[Whitepaper v1] – Yield Market System for Pegged Block-chain Currencies
*** START WHITEPAPER ***1. Introduction
This (draft v1) whitepaper describes a modular yield-based system for implementing pegged currencies on a block-chain. It is a complete architecture in that it integrates currency and bill/bond markets in a single system.
Bills and bonds are traded in yield and price interchangeably. The primary effort behind this whitepaper has been in trying to design an at-call currency market that is quoted purely in yield, rather than price. This would allow all parties to trade at a common at-call interest rate, and allow more intuitive comparison to term positions within a broader yield curve structure.
Embarrassingly it began as some initial rough designs and built into a very long whitepaper, and I’ve not had a chance to present the basic ideas to the community. Of course there may be something terribly wrong with it all. Anyway, it’s time to find out and submit it to the community. At a minimum there will be some unique ideas that may get people thinking along some different lines.
This is a novel solution to the pegging problem in that competition amongst all parties is purely on yield. The current BitAssets approach in Bitshares mainly competes on price, with the exception of short orders placed at the peg. Whether the optimal yield-based system ultimately proves better than an optimal price-based system is yet to be determined, as a fuller architecture for an optimal price-based system is still evolving currently within BitShares. Along with presenting this whitepaper on a yield-based approach, I challenge the community to think about the most complete price-based architecture (including integration with bond markets) so that we may make a good comparison. I’m happy if ideas are borrowed, that’s the point of sharing. This whitepaper itself may also be further refined.
The benefits of a pure yield-based approach are anticipated to be:
- Instant exchange of the currency token for the native token at the peg
- Maximum possible pegging of exchange prices in external markets
- Improved market-making, arbitrage, and liquidity
- A range of lending and borrowing terms to meet a wider range of user preferences
- Market resilience to supply-demand mismatches and shocks
- A modular market structure with a simply defined matching algorithm in each market
- A more stable foundation for other financial services to build upon
Traditional money markets make use of an interest rate structure (or yield curve) that equilibrates supply and demand at varying durations. Flexible changes in the shape, level and steepness of yield curves allows the market to absorb changes in preferences and eliminates the need for rapid changes in the supply of base money.
This whitepaper seeks to define a similar structure that can be used for pegged currencies on a block-chain. It proposes consistent yield-based competition for a number of critical markets that must be economically linked to provide the ideal properties for a pegged currency system.
Bytemaster delivered a number of original insights on pegged block-chain assets:
- they could be fully collateralized by the native token of the block-chain to eliminate counterparty risk,
- they could be issued by parties that would like to leverage their exposure to the native token relative to the reference asset, and
- issuers might be willing to pay interest to holders of the pegged asset for the ability to leverage, allowing yield on the currency.
Implementation since then has shown that it is possible to construct such a system that is capable of tracking the value of a reference asset.
However, there are unresolved usability issues with today’s pegged currencies in Bitshares. Peg tightness and liquidity both need to be significantly improved, complexity and bug exposure removed, and greater user flexibility introduced across the term structure to satisfy a greater range of user preferences.
Key sources of complexity in the current system are:
(i) that non-expiring fungible currency and expiring non-fungible shorts are wrapped in a single market, and
(ii) matching prioritization uses price for some parties and interest for others.
[Start edit 27 Apr] The proposed BitAsset 3.0 eliminates (i) but turns matching prioritization to collateral for shorts. This eliminates yield, and treats currency as non-interest bearing cash. How this might fit in is explored in the Implementation section of the whitepaper. [End edit 27 Apr]
This proposal looks to alter the current implementation to a more modular and consistent approach with yield-based markets at a number of durations.
To achieve this, the currency system is decomposed into a number of markets that are economically linked. These are
i) a Currency Creation Market, in which new currency units are created and destroyed against the native token at the feed price, and
ii) a Bill Creation Market (or Bond Market), in which new loans in the currency unit are created and destroyed at a range of terms.
Any one of these markets in isolation is not effective without the others. They are each critical linked components of the entire system. So the behaviors within each market are influenced by the whole.
Every currency and bill token (long) is essentially a claim to receive a market-determined yield. Every short on the currency and bill tokens is essentially an obligation to pay exactly that same rate to the longs. The markets in these tokens are each competitions in yield alone that continuously allocate the tokens to the most eager longs and the most eager shorts.
Together these markets form a yield curve from a term of zero (being the Currency Creation Market) to arbitrarily longer terms (in the Bill Creation Market). This consistency of a competition for yield leads to strong economic linkages right across the yield curve.
To accomplish this, in each of the markets by term, all longs, as well as all shorts, share a common interest rate. This ensures that all parties are treated equitably, and is the only way to ensure economic neutrality (no economic gain or loss) from simultaneously holding both sides of a market. While in the Bills Market the competition for yield leads to a floating price today for a specified future payment at expiry (equivalent to trading in zero coupon bonds), in the Currency Creation Market the price is fixed at the price feed, and the variable interest represents a continuous transfer from shorts to longs. This creates a need for some implementation differences between the Currency Creation Market and the Bill Creation Market.
The key challenge to the proposed system, at least in its purest form, is a heavy reliance on accurate and timely price feeds of the peg price into the system. However, as any pegged currency system must require owners to be able to redeem from issuers at a fair price, some such input is a critical requirement. This is an important challenge to be investigated, debated, and solved by the community. If not adequately solved, it could undermine the system proposed here [edit 23 Apr: in fact it will undermine any pegged currency system
The following are pre-conditions to the required architecture:
(i) The currency must be redeemable on the block-chain to eliminate counterparty risk,
(ii) The currency must be backed by a pool of native tokens to meet redemptions, to avoid inflation of native tokens for redemptions
(iii) Exchange of  native tokens for creation or destruction of currency [end edit] must be facilitated at the feed price (near instantly) to ensure maximum pegging in all markets
(iv) There needs to be a single floating variable to ensure supply and demand can equilibrate at the peg, the most recognized being interest
(v) The interest rate must be determined by market forces between buyers and sellers, to ensure markets always clear (no shortage or surplus at the feed price)
(vi) Markets at varying terms should be available, so that mismatches in term preferences between buyers and sellers can be priced along the yield curve, rather than stifling an isolated market.