Who will pay the "interest" on HERO?
A few days ago, I wrote an article about the coming-soon BitShares product called HERO. This investment product is a smart contract token (or smartcoin, or if you like @stan's grandiosity, "mathemagical dreamcoin") that will be mathematically defined to appreciate by 5% annually. I have some serious doubts about its ability to do so, but I find the concept nonetheless intriguing. For more information about HERO itself, see @stan's original post and the official HERO documentation website.
Will HERO socialize risk? (TL;DR: no.)
The first question that BTS holders should ask about HERO is whether they will be on the hook for the "interest" that will be paid out on HERO tokens. (Note: HERO will not strictly pay interest; it is rather designed to appreciate at a predefined rate, thus effectively paying interest. I will use the two terms interchangeably in this article.) Fortunately, ordinary BTS holders will not be required to pay out interest. If not BTS holders, then who?
Note that if HERO were being built on Steem with the same mechanism that SBD uses, the answer to the question would be "yes." In Steem, SBD is backed by printing new STEEM tokens. BitShares uses a different mechanism to peg smartcoins. To really understand how HERO will work and where the interest will come from, we need a quick primer on smartcoins.
How do BitShares smartcoins work?
There are many explanations of this all over the place, but there are two basic operations that you need to understand to see how this works:
- Borrow
- Settle
(Note: the third, Margin Call, is also very important but not necessary for my explanation here.)
Borrow works like this, as depicted in the very cheesy diagram below. A BTS holder commits some of his BTS to be locked away in a collateral smart contract, and then receives some brand-spankin-new HERO in return. This person is the free to sell the HERO. Typically, you would borrow HERO when you think that HERO is overpriced in the market (or when you think BTS is underpriced), hoping that the price of HERO will drop (or BTS will rise) and you'll be able to buy back the HERO you previously sold (i.e., sell back the BTS you traded it for) and recoup your investment.
The second part of the mechanism, "Settlement," works like this (in a more complicated way, but you'll get the idea here). Again, I have a probably-unhelpful diagram to help out. Do note that the diagram is extremely oversimplified. Recall our original BTS holder who borrowed the HERO into existence; that person owes a "debt" of HERO to the network. Anyone who owns HERO can "call in that debt" whenever they like. This is called "Settling." If the HERO holder chooses to settle, this means they want to trade their HERO for an equivalent amount of BTS. Those BTS tokens are always available, since the people who created HERO in the first place locked them away as collateral. So when a HERO holder requests settlement, the network goes and finds the HERO borrower with the least collateral, erases part of their debt, and gives part of their BTS collateral to the person requesting settlement.
So who pays the interest, and can they get out of it?
The people who originally borrow the HERO into existence are the ones who are solely on the hook to pay the interest. But there is an important catch in here: Strictly speaking, they have no obligation to pay the interest itself; they merely have to support a minimum price for HERO tokens. There is no maximum price for HERO tokens! Consider this scenario: suppose that HERO trades consistently at double its feed price. That is, double its minimum price. Its minimum price corresponds to an annual appreciation of 5%; double its minimum price corresponds to annual appreciation of only 2.5%.
This presents a very interesting strategic problem. If a BTS holder sees a smartcoin trading at double its feed price, they will be sorely tempted to borrow some and sell it. They've been trained to believe that smartcoins are "supposed to" trade right at their feed price; if they see one double the feed, they'll think that it's likely to lose 50% of its value soon and will want to short sell it. On the other hand, if I see an asset that appreciates at a consistent 2.5% annually, I'll be sorely tempted to buy it. Good luck getting that from a bank account (except, of course, LMCU Max Checking)!
The other interesting complication is that settlement only happens at the feed price (margin calls happen at a higher price, but not typically 2x higher). This means that if I buy HERO expecting a 2.5% return because it's trading at double the feed, I'll only get this from appreciation; I can't actually get it through settlement. Will this reduce the buying pressure? Probably, but only time will tell.
Then what is a fair price for HERO?
So what should we expect a fair price to be? That's very uncertain! The only thing I can say that I believe for sure is that HERO will trade on average above its feed price, so that it pays less than 5% interest. It's going to be a fascinating experiment!
If you want to trade HERO when it launches, sign up with my referral link: https://bitshares.openledger.info?r=zebulon
heard about your article today from @bbrewer
https://steemit.com/bitshares/@bbrewer/is-bitshares-finally-having-its-day-in-the-sun
Very intrigued. steemit a great way to get my source of info on crypto. amazing community we have here in sharing info.
Totally agree with you.
Thanks for the analysis.
The HERO has a well defined price as a function of time, but I agree you may have to pay a premium to get one. There are many such examples, like what you might have to pay for a bond as interest rates fluctuate.
Nevertheless, everyone can see the reference price and decide if they want to pay the asking price premium. The market will set this value based on its perceived worth, but the market doesn't change the promised smart contract terms.
In the end, the HERO is an attempt to sweeten the deal just enough for ordinary savers to get them to try out digital currencies for the first time. Clearly the other benefits we all know and love have not been resonating with the general public. But this just might.
The only difference for the issuer is whether she thinks BTS will appreciate more than 2.5% annually. This is a small hurdle added to the bigger question of whether BTS will appreciate at all.
If you are a whale contemplating issuing a substantial number of HEROs over an extended period of time, your own buying pressure ought to answer that question until the business you are bootstrapping generates enough earnings to make further growth self-sustaining.
We provide options. We shall see if they become popular or not.
Well, first you'll see if they work or not. ;) Don't get me wrong - I'm actually very excited to see what the effective rate of return ends up being for HERO. However, I also think the bitshares echo chamber has lost a lot of people a lot of money over the past several years. Maybe someone will read this and realize that there is nothing to prevent the market price of HERO from being considerably higher than the price feed. The feed price is only a lower bound on the market price.
A whale, I'd hope, would study the smartcoin mechanism carefully enough to understand this.
By the way, here's a smartcoin technical question: suppose HERO is trading at 2x the price feed. If someone makes the mistake of asking for a force-settlement, they'll only get half of the market rate, right? And the short position that is closed will get to close their short position at half price?
That's exactly what should happen.
The HERO is a fungible smart contract that guarantees you can cash out for a pile of BitShares at the well defined price feed. If you paid more for that you did so at your own risk.
This factor alone will keep the 2x scenario from happening. Its sort of like the limits the FDIC places on how much they are willing to promise to insure.
We'll need to make sure the HERO web site explains the risks and nuances to clearly to all buyers.
No different really than paying more than a dollar to get a dollar at a loan shark emporium. If you do that, you are not altering the value of the dollar you are paying a premium you find worthwhile.
Probably, but not necessarily! You don't know a price until you smash a demand curve against a supply curve. If there is enough demand for 2.5% returns (on the HERO demand side), then 2x is consistent with that. It's probably unlikely, because that far from the feed, it would probably be pretty volatile and 2.5% returns with big price swings are probably not that valuable. But who knows? There are a lot of "probablys."
I don't think that's a good analogy, or at least there's a sliding scale that it's missing. If HERO had a totally stable price at 2x the feed, it would be worth buying for anyone who wants 2.5% returns. Rational people would never settle, and shorters who tried to drive the price lower would be selling into stiff demand and wouldn't profit. Of course - the 2x number is just "for instance," and the more I think about it the more I think it's way too high. But 1.4x? Seems believable. This is part of why I'm so intrigued by HERO; it's going to be such a cool experiment.
Am I wrong or are my missing something. Currently prices for the buy orders for hero are all lower than the feed price. Maybe you areb anticipating a demand surge that will cause a price hike to double its feed price because am not seeing it. That is actually my worry asides five percent APR. I hope the PR guys make inroads into people to generate demand or we will be left with excess supply of the Hero exerting a downward pressure on the price. So i keep wondering why you are so sure its gonna sell at a premium.
If you hold a HERO, you can "request settlement," which means you give up the HERO and get paid an equivalent number of BTS (measured by the feed price). So even if many many people borrow HERO into existence, the excess supply can't push the price below the feed price because people would buy the low-price tokens and settle them for a profit.
There is extremely high demand below the price feed because the network enforces the price feed as a floor.
We'll see about the premium. The token still doesn't have much liquidity, so it's hard to judge yet.
I really appreciated this article and the discussion in the comments. (Apologies for the thread necro).
Very good! Thank you for your analysis