Cryptocurrencies like bitcoin have to solve three important problems if they are to become currencies:
Unstable values
High transactions costs
Anonymity
Basecoin is trying to resolve that first problem, unstable values.
Basecoin’s idea is to expand and contract the supply so as to maintain a stable value. If the value of the basecoin starts to rise, more will be issued. If it falls, the number will be reduced.
Okay, sounds intriguing, but lets reverse engineer that just a bit. This helpful definition will be the first cut: Seniorage
seign·ior·age
noun
profit made by a government by issuing currency, especially the difference between the face value of coins and their production costs
the Crown’s right to a percentage on bullion brought to a mint for coining.
Who gets the seignorage when basecoins are increased? And just what do you get for your basecoins if the algorithm is reducing the numbers? From their white paper:
If Basis is trading for more than $1, the blockchain creates and distributes new Basis. These Basis are given by protocol-determined priority to holders of bond tokens and Base Shares, two separate classes of tokens that we’ll detail later.
If Basis is trading for less than $1, the blockchain creates and sells bond tokens in an open auction to take coins out of circulation. Bond tokens cost less than 1 Basis, and they have the potential to be redeemed for exactly 1 Basis when Basis is created to expand supply.
Basecoins get traded for … claims to future basecoins?
You should be able to see instantly how this will unwind. Suppose the algorithm wants to reduce basecoins. It then trades basecoins for “basecoin bonds” which are first-inline promises to receive future basecoin expansions. But those bonds will only have value during temporary drops of demand. If there is a permanent drop in demand, the bonds will never be redeemed and have no value. They are at best claims to future seignorage. Any peg collapses in a run, and the run threshold is mighty close here.
But it gets worse.
Just how are the bonds different from the basecoin itself? I presume you can trade the bonds too, so they are just as liquid as the actual basecoins. Or, in milliseconds, you could trade a basecoin bond for a basecoin and then the receiver back again. So, since they now pay interest, they are better in every way as an asset to hold. In monetary theory “bonds” are crucially less liquid than “money” allowing bonds to pay a higher interest.
The whole point of cryptocurrency is to make everything liquid. There can only be lasting seignorage, a “money” that pays less interest than “bonds,” if the money is in restricted supply. The fact of cryptocurrency is, even if you limit the supply of your currency, a competitor can come along and supply a different currency.
What would be a better way? In a liquid market with competitive currency supply, only backed money can have lasting value.
It’s time to face hard truths. What happened to the dollars that got turned in to basecoin when the coins were created? Why are they not still there to back basecoin retrenchment? Answer: Base shares…
They have gone into investors pockets! And quickly out to real dollars where frustrated later basecoin investors can’t get them. Yes indeed, the seignorage from printing a new money can be an attractive investment.
Bitcoin was modeled after gold. There is a finite supply, so a transactions demand can lead to an intrinsically worthless token having value. Alas bitcoin forgot the lesson of gold that money demand can move around a lot, so the value can be very unstable over time. And unlike gold, there is nothing stopping infinite supply expansion of cryptocurrency substitutes. That’s not subtle. Those faults are immediately obvious when anyone with a smattering of economics looks at the design.
The Fed was founded in 1907 in part to provide an “elastic currency,” exactly the lesson missing from bitcoin and at the center of basecoin. Alas, the Fed trades money for treasury bonds, backed by taxes, not for Fed bonds backed by future seignorage. And laws against using foreign currency or issuing private currency help a lot.
Basecoin buyers will soon learn the lesson that bonds cannot pay more interest than money in a liquid market, and that claims to future seignorage cannot back money in the face of competitive currencies.
The End?
27Apr