Two Potential Scenarios
What happens to the $1.00 US stable price if the demand for NuBits exceeds the available supply?
When demand is increasing, more NuBits are required to maintain the price at $1.00 US. NuShareholders will vote to introduce new NuBits into circulation with a grant to a custodian. This custodian then places the NuBits up for sale on an exchange.
What happens to the $1.00 US stable price if the demand for NuBits is less than the available supply?
The price support mechanism of offering interest for funds taken out of circulation is extremely robust. What is required for this mechanism to fail is unanimous consensus of all market participants that NuBit demand will certainly never increase above its previous peak. When this occurs, it means that NuBits are obsolete and they are not meeting a need. It doesn’t make sense to not use something today because it may become obsolete someday. As this outcome 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.
When the peg is lost, it will go straight to zero. And, it doesn’t necessarily mean the failure of Nu, just of the individual currency.
To demonstrate the robustness of the peg, let’s imagine a future where NuBit demand is only 10% of its peak. It is obsolete and demand has been in decline for three years. Nearly everyone has given up on it. However, there are a handful of individuals who believe there is a 30% chance that NuBits will still have value in a year because they are NuShareholders and plan to implement a bold and daring plan to change the protocol to meet different needs than NuBits have in the past. These individuals would buy NuBits if there was 400% interest rate offered for one year. So it will be offered by NuShareholders and taken by the speculators, and the peg will stand at $1.00 US. When this large sum of NuBits is created and unparked after one year, then the situation is much worse if demand has not picked up due to the success of their bold plan to redefine NuBits. Perhaps then even these shareholders and speculators will give up on it. In that case NuBits would not be worth less, they would be worth nothing. And not many people would care or be affected.
However, the system can handle even multi-year dips in demand gracefully and recover. All that is required is for some people to believe there is some chance that total demand will reach a new peak. This is a nominal peak, not inflation adjusted peak. So in a case where NuBit demand declined for three years and there was 13% inflation over those three years and an average of 4% annual interest was required to create sufficient demand for NuBits during those three years, then the amount of real value stored would not even have to quite reach its previous peak in order to push interest rates down to zero, signaling a healthy system.
Given rapidly rising levels of wealth in the world today combined with inflation of USD, the total proportion of global wealth held in NuBits can enter a widely acknowledged permanent decline, and as long as the decline rate is not too sharp, the system will still be sustainable.
In summary, the primary support mechanism is very robust and is not expected to fail partially, but rather completely after NuBits have passed from the hands of ordinary businesses and people to speculators willing to take great risk for great reward, having long signaled that it was in difficulty.
If NuBits are a success, then this scenario is far in the future. In the meantime it can do much to meet a wide variety of needs. Everything dies or goes away in the end, but that is hardly a good argument against living or using a technology you find empowering.
Additional Price Support Innovations
Variable transaction fees
The Nu network now has the ability to charge variable transaction fees for both NuBits and NuShares. Transaction fees are permanently destroyed on the Nu network, acting as a deflationary mechanism for the supply of both NuBits and NuShares. This enhancement in Nu v2.0 permits shareholders to vote to set transaction fees. Further information on the mechanics behind variable transaction fees can be found here.
NuBits burning through the sale of NuShares
NuShareholders voted in 2015 to allow the creation of NuShares through custodial grants. This action created an additional tier of Nu liquidity to better protect the $1.00 peg. In the event of parking rates being offered for a prolonged period of time, NuShareholders can vote to create new NuShares that are sold through auction. The proceeds from this auction would then be used to purchase NBT on the open market, at which point the purchased NBT would be destroyed permanently by the custodian. The net result would be a dilution of equity value for all NuShareholders in order to reduce the outstanding supply of NBT in circulation. This price support mechanism allows NuShareholders to reduce the supply of NBT to match periods of contracting demand.
In 2015 NuShareholders began to establish group liquidity pools to replace the individual liquidity providers that were originally specified in the Nu white paper. Users who are willing to provide liquidity for the Nu network can be compensated at varying rates, depending on the types of liquidity provided. For more information, please visit our Liquidity Pools page.
Long-Term Network Sustainability
As originally written by Jordan Lee in July 2015.
NuShares can be created and sold for NuBits so long as the price of NuShares is not zero. So, under what circumstances could we expect the NuShare price to become zero? There would have to be complete consensus that there would never again be demand for additional currency and NuShares would never receive a dividend in a new system such as B&C Exchange again. Over the last year, despite only very modest adoption of NuBits, the annualized dividend yield of NuShares has been a stunning 29.04%. Between BlockShare and Peercoin dividends, $409,811 has been issued as dividends over the 10 month life of NuShares. With the current NSR market cap of $1,695,396, that is 24.2% dividend, and an annual dividend yield of 29.04%.
Let’s consider the factors that can effect the total liabilities of our network in the form of NuBits and other currency in our network:
- Change in the value or purchasing power of NuBits (such as due to US dollar inflation)
- Change in the total money stock of all currencies (principally outside our network)
- NuBits burned as transaction fees
- NuBits whose private key is lost
- Changes in the proportion of demand for currency in our network versus demand for all currency globally
The importance of factor 5 is well understood and factor 3 is reasonably well understood. Factors 1, 2 and 4 appear to be generally overlooked.
Let’s examine these factors in greater detail. Factor 3 is dependent on how shareholders set the soon to be variable transaction fee and the velocity of currency in the network. I suspect the transaction fee will be raised from its current hard coded value of 0.01. Let us suppose it averages 0.04 in the future. Currently, there are an average of 47 NuBit transactions per day with around 330,000 NuBits in circulation. 47 * 0.04 *365 = 686.2 NuBits per year. With this scenario 0.207% of NuBits are burned each year in transaction fees. Then there are NuBits whose private key has been lost. One estimate suggests up to 35% of Bitcoins have been lost in this way. While that estimate is likely too high, and the actual quantity of lost Bitcoins or NuBits will never be known, it is quite clear lost NuBits will apply substantial downward pressure on the quantity of NuBits in circulation. Let’s conservatively assume 1% of NuBits are lost each year.
Now consider that the total stock of money is increasing over time well beyond the rate of inflation. While annual US dollar inflation has averaged 1.75% over the last five years, the US dollar M2 money stock has increased an average of 5.8% per year. This means that when inflation is subtracted, the monetary stock has risen an average of 4.05% per year. As productivity increases, people simply have more wealth and demand more money.
So, let us suppose the proportion of all currency in the world held as NuBits remains constant. Let us assume 1.75% inflation, a 4.05% increase in M2 money stock, 0.2% NuBits burned as transaction fees and 1% of all NuBit private keys lost each year. Under this scenario, new demand for NuBits will rise 7% per year while the proportion of all currency in the world held as NuBits remains constant. Said another way, given the assumptions and extension of historical trends just described, the proportion of all currency in the world held as NuBits could drop 7% per year without requiring any burning of NuBits via NuShare sale.
Now let’s consider operating expenses such as liquidity provision and development. In the coming months, we expect to spend around $10,000 per month on development and $10,000 per month on liquidity. That is 14% per year given a July 2015 market cap of 1.7 million. If Nu is even modestly successful, I expect the percent spent on development to decline and the percent spent on liquidity to dramatically decline. If these combined expenses dropped below 7% annually, Nu would be sustainable without ever increasing the share of global currency held in our network, given the modest economic assumptions detailed above.
In summary, in order for NuShares to drop to zero, all market participants would need to conclude the proportion of global currency held within our network is in permanent decline and no more dividends of new equity such as BlockShares would ever be issued. Is this possible? Of course. It is even likely over the very long term. But it seems unlikely such a scenario will emerge in a short period of time. The longer we keep the NuBits peg and the longer network use expands, it becomes less and less probable that this will occur in the short term if ever. If we as the Nu Network are able to remain adaptive in responding to industry needs, we’ll find ourselves an invaluable part of this market, an embedded reliable constant for the community and potentially eternal… Conversely, if the value of NuShares were to drop to zero (exempting a temporary flash crash), then the peg is likely to be lost without a sizable trustworthy reserve of liquidity enforcing the peg.