We created Steem Dollars with the intention of keeping value within the Steem network. The idea behind Steem Dollars is that people would be more willing to hold their Steem Dollars than a volatile cryptocurrency. The interest rate on Steem Dollars was designed to attract capital.
In my opinion, the Steem Dollar system is only working at 10% of its potential because the frequency and duration of time that Steem Dollars have traded between $0.80 and $0.90. This level of volatility means many people still prefer to “run to the exits” rather than hold on to their Steem Dollars and earn 10% interest. The market has spoken, Steem Dollars, as they are managed today, are not worth $1.00 even with 10% interest.
What follows is my personal opinion and should not be taken to represent the opinion of Steemit, Inc. This disclaimer applies to all posts I make from this account.
Why Steem Dollars are Discounted
A Steem Dollar does not represent the current value of Steem, but the 7 day median price. They are not backed by immediate delivery, but by delivery in 1 week. These two characteristics mean that the market prices in the cost of a 1 week option into the current price. The more volatile Steem becomes the higher the option premium.
The price of options go up when there is strong market sentiment on the expected future price. In a down market the cost to buy an option to hedge against future losses is much higher than the price to buy against future gains. In a bull market the opposite is true.
Why we should Improve the Peg
A strong peg of Steem Dollar vs Dollars means the market will have a strong degree of confidence in the Steem Dollar. The more confidence the market has, the more value / demand there will be to hold Steem Dollars. This in turn means there is a ready and active market for those who earn Steem Dollars to sell into when they want to.
Having confidence that there will be market liquidity at around $1.00 when you want it goes a long way toward people being willing to trust their wealth to a currency. It goes a long way toward merchants being willing and able to accept Steem Dollars at face value. All of these things help grow the value of the Steem network by making it easier to use and building trust.
How to Improve the Peg
There is a simple and straight forward means to improving the peg that can be performed without a hard fork and completely within the options outlined in the white paper. It requires Witnesses to publish a price feed that is adjusted by an amount proportional to the current option premium.
Lets use a simple market scenario:
The current price of STEEM to Dollars is $0.50
The current market price of a Steem Dollar is $0.80
Then the price feed should be 0.40 SD /STEEM
Todays price feed of $0.50 would cause 100 SD to yield 200 STEEM. With the adjusted price feed, 100 SD would yield 250 STEEM which would clearly make Steem Dollars more valuable.
With this adjustment to the price feed, speculators have greater financial incentive to trade toward the peg because the volatility risk associated with converting at the feed has been largely mitigated.
If at some point in the future the Steem Dollar starts to consistently trade at more than $1.00 then the interest rate can be reduced or the feed can reduce its premium.
Keeping a lid on Steem Dollar Supply
The result of making conversion from Steem Dollar to Steem more profitable means it will be utilized more frequently whenever the price of Steem Dollars fall below a dollar. This in turn will help shrink the Steem Dollar supply which helps keep a low debt-to-equity ratio and improve overall economic stability of the platform.
Transparency of Witnesses
I think it is incredibly important that witnesses establish fixed and predictable offsets in their price feed so that other market participants can make more informed decisions about the expected future redemption prices of Steem Dollars.
Raising Interest Rate would be Ineffective
Some people have suggested raising the interest rate as a means of increasing demand for Steem Dollars and restoring the peg. The problem with this approach is that interest rates are only effective when volatility is contained. Why would someone buy Steem Dollars at $1.00 when there is a high probability that they could be forced to sell at $0.80 if the interest rate is only 10% per year. Interest rates help with long-term price support, but do little in the face of large swings in volatility.
When Steem Dollars are trading at $0.80 there is an implicit market interest rate of 30% assuming Steem Dollars eventually revert to $1.00 within a year. Those who believe in the economic fundamentals behind Steem Dollars don’t need more interest and those who don’t believe in the fundamentals would require significant interest to compensate for the long-term risk.
Because there is only one interest rate, we end up paying all holders of Steem Dollars much higher interest rates in order to attract each additional Steem Dollar buyer. When we increase the STEEM backing of a Steem Dollar it actually costs the network nothing.
Reduce SBD Creation Rate
When we adjust the price feed we also reduce the number of Steem Dollars awarded to posts which in turn reduces the supply of Steem Dollars. This helps keep the network solvent while simultaneously biasing the estimated payouts in a conservative manner. It is always better to under promise and over deliver. Currently, Steem Dollars are over promising and under delivering.
Why Steemit, Inc cannot play Market Maker
For some time the Steemit account has attempted to buy Steem Dollars with Steem to support the peg. Our actions have had a two-fold effect of causing us to realize capital gains and introducing more STEEM on the market (driving down the price of STEEM). This is not a long-term sustainable approach for Steemit, Inc nor the Steem blockchain and may result in undesirable tax consequences.
When the blockchain through witness price feeds performs the same actions of supporting the price through redemption requests there are no tax consequences and no dependency on a limited pool of funds that are unable to sustain the peg long term.
Call to Action
I think all witnesses need to pro-actively manage the price feed such that a Steem Dollar never falls below $1.00 for more than 1 day per week. This means adjusting the price feed and interest rate in what ever way they can to ensure that a Steem Dollar never breaks the buck.
The benefit of having a value of more than $1.00 is that market participants can begin to rely on its value. If people can rely on its value, then there is no reason for them to cash out into their bank account. In fact, there may be every reason in the world to move your money out of your bank account and into Steem Dollars.
If you want to boost the price of Steem, then we must support the Steem Dollar by adjusting the price feed. I call on all voters to carefully consider how the witnesses you vote for support the price feed.
Lets all vote to support the Steem Dollar and give investors confidence in storing their hard earned money on the Steem blockchain.