Coin Minting 101 and Responsible Monetary Policy

This is a bit long, I’ll admit — but here I have assembled a crash course on responsible monetary policy and how cryptocurrencies enable a hands-off style of inflation that revolutionizes predictability for value creation. The end will specifically focus on DAPScoin, but the majority of the article applies to all cryptocurrencies.

(Disclosure: I am an admin for DAPS)

Financial Systems

One of the major innovations associated with Blockchain technologies is the mathematically controlled inflation models. It allows for transparency and a level of trust that is not achievable in a currency that is controlled by a small number of people. When you rely on machine code to produce and regulate currency, you avoid common problems such as bad actors colluding or excessive printing of money. If the code of a Blockchain is verified to run a set of known rules, they cannot be changed without resulting in errors and incompatible behavior. Compare this to a small group of people agreeing on an interest rate and implementing it, usually without widespread knowledge of the reasons why or consent from those who use the currency.

Balancing inflation and value is not an easy task; it requires balancing the law of supply and demand (scarcity) to retain value for a long period of time. The US dollar is currently the most stable form of paper currency to date. The inflation rate has been around 2% a year for many years. The British Pound has been around longer than the US Dollar, but it has lost much of its value due to rampant inflation over time. There are several example on how NOT to run a currency, such as the Venezuelan Bolivar, which has had an inflation rate which caused it to be useless as a currency. Historically, there have even been currencies burned because the heat from the fire is more valuable than the currency itself. In these cases, the inflation reaches up to and over 1000% a year, meaning that it is not scarce and therefore not valuable and useless as a bartering tool in day to day life. This kind of inflation is deemed “hyper inflation” due to the rapid increase in supply and loss in value.

In a country whose currency has become hyper inflated, the living conditions of the average citizen decay at an atrocious rate. Since the buying power has decreased exponentially, you may end up paying thousands of notes for one cup of coffee. Merchants have to price their goods at the beginning of the day, sometimes twice a day due to the unstable market price. Banks do not have enough paper notes for all their citizens, so access to funds is restricted and rationed. This means even though the numbers in your digital account say you have a balance, you may not be able to access your funds at your discretion. There are reports from countries that suffer from this condition that their citizens on average are losing weight due to food shortages. This is the final stage of all privately issued currencies that do not adequately control their inflation, and quite possibly all currencies that rely on “quantitative easing” (printing money at will) to “stimulate” their economies. Studies show that the average life expectancy of a fiat currency is 27 years. In addition, every 30 to 40 years the dominant currency must be reworked due to its imminent failure.

Cryptocurrency

Bitcoin was the first attempt to control this vital source of value by non-human means. Satoshi Nakamoto brought together elements of computer science, game theory, and economics to fashion a network that tames the beast of inflation and at the same time, does not allow the rules to be so easily changed at the whim of humans. The code creates new Bitcoin for each block “mined”. In other words, the computer proves that it has done work (“Proof of Work”), other computers check that the work has been done and that it was done first (consensus), if the block (set of transactions) is accepted, it is added to the chain of blocks (blockchain), and this means that the block has been “mined” (accepted on the network), and the computer that generated this block is rewarded with new Bitcoin minted by this process. This is the magic behind cryptocurrency. It is the reason it can be trusted and verified by anyone, anywhere in the world.

Now, there is far more to the process of Bitcoin than the short example given, but hopefully it sheds some light on how inflation is handled on the network. A more in depth look at how each part works and fits together may be provided in the future.

The number of Bitcoin contained in block rewards is fixed and unchangeable without creating a fork that is incompatible with the main Bitcoin network. Initially this reward was 50 Bitcoin per block and the network made sure this was true for all blocks accepted to the network. After 210,000 blocks, the reward was cut in half to 25 Bitcoin per block. 210,000 blocks later, it cut in half again to 12.5 Bitcoin per block, and eventually there will be no more new Bitcoin minted. This inflation schedule is verified at all times by the network to ensure nobody is rewarded more Bitcoin than the number specified as the current block reward. But what happens when the total supply is reached? How is it possible to continue to reward miners when no new Bitcoin are created?

With each transaction submitted to the network, the sender must pay a fee to the miners to include their transaction. The miners choose the transactions that will give them the greatest reward, and if they are the first to submit the block to the blockchain, then they receive all the fees in the included transactions. At the release of the network and in its current state, the fees included with the transactions are not enough to be profitable for miners to secure the network. In essence, the newly minted Bitcoin released as inflation are to make sure miners are incentivized to secure the network until such time that the transaction fees alone are profitable enough for miners to secure the network.

Since the creation of Bitcoin, many other cryptocurrencies have been created. These new coins usually change certain parameters of Bitcoin, sometimes drastically and other times in very small ways. This experimentation allows a look into how economic activity works, and if these models create value and scarcity or destroy it. With every change in the design of the inflation schedule, there is a change in the incentives for the users of the network. We will cover this more in-depth later in this article.

There have been many other innovations in consensus mechanisms since the inception of Proof of Work. Some examples include Proof of Stake, Delegated Proof of Stake, Proof of Capacity, Proof of Importance and many, many other creative designs.

Proof of Stake is a younger consensus mechanism than Proof of Work, and has a different approach to block rewards. This type of network requires a user to lock up (“stake”) their funds to secure the network. It uses much less energy than Proof of Work, and requires more starting capital as opposed to more computing power. Some Proof of Stake networks also use Masternodes, which have certain requirements that may or may not reduce profitability, such as paying for a Virtual Private Server (VPS) or requiring your computer to be on at all times.

Inflation Models

Whether Proof of Work, Proof of Stake, or any other method of achieving consensus is used, controlling the amount of inflation has lasting consequences on the lifespan of a currency. Too much inflation results in a decrease in scarcity and a collapse of price, too little and it may not be worth the time and resources to secure the network when compared to the price. The network itself does not care about the price, but the humans using the network do and this is true whether we are talking about government issued currencies or cryptocurrencies.

Balanced economic models and set of incentives are key to a long lasting, valuable currency. There are many factors that go into this, and when experimenting with new models usually there are some unforeseen effects. For example, using a larger block size mean that it takes more computer power and capacity to run, pricing out smaller competitors and leading to a centralization of the network. This centralization means that only a small number of people are getting all of the inflation rewards, negatively impacting the distribution of the network by pooling all the money in the top rich wallets.

Here are some examples of how inflation could affect how long a certain network lasts:

1–4 % inflation

If a network has a rate of 1% per year, the cost of the resources expended must be lower than the expected return for this currency. People may not rush in for such a low return, which may keep the price stable for longer. It also means that one may have to wait longer for a reward on their initial capital. For Proof of Work networks, this has a high chance of being unprofitable for those securing the network. The cost of electricity alone will more than likely outweigh the rewards received unless the price is very high, so it isn’t impossible but it is highly unlikely. This could lead to the network ceasing to function, as the miners verify the transactions. Proof of Stake has a better chance of being profitable, as the computer is not expending energy like in a PoW network, but will probably require a large sum of coins to make a significant reward for securing the network. If the network is able to be valuable enough to make the reward profitable, the low inflation percentage makes the network have a higher chance of a long lifespan.

5–10 % inflation

Most of the same dynamics still apply to this level of inflation as the last, though the increase in rewards come at the cost of the the lifespan and health of a coin.

10% is the high end of sustainability and when increasing inflation beyond this number, the lifespan becomes shorter and becomes exposed to other threats to its economy. The higher rewards incentivize the earliest users and the market will quickly succumb to selling pressure as decreasing scarcity affects the price. A 400% yearly inflation scheme means that by the end of the year, you will have your initial capital PLUS your initial capital times FOUR. This type of inflation may see a lifespan of a few months as people sell off their new coins for quick profit.

There are problems with fixed percentage rewards as well, mainly the principle of “the rich get richer”. Simply stated, if you have a large amount of capital, you will generate far more returns than someone with less. This is a fundamental part of currency and it is not possible to completely remove it, one can only make its effect larger or smaller.

Coin Supply

The number of coins available also has economic repercussions. Some of these are psychological and some are derived by calculations. Market Cap has come to have major importance in the world of cryptocurrency, despite being flawed in many and significant ways. Market Cap is calculated by multiplying the number of coins in circulation by the current price. This calculation assumes that every coin can be sold at the current market price, which is overwhelmingly not the case. It also assumes that the price of the coin is somehow tied to its supply because of how it moves up or down in rank. Price discovery is a tough task, over- and undervaluation is common and the psychological effect of Market Cap rank is not necessarily based in reality. Low supply is generally seen as able to have a higher price due to the Market Cap principle, though this isn’t always the case. What matters most is value and dispersion, that is how useful is a thing for it’s purpose, and how many people control the price based on their individual money management techniques.

A common hurdle to cryptocurrency adoption is the relatively low “liquidity” (coins available at a given price point). This is an emerging market, and the number of buyers and sellers can affect purchases in an everyday business environment. For example, say you were to purchase a new car with Bitcoin. The dealer accepts your payment of 2 Bitcoin, but their electric bill is due and the electric company does not accept Bitcoin for payments. This means that the dealer will have to convert the payment into a form that the electric company will accept, usually a local fiat currency. The dealer will then have to figure out how they can get the best price for their Bitcoin and how to get it into their bank account as fast as possible. For this they need a fiat off-ramp (Gemini, Coinbase, Bitladon, etc). If they decide to only use one of these exchanges, they are at risk of not being able to sell all 2 Bitcoin at the same price due to lack of liquidity. They can use more than one fiat off-ramp service, but then they will be doing at least double the amount of work to convert to fiat. There is a danger of crashing the price as well. If the order books are sufficiently thin or the sell amount is sufficiently large, then it is possible to move the price of Bitcoin by a large percentage in a single sell.

There is also the issue of volatility; if the dealer chooses to hold instead of sell and the price drops, then they lost money on the sale. If the price rises, then the customer who purchased the car has paid more than if they had waited for a price increase. As long as Bitcoin is able to move more than 10% a day in price, then buyers and sellers risk their purchases costing more or less than they intended. At this point, fiat currency has the liquidity and market penetration to move large sums of value without affecting the current price of the currency in relation to other currency options. It may be possible for cryptocurrencies to achieve this level of liquidity, but this remains to be seen.

Bringing it all Together

We’ve covered quite a bit so far, but these are just the very basic pieces of currency valuation. There are many more details and principles that affect the health and longevity of a currency, but these simple views can help make sense of how they work. Here is a quick recap of what was covered so far:

• Human-controlled currencies are subject to human error. Policies can be altered at will by a small number of people and are subject to collusion, bribery, self-benefit and other distinctly human problems.

• Cryptocurrencies are computer-controlled and policies are not as easily changed. There is still human error present but it’s easier to predict and program immutable economic models

• Inflation is a major influence of supply and demand. High inflation causes rapid decrease in scarcity, and low inflation risks never being profitable.

• Coin supply may or may not affect price, it is the distribution of the coins that makes a difference.

How does DAPS balance these models? Let’s find out!

How DAPS Does it Different

The model DAPS strives for is balance. The idea is to cover as many possible scenarios as possible. Heading into the 10th year since the birth of cryptocurrency, many of these economic experiments have come and gone and left with us a lesson of either what to do, or what not to do. Great strides have been made in the technology surrounding cryptocurrencies, or as Andreas Antonopoulous calls it, “programmable money”. The power of programming money enables a complexity of economy that is not reproducible in an analog monetary system. The DAPS project plans to merge the best of these principles to create a balanced cryptocurrency with the added bonus of anonymity for all. DAPScoin’s economic model will include:

• Masternodes

• Proof of Stake v3

• Proof of Audit mining

Combined, they create an economic powerhouse that can stay profitable in a wide range of potential situations.

Masternodes

Masternodes are a technique for securing transactions and enabling certain privacy features but their economic importance is often misunderstood. Masternodes require that you “lock” your coins in your wallet or other service in order to be eligible for block rewards. There are two main parts to their economic effect: number of coins needed to qualify and the percentage of the inflation they receive.

The number of coins needed to run a masternode increases scarcity by ensuring that a certain number of coins will not be sold on the market at the times they are locked and generating block rewards. It also affects the ability for those with less capital to be priced out of owning enough coins for a full masternode. This creates a barrier of entry that is increasing or decreasing along with the price. DAPS has set the requirement of 1 million coins for 1 masternode. This is 1/60,000th of the total supply and the barrier to entry moves in a relatively smaller range when compared to the total supply.

The block rewards are guaranteed for masternodes. When a new masternode is live, it is placed in a queue to receive the block rewards. How often you receive the rewards is dependent on the number of masternodes. If you have 1 of 100, you will get a reward every 100 blocks. If you are 1 of 1000, you will receive a reward every 1000 blocks, etc. We will cover more specifics of how rewards are distributed later, as part of it relies on the percentage of masternodes versus the percentage of those who are staking.

Proof of Stake v3

In a simple Proof of Stake system, the block rewards will be a fixed percentage and how often you receive them will depend on your “weight” (amount of coins and amount of time waiting for a block reward). This is a classic “rich get richer” scenario: it favors those with a large amount of coins by staking frequently and at a percentage of their total coins. PoSv3 attempts to fix that problem by introducing and element of luck and fixed rewards. Fixed rewards means that the block reward is not based on the amount of coins that are staking. This significantly equalizes the block reward across all parties who are staking. The element of luck assures that everyone has a chance to claim the block rewards.

Staking also requires less tech knowledge to run. Many services offer online staking, and it doesn’t require a fixed IP address or VPS to run. The staking wallet is not required to run at all times either, but it will need to run to be eligible for block rewards.

Proof of Audit

Considering this is a brand new concept in the blockchain space, the economics are unknown at the moment. PoA is based on Proof of Work, so it requires resource expenditure to mine. It accounts for 10% of the block reward.

Math and Profitability

We have covered the concepts behind the DAPS minting system, and now we will apply some numbers to these concepts.

Block rewards are set at 1050 DAPS per block. This breakdown is on a per block basis.

• 5% (50 DAPS) goes to the Dev fund
• 10% (100 DAPS) goes to the Proof of Audit miners
• The remaining 85% (900 DAPS) is split between masternodes and PoSv3

In order to calculate Masternode vs. Staking rewards, we will need to know what percentage of the network is dominated by masternodes.

IF 40% OR LESS of the network are masternodes, then 60% (540 DAPS) of the block rewards is paid to the masternode >that submitted the block. The remaining 40% (360 DAPS) goes to the luckiest staker.

IF 60% OR MORE of the network is dominated by masternodes, then the above statement is reversed. 40% goes to >masternodes and 60% goes to stakers.

BETWEEN 40% AND 60% dominance, the network will compensate for the change in dominance. This means that for >every 1% increase over 40% in dominance, there is a 1% decrease in rewards for masternodes, and 1% increase in >rewards for stakers.

Profitability of either of these choices for individuals cannot be accurately calculated without knowing the network conditions. It does allow for a wide range of options for the end user, which is the goal. One can choose to run only masternodes, or only stake, or any combination of these two. Plus, with the addition of multinodes, it is possible to run more than 1 masternode for 1 IP address, further decreasing the cost per masternode.

Every minute, a block is created and 1050 DAPS are added, and so 551,880,000 coins are added per year until the total amount of minted DAPS equals 10 billion. This works out to about 16 years of emissions, after which the rewards will rely on transaction fees to provide the rewards for those who secure the network.

If you made it this far, congratulations! Now you know one advantage cryptocurrency has over other privately issued currencies, how the economics of block rewards work and how DAPS is splicing the best cryptocurrency has to offer in one place. Have a great day!