Stable Cryptocurrencies
There are two problems with using Bitcoin as a substitute for conventional currencies. One is that transaction costs are high; I gather there are some proposals to solve that. The other is that its value is very unstable. So far that has been a plus, since the value has mostly gone up. But in general it is a minus, since it means that if you are holding a substantial amount of currency for transactions you are also speculating in its value, whether or not you want to.
That raises the interesting question of whether it is possible to construct a cryptocurrency with a stable value. Basecoin is a recent attempt to do so. I have not examined how it works carefully enough to offer any opinion on it, but I think in principle the project is doable.
Suppose you want a currency which exchanges at one for one with the U.S. dollar. There is a real world example of a solution to that problem, although it was for paper currency not cryptocurrency–the Hong Kong dollar issued by the Bank of Hong Kong and Kowloon (I think also by a second bank–all this is from memory, so details may be off). It maintained a constant exchange rate with the dollar (not one for one) by a simple mechanism. Any time the $HK went above the target rate the bank printed more, any time it went below they bought some and took them off the market.
Basecoin works on the same principle. In theory it eventually shifts from pegged to the dollar to pegged to a market basket of goods.
Basecoin works on the same principle. In theory it eventually shifts from pegged to the dollar to pegged to a market basket of goods.
Pre-bitcoin, Chaumian digital cash was supposed to provide a currency that could be exchanged by sending messages, with neither party having to trust or know the identify of the other. The problem was that it required an issuer, a trusted bank. A digital currency makes enforcing money laundering rules hard, an anonymous digital currency, which the Chaumian version would have been, makes it impossible, so governments very much don’t want it to exist, which makes it hard to establish a trusted issuer.
The beauty of Bitcoin is that there is no issuer, so the problem goes away.
How do you maintain a stable digital currency without an issuer, a private central bank? I do not know the details of how Basecoin proposes to do it, but here is my version:
You start with ten issuers, each a respected private firm, probably in different countries, each with a private key/public key pair that it can use to prove its identity. You have some way that the software can measure the exchange rate between your currency and the dollar–the Ethereum people I have talked with refer to a mechanism for reporting real world facts to the software as an oracle and have some ingenious ideas for making one work. The software then establishes the following rules:
1. Any time the exchange rate is above the target, one of the issuers can create one more coin. Which issuer gets to do it depends on which ones created the last nine coins–they go in sequence.
2. Any time the exchange rate is below the target, one of the issuers, again in sequence, is supposed to buy a coin and take it out of circulation.
3. An issuer that fails to obey rule 2 is no longer in the sequence for rule 1. Each time it fails to obey it, its debt to the system goes up by one. Only when it has repaid that debt by taking the corresponding number of coins out of circulation does it rejoin the sequence of issuers.
4. If the exchange rate is above the target and the issuer whose turn it is to issue a dollar doesn’t, after an hour it loses its turn to the next issuer in sequence.
Assume an expanding demand for the currency, first from its initial spread, in the long term from economic growth. Issuers profit because they are getting an interest free loan in the form of the the coins they print to hold the value down to a dollar. That gives each issuer an incentive to obey rule 2, so as to maintain its ability to issue.
Rule 4 exists mostly to cover the possibility of an issuer going out of business or being shut down by its government. There should be a mechanism making it possible, if that happens, to transfer its status to a new issuer. In the simplest case, that is done by selling the private key that proves its identity to another firm that wants to replace it.
What is wrong with this proposal?
I was pointed at this problem, and at Basecoin, by my son Patri. I gather it has been discussed at some length recently, so I may well be reinventing the wheel, but I find it more interesting to think such things out for myself than to start by reading what other people have written.
That reminds me of an anecdote about my friend and ex-colleague the late Gordon Tullock. Someone prominent wrote an article. Tullock wrote a rebuttal. The original author wrote a response, claiming that Tullock had entirely misunderstood the original article. It included the line (by memory so not verbatim):
We have all been long impressed by how much Professor Tullock has written. It is even more impressive to realize that he has written so much without being able to read.
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