currently on issue anywhere in the world, including those that other holders may have converted into, to the degree this is captured by your blockchain history.

2.3 Within these strictures, the exchange rate would be set such as to trade a given percentage increase of one for the same percentage decrease of the other, with percentages defined as whichever is greater between the current supply and the supply after the exchange divided by whichever is lower less one. Stated otherwise, within each portfolio the product of RedLeks and BlackLeks will always remain constant. Don’t divide by zero. 

2.4 The original version of this post included a hard floor to the exchange rate which yours truly added without realising that it would allow the supply of both coins to go to infinity if exploited (could it be exploited given the coordination problem? Too big a risk to take). After mulling this over for a couple of hours, removed that constraint in this version but this creates the very real problem of division by zero, i.e. that it would be feasible to have the supply of either the RedLek or (less likely) the BlackLek go to zero. Don't have a solution to this scenario, not too unlikely for RedLeks after ICO but becoming less and less likely with adoption. The creator must keep both coins in their own portfolio after ICO until such time as circulation picks up, but feel free to present any alternative solution that is any less half-assed.

2.5 RedLeks can be transferred across portfolios as any other cryptocurrency unit can, hopefully with some anonymity, hopefully with some speed. BlackLeks live in people’s portfolios and can never be transferred across portfolios (except maybe once, at ICO, see 2.7). These can only be “transferred” by getting RedLeks across and having the other party convert in situ. In principle, if both portfolios share the same knowledge of the world, you can transfer the exact amount of BlackLeks anyway. In a sense, BlackLeks are the unit of account within the system, not a proper cryptocurrency at all.

2.6 The RedLek is the unit of account with a supply that will grow with the excess of demand for spending over changes in velocity. The BlackLek is the store of value, with a supply that will decrease as the economy grows, outdoing its fixed supply brethren in that function.

2.7 At ICO you can simply issue BlackLeks but make sure to keep some RedLeks in your own portfolio to prevent the supply from going to zero, at least until such time as other users start creating and circulating RedLeks. Otherwise, at ICO you sell RedLeks only, such as not to make a one-time exception to the “BlackLeks can’t transfer” rule. Be sure to back-solve for the appropriate number of BlackLeks being in the system (compared to those held by the issuer, as per 3.11) the nanosecond after sale when all portfolios convert everything into BlackLeks (3.5).

2.8 All done, you can stop reading now. Feel free to implement or share with those who might, but please keep the names of the coins as they are, give credit and do let me know of the ICO beforehand. Some free allocation wouldn’t be bad either, to be honest.

  

3 Why would this work?

3.1 If a set of decentralised issuers is to be prevented from hyperinflating the supply away, they must be subject to some form of a feedback mechanism (issuers can’t coordinate to maximise value). What stops holders from creating as many RedLeks as they can? The waiting game.

3.2 You can get more bang for your buck if you convert BlackLeks into RedLeks later than the others must. If you need to spend while the global supply of the former goes from 10 to 9, you’ll boost your supply of the latter by 11%. If you can wait and convert when the supply of BlackLeks goes from 9 to 8, you boost your RedLek stash by 12.5%, while giving up the same single BlackLek. So you wait, or at least try to.

3.3 Any holder has a finite supply of RedLeks and/or BlackLeks, hopefully no impact at all on the exchange rate, and can only spend the former. Assuming RedLeks are accepted as a means of payment (bit of an issue here, see 3.7), the more RedLeks are spent, the more the supply of BlackLeks dwindles, valorising the remaining units.

3.4 Some folks have high time preferences and don’t care about no waiting game. Probably not the profile of the usual early adopter of things like these, but if you want to make this money proper you’ll get to those spenders eventually. No problem, after all users hold just as many BlackLeks as their time preference dictate the system will be in equilibrium, and only create new money when time preferences across the entire user base increase, all else being equal. How about that, FRB?

3.5 You want others to spend as much as they can, but you should spend as little as you must, all the while keeping your entire portfolio in BlackLeks until such time as you need to spend something, at which time you convert. So, the portfolio will probably automatically do this for you, convert everything into BlackLeks and let you pay RedLeks without the need for you to do a thing, while always showing a (slowly growing) sum of RedLeks as balance. Will people even know what a BlackLek is?

3.6 The supply of RedLeks will increase with demand for spending (to the degree that velocity pickup does not suffice), but no further than strictly necessary to keep up with the spending needs of the economy / user base.

3.61 I think what the setup does is set the marginal cost of money at the natural interest rate, which I think is optimal. Could be wrong on any combination of those two though.

3.7 A major issue I can foresee is that the uptake of this currency would be even harder than the uptake of a standard shitcoin. The same mechanism that incentivises you to hold on to BlackLeks and not convert more than what you absolutely need to spend into RedLeks would make the uptake of the latter an uphill battle. And if RedLeks don’t circulate, BlackLeks are not worth anything. Not sure I have a good way out of this, just two bad options below. Hopefully the issue won’t be too pressing in practice, and people will be drawn to just another shitcoin. Strong anonymity would help getting this off the ground, as it did for Bitcoin.

3.8 One way to deal with 3.7 is to create a venue that only accepts RedLeks, with the relatively low effort one being an online predictions market where bets are placed and redeemed in RedLeks. A lottery of fair odds would be even lower effort.

3.9 Or the issuer can promise to use all (some?) the tethers he gets at ICO to intervene in the market and buy RedLeks when suitable (say so publicly). A simple autoregression will show a particularly bad day, which is your time to shine. At some point, the pot will run out though.

3.10 Or maybe the entire issue is being overthought. Perhaps the conflict between the incentive not to spend RedLeks and the incentive to get some value out of BlackLeks will settle into a nice equilibrium early on, and users will spend what they deem optimal, assuming they have some freedom to spend RedLeks anywhere.

3.11 Another issue is some genius keeping to himself a large stash of BlackLeks after the initial ICO, which would spook all holders far more than it does with a fixed supply coin (BlackLeks will dwindle in time, and your share will explode if you let it). If a holder has a large enough proportion of BlackLeks such as to impact the exchange rate, the limitations of the system start to cede. In the extreme scenario of just one holder having all BlackLeks (assume away conversions for the sake of the argument), there would be nothing holding him back from printing trillions. Big stashes of BlackLeks left over from the ICO? Don’t do that.

3.12 Could a similar system be implemented in a centralised fashion, i.e. by some Central Bank out of ideas? Central Banks nowadays mostly target inflation. This is just a patch, a rough guide CBs rely on to determine when to amend the supply of money. The real goal, that of matching demand, is attempted only through the stabilisation of some proxy of purchasing power. The system I propose here system would stabilise supply automatically, and no one would need to get into arguments on core inflation anymore.

3.13 The same issue re a large holder of BlackLeks as under 3.11 would come to the fore with a centralised issuer, but harder. So, a central authority using such a system would only work if that authority only functions as a central clearinghouse, tracking everyone’s BlackLek deposits, but holding little of their own (still centralised in the sense of acting as a single point of failure). Monetary Boards are a thing. The centralised version would certainly be unbound by scaling constraints, something I fear the decentralised version may not be able to replicate. No matter, make up for it in anonymity.

3.131 If such a scheme were to be run by a centralised clearinghouse, one could never increase the supply of both RedLeks and BlackLeks at the same time and their product would always remain constant. But running this from a decentralised blockchain would allow for the supply of both to increase in time and their product to vary upward or downward a bit. Not a big issue in the great scheme of things.

3.14 Final issue (heh, if only) is divisibility, and the extreme stress this system will place on BlackLeks to be divisible. In principle, if these are infinitely divisible there is no limit at all to the supply of RedLeks one can create if need be. But infinitely divisible units may not be feasible, even if only units of account, at which point one will need to calculate carefully the initial supply of BlackLeks at ICO. Assume you will conquer the world, she’ll be fine.

3.15 Will this work? Will the issue hyperinflate anyway? Will it ever take off as a spending tool? Will the system be self-adjusting or will the users fall prey to random panics? I don’t know for sure. I won’t be the commie I disparaged earlier, and claim to know enough about this mammoth system of monetary calculation to make predictions with confidence. Wouldn’t be bad to try though.

3.16 Might be as good a time as any to mention that I know little to nothing of the technical intricacies of blockchain, hence have no idea if this design is at all feasible. You be the judge.

4 An alternative design

4.1 In recent discussion with someone far more knowledgeable than myself, I was told that it is either very, very hard, or outright impossible to have a blockchain-based cryptocurrency whose supply is not fixed on day one. What to do?

4.2 You fix the supply of both RedLeks and BlackLeks on day one, but assign 99% and 50% of their respective supplies to an automated trading portfolio, and only ICO the remining 1% and 50%.

4.3 Whoever wants to convert one into the other, sends the number of coins to this one centralized portfolio, which checks its own blockchain, determines the exchange rate as per 2.3 (assuming its own hoard does not exist), and send back the alternate. This is hardcoded, and the portfolio cannot be stopped or its operations amended. 

4.4 BlackLeks can only be sent to this one address, and nowhere else.

4.5 On the upside, since all conversion transactions are going through one central point, the portfolio knowns in theory the exact number of RedLeks and BlackLeks out there (since all of them have either bene created on day one or have been traded by this portfolio), and the issue of supply slowly creeping up as per 3.131 above would not materialize at all.

4.6 On the downside, we have a centralized point of failure and still have a hard limit on how many RedLeks can be “created” (released by the central portfolio). I think you can chain link a new RedLek 2.0 once the supply of the original RedLek approached the actual supply at the portfolio’s disposal, by pegging the two and retaining the same exchange ratio principle with the BlackLek, but maybe there’s a money pump think going on there which I cannot see.