The Search for a Stable Cryptocurrency

The Quest for a Stable Cryptocurrency

The cryptocurrency landscape has been marked by a dichotomy: on one hand, the decentralized payment network offered by Bitcoin and other cryptocurrencies has been a game-changer, providing a censorship-resistant and low-cost way to send payments across the globe. On the other hand, the currency itself has been plagued by extreme volatility, making it a less-than-ideal store of value. This has led to a growing interest in a simple question: can we have the best of both worlds? Can we have a cryptocurrency that offers the full decentralization of a cryptographic payment network, but with a higher level of price stability?

The Challenge of Price Stability

The problem of achieving price stability in a cryptocurrency is far from trivial. Unlike traditional fiat currencies, which are backed by central banks and governments, cryptocurrencies are decentralized and rely on complex algorithms to regulate their supply. This makes it difficult to implement a traditional monetary policy, where the central bank can adjust interest rates or print more money to stabilize the economy.

Exogenous Solutions

One approach to measuring a currency's price in a decentralized way is to use exogenous solutions, which try to measure the price with respect to some precise index from the outside. One known class of mechanisms for this is the Schellingcoin, which essentially involves having everyone vote on what the result is, using some set chosen randomly based on mining power or stake in some currency to prevent sybil attacks. However, this method has its limitations, as it can be vulnerable to manipulation and coordination among participants.

Endogenous Solutions

Another approach is to use endogenous solutions, which try to use internal variables of the network to measure price. This can be done by identifying a service inside the network that is known to have a roughly stable real-value price, and measuring the price of that service inside the network as measured in the network's own token. Examples of such services include computation (measured via mining difficulty), transaction fees, data storage, and bandwidth provision.

Estimators and the Quest for Price Stability

To measure the price of a currency endogenously, we need to find a way to estimate it using internal variables of the network. One approach is to use a variant of simulated annealing to find the optimal values for the estimator, using historical data as "training data". This can help us to select the best parameters for the estimator and improve its accuracy.

The Bounded Estimator

One estimator that has been proposed is the bounded estimator, which assumes that all growth in difficulty is due to Moore's law, but also assumes that Moore's law cannot go backwards or faster than a certain rate. Any growth outside these bounds is assumed to be coming from price rises or drops. This can help to stabilize the currency by compensating for rapid price changes.

The SchellingDollar

Another approach to achieving price stability is the SchellingDollar, which involves creating a stable-coin that is pegged to a volatile-coin. The stable-coin is initially distributed, but users can only acquire or increase their negative balance of stable-coins if they have a quantity of volatile-coins equal in value to twice their new stable-coin balance. If the value of a user's negative stable-coins exceeds 90% of the value of their volatile-coins, then the user's stable-coin and volatile-coin balances are both reduced to zero.

Seignorage Shares

A fourth model is "seignorage shares", which involves creating a stable-coin that is pegged to a volatile-coin. Anyone can purchase volatile-coins for stable-coins or volatile-coins for stable-coins from the system at a rate of $1 worth of volatile-coin per stable-coin. The profit and loss scenarios for the system are simple: absorbing volatile-coins to issue new stable-coins is a profit, while issuing volatile-coins to absorb stable-coins is a loss.

Conclusion

The quest for a stable cryptocurrency is a complex and challenging problem. While there are various approaches to achieving price stability, each has its limitations and vulnerabilities. The SchellingDollar and seignorage shares are two promising models that have been proposed, but they also have their own set of challenges and risks. Ultimately, the development of a stable cryptocurrency will require a deep understanding of the underlying economics and a willingness to experiment and adapt to changing circumstances.

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Source: https://blog.ethereum.org/en/2014/11/11/search-stable-cryptocurrency