Black swan on Vacha reservoir, Bulgaria by Kiril Krastev
Over the past couple of weeks, our team has been working through the Steem Dollar mechanics in an effort to secure the economic foundation of Steem against black swan events. It should be obvious to all that if at any point in the future the market cap of Steem fell below the supply of Steem Dollars then the Steem Dollar would break. Long before that happened there would be a run on the bank.
We designed the Steem incentives to always push Steem toward a Steem Dollar supply equal to about 5% of the available market cap. This happens because for every Steem Dollar we create we create about 19 Steem Dollar’s worth of Steem and Steem Power.
This system works well when the market cap is rising or relatively stable, but there is one edge case which could cause the system to unravel. When the market cap falls and pushes the Steem Dollar ratio to dangerously high levels (20% or more of market cap), then the network must start paying off its “debt” with “equity” and reducing the Steem Dollar supply.
Extremely Unlikely but not Impossible
Before anyone starts worrying, lets look at what would have to happen before these kind of scenarios become a concern.
Currently Steem Dollars represent about 1% of market cap and total about $2.1 million dollars. This is a very safe level. The market cap would have to fall to $10.5 million dollars before Steem Dollars represents 20% or more of the market cap.
Each day the supply of Steem Dollars is increasing so over time the danger zone market cap will rise.
Reducing Steem Dollar Supply in Down Market
There is only one way to reduce the Steem Dollar supply and that is by users voluntarily converting their Steem Dollars to STEEM at the price feed via the 7 day conversion. This processes can be incentivized by offering a short-term premium conversion rate that gives each Steem Dollar holder $1.25 worth of STEEM when they convert. This is possible by having the witnesses temporarily adjust the price feed.
It would be critical that the premium remain temporary and has a pre-planned deadline or else the market would permanently adjust the trading value of Steem Dollars to reflect this new premium conversion rate.
Steem Whales can also buy Steem Dollars on the market by powering down some STEEM and then convert to back to STEEM. This process would not necessarily be profitable for whales and suffers tragedy of the commons. One whale would carry the burden for the benefit of the entire platform.
Stop Increasing the Supply
Of course it gets difficult to reduce the Steem Dollar supply when the supply keeps growing due to interest and author rewards. The fastest way to dig yourself out of a hole is to stop digging. As it exists today, this isn’t an option for author rewards but it is possible to reduce the interest rate to 0%.
New Enhancements for Stability
In the up coming hard fork we will be including changes to the protocol designed to protect all parties in the event persistent price declines and lack of redemption requests allow the Steem Dollar supply to reach unhealthy and unsustainable levels.
Gradual Shift in Author Rewards
As the Steem Dollar supply grows from 3% to 5% the percent of author rewards paid in Steem Dollars will go from 50% to 0% and the percent paid as liquid STEEM will go from 0% to 50%. In this way authors are still awarded with liquid assets, but the network gradually slows down the printing presses on Steem Dollars.
At current levels, this measure wouldn’t take effect unless the market cap fell to $70M and would completely stop issuing new Steem Dollars when the market cap fell to about $40M.
Gradual Forced Redemption of Steem Dollars for STEEM
Any time the Steem Dollar supply reaches 20% of the market cap, 1% of everyone’s Steem Dollars will be converted to Steem Power at the price feed. This action can be viewed as a partial “bail-in” where everyone is treated equally. This will immediately reduce the Steem Dollar percent of total market cap while preventing immediate dumping of the STEEM which could accelerate the collapse in a positive feedback loop.
Steem Dollar holders that wish to avoid this forced redemption should convert to STEEM and sell on the market. If done via the 7 day conversion process, then the supply should decrease naturally and all Steem Dollar holders can be spared the “bail in”.
It is our belief that having this safety net in place before it becomes an issue will help the entire community know how stake will be allocated in the event of persistent long term declines in price. The existence of this safety net will in turn reduce the likelihood that fear will turn into panic selling that would ultimately precipitate such an event.
It should be obvious to all that Steem Dollars are not backed by any individual holding dollars in a bank or promising to pay US dollars and that the only thing you are guaranteed is some amount of STEEM. The STEEM cannot be guaranteed to have purchasing power.
Under the enhanced rules everyone is protected and fairly dealt with in the unfortunate event that the market cap of the platform is unable to sustain the Steem Dollar debt levels.
If anyone has any concerns or has better solutions in mind please let us know.