How the Steem Dollar Peg Works

in #steem8 years ago (edited)

After watching the Free Talk Live show discussing Steem, I noticed one question kept coming up over and over again: how does the Steem Dollar stay pegged to the dollar? In this video, I answer that question.

Would you like me to cover another topic? Make requests below! :)

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Don't you have an error when state the price will the price on the day when the contract executes at the end of the week? The entire point of the 1 week delay is to force an average weighted price over the entire week, since the attacker can't likely sustain the attack for all 7 days.

Yes, his statement was a simplification. The price is not the price on that day, but the mean price over the period of a week as declared by the witnesses.

If there are rapid price fluctuations, it may or may not be in your best interest to convert your Steem Dollars (you might get an overly good deal or overly bad deal or even exchange). The point is that you can't predict what you'll get at the time you execute the contract. Over time, most likely you'll average an even exchange rate between SD and STEEM.

I wonder though if the constant high inflation of STEEM means that over time your exchange rate between SD and STEEM will actually be slightly biased towards discounted SD.

Slightly yes but not as much as the actual discount. This could be corrected for by a slight offsetting adjustment in the feed price, if that made the difference (but it doesn't).

Yeah, I guess it's pretty obvious that inflation wouldn't account for a 15% discount. So why aren't large players betting on the peg and buying up all the SBD at discount?

Suggestions? How about next time write it down, so I can spend one minute skimming it (which I would do) instead of 5 minutes watching it (which I didn't do).

Well the super short version is: a SD is a smart contract representing $1 of debt from the Steem blockchain at large to the holder of the SD. That contract can be sold, in which case it's worth about a dollar, since it represents $1 worth of steem at some point in the future; or it can be executed. If it's executed, the blockchain locks it up for a week, then prints $1 worth of new steem at the end of the week and gives it to the SD holder, and destroys the SD.

The one-week delay is necessary to prevent market manipulation: a whale could dump funds on the markets skewing the price, then execute the contract at a biased price. To prevent this, the week-long delay is used to raise the bar; the attacker would have to maintain a manipulated price for half of that week (or so, I don't know the exact timeframe) to affect the price his contract executes at.

Did you mention the interest rate?

@bacchist Wait, what? SBD pays interest directly? This is something I didn't know. Can you please link the source? I don't recall that being in the whitepaper anywhere and if I missed it then I have been making some really bad financial decisions (been converting SBD to bitUSD taking a slight loss).

I will upvote that information!

@bacchist Wow I just re-read the paper and you're right. It's right there! Upvoted you, also just became your 100th follower. Thanks for that bit of information!

It is in the whitepaper. Now itis monthly 1% and the interest paid in every 30 days. As I know the witnesses vote for the interest rate.

It is certainly in the white paper. It is also in the white paper that the interest rate should be raised if the market is valuing SBD below $1 USD and the debt-to-ownership ratio isn't too high. And interest payments should be discontinued if the market is valuing SBD above $1 USD.

Unfortunately (in my opinion) the interest rate has not been responding to the market undervaluing SBD... I don't think it has ever changed from the 10% apr that it has always been. It's an important part of the peg that should be functioning and should also be promoted more than it currently is, so that it has an actual effect on the market rather than being some obscure thing as it currently is.

Yes, I am curious about the interest rate as well as the price feeds and how that all operatess.

No I didn't. Good point. :) Steem pays interest on SBD to encourage people to hold it rather than convert it to STEEM immediately. This is because the chain wants to avoid inflating STEEM for as long as possible, as conversions are paid out of inflation.

Thanks. So much of the web has switched to video these days. I prefer plain text. Or, if you must do video, for those who won't read, at least a full transcript.

What's a whale btw?

Is "Steem" mined like Bitcoin, with a mathematical limit to how much Steem can be mined?

A whale = an account holder who has a very large amount of some asset, enough so that selling it all at once could significantly impact market prices.

There is a mining process analogous to how Bitcoin is mined, but unlike Bitcoin there is no upper limit to the amount of Steem that can be created. You should read the whitepaper; it covers this topic in great detail.

How does the blockchain now what $1 of steem is?

100% agree... it'd be great if you could add the short-version to the post, and tease more detail in the video.

Holy mother of beards sir!
Grew slightly since Acapulco ^^

Ok I'll watch your vid and upvote now. I just had to comment on el beardo. Not sure my brain could've paid attention if I didn't get that out of the way.

Lol, yeah just a bit. ;) Thanks!

One correction, and i understand that there has been some confusion on this.

The steem that you get when you convert an SBD is not created when you convert it. Its created at the same time the SBD is created. That steem is added to the vesting fund (where SP balances are stored) . If it takes more steem to redeem your dollar (ie if the price of steem goes down) then the loss is socialized to all SP holders. The same with the gain if it takes less steem to redeem the SBD than was created when the SBD was.

SO if the price of steem went low enough, redeeming SBD could actually make your SP balances run backwards by depleting the vesting fund.

Interesting. I did not know this.

you have very nice color eyes

That talk was an embarrassment, particularly after Jeff left. It was clear no one there knew anything about Steem aside from FUD spread across the internet. The most hilarious part was when the host kept talking about a cap of 47,000 users from the "whitepaper". No idea what he was looking at, but it sure as hell wasn't the Whitepaper.

That said, a valid question is why the 1 Steem Dollar is US$ 0.85 at the exchanges.

Haha, yeah, though even when Jeff was there, there was a lot of uncertainty and confusion. Jeff is super pumped about Steem, and I'm glad that he's doing so much to promote it, but he has much to learn yet (which he's vocally aware of, so good on him).

Off the top of my head, I can think of two reasons why 1 SD would trade at substantially less than $1:

  • Low liquidity
    • There's just not enough people buying/selling it to maintain a reasonable price
    • Solution: people should buy up these dirt cheap Steem Dollars!
  • Lack of trust
    • Steem dollars are redeemable for $1 worth of STEEM as long as STEEM is worth something
    • If people don't trust STEEM's market cap to stay greater than the total supply of SBD, they reasonably won't trust SBD to be worth a full dollar

I feel it has something to do with discrepancies between Internal Market and exchanges. Currently, the Internal Market is trading at SBD 1.97 for 1 Steem. If SBD 1 = USD 1, the exchanges would be trading at US$ 1.97 too. But the exchanges are at US$1.70. By undervaluing the SBD at $0.90, it keeps the USD value of the Internal Market much closer to the exchanges. However, in this case, should the Steem price not rise to meet the Internal Market? And not a fall in the SBD?

But anyhow, that's how it has worked out so far. I hope this stabilizes in the future, and the Steem founders are taking measures to do so.

The internal market is almost entirely irrelevant at this point. Hardly anyone uses it and I question whether it is even needed. (We have it and it works, so I wouldn't suggest getting rid of it, but if we did, the essential functions of Steem would not be affected at all.)

I agree with @modprobe's answer.

The internal market is using a 7-day rolling average price for Steem.

The internal market is based on supply and demand, just as Poloniex or Bittrex. The price will generally track to the price found on external markets.

Also the fact that it's locked up for 7 days. I've posted arguing that it should be changed from a 7 day waiting period to a 3 day waiting period, due to the risk that is involved. Changes in the market can cause the user to lose money... If the price of STEEM is below the weekly average when the order is executed by a greater proportion than the market is undervaluing SBD, they will have lost value. It's hard to forecast what the market is going to do a week out.

I believe it's trading at a discount because of the 1-week delay in price feeds. If STEEM were increasing in value, SBD would be trading at a premium. I think... I haven't completely worked out all the details yet.

Anyway, the conversion price lags the real-world price by about half a week, which means I'm not confident that I'd make money by buying SBD at a discount and then converting it to STEEM.

@biophil Excellent insight and you are 100% spot on. People are pricing in the risk of a slide in the dollar value of steem. They want out and they want out now. Back when the price of steem was rising, you couldn't buy SBD for less than a 30% premium. I have a post from back when that was a fact, explaining to people that they should sell SBD on polo to drive the price back down to normal.

Right now, the very best thing you can do financially is either to hold SBD (which I've just found gains 10% interest), or convert it to steem thereby giving you about a 20% gain in dollar terms and also destroys the excess steem in the system.

Yeah, I'm running a SBD-to-STEEM conversion experiment right now where I'm converting a set amount of SBD per day and then re-purchasing SBD when the conversion goes through. My first attempt that I completed today netted me a little over 2% (I started with 200 SBD, ended up with just over 204). That is very very far from the 15% that all of the face values are suggesting, and I don't know where you came up with 20% - that's simply not available today. :)

I think it is a combination of two things:

  • Discounting due to the risk that the Steem economy will not have enough value to pay for all the Steem dollars it has issued or will collapse entirely.
  • Discounting due to the volatility in the price of Steem and the time it takes to convert Steem dollars to Steem.

If you think people are pricing it wrong, buy up Steem dollars and convert them to Steem. But the fact that this price discrepancy remains shows that nobody is willing to bet a ton of money that the price is wrong.

I'd do this, but the 1-week delayed feed puts a lot of uncertainty into that conversion because the conversion price lags the real-world price by about half a week.

Exactly. And it's possible that most of the "discount" is the rational pricing of that risk.

Thanks @modprobe. I get asked about this one a lot too and I never felt I understood it well enough to make a video. Now I don't have to! :)

Short and on-point. Killed it!

Thanks so much for the great explanation! Having experts like you explaining this is essential to educating Steemers. I just love what I'm learning here and appreciate your efforts. What a great community! Followed!

Thanks for the explanation @modprobe, I think you should explain to Tone Vays one thing or two on how Steemit needs a blockchain to run on. // thanks again

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