Stablecoin thoughts, a lesson learnt, the ideal, and a perhaps Hive connection

Stablecoin thoughts

Recent news events got me to thinking.

The concept of the stablecoin, a cryptocurrency linked or pegged to fiat currency, is appealing. They could help bridge paper money that we have and have traditionally used over to the blockchain space for use there. Stablecoins could also help ameliorate crypto-volatility.

_{Stability and trust, which comes first?}

As I understand, there are two ways to approach this aimed-for stability:

Peg the fiat to the crypto by backing the crypto with fiat at a 1:1 ratio. That is, for every $1 in crypto there is $1 in fiat or paper money. Simply, there is a vault with a cash supply that exactly equates to the crypto supply. This is the route that Tether has supposedly taken, though their records are not open. More verifiable, I'd point to the Gemini dollar (GUSD) by the Winkelvoss twins. I give them credit for trying hard to work with regulators and have auditors view the books for the Gemini dollar to show they hold one USD for every one GUSD.
Or secondly, an algorithmic DAO mathematically pegs the stablecoin. There are different ways to do this and it can get nerdy. But, the purported benefit of this approach is that, being a DAO, the fickle human element is removed and replaced by non-fickle computer code. This is the approach taken by MakerDAO with their stablecoin Dai. This is also the approach used by Terra and the recently busted TerraUSD (UST) coin. The LUNA and UST charts are rather dramatic and easy to comprehend at a glance:

_{LUNA and its recent fall.}

_{The depegging of UST.}

Check the current price for LUNA or UST right now.

This second approach has had me intrigued. It jives with the crypto ethos of decentralization. The first approach requires a trusted third party, like Gemini or Tether (maybe?). However, the algorithmic approach is run by a DAO, which, once launched, is run by no one. (Perhaps validators or witnesses may be able to alter the DAO ex post facto, but this would still much more decentralized than a single entity, which could fail or deceive.)

This approach intrigues me also by applying one of the most basic tenets of economics: incentives. As I understand, a stablecoin like UST essentially operates off the fundamentals of monetary supply with the profit motive incentive thrown in. Of course, recent events have seen this LUNA and UST system "depeg" and break down. Yet, the concept follows below.

There are/were three premises to make this machine function.

At any time, you can swap between UST and LUNA at a 1:1 ratio. This swap is regardless of any UST/USD or LUNA/USD prices on the open market for either coin. The UST/LUNA swap is simply 1-to-1.
If UST traded for, say, $1.05, there is an incentive to swap your LUNA for UST. The incentive exists simply because $1.05 in UST is greater than $1 worth of LUNA. You expect that $1.05 to drop toward $1, so you take your 5% profit now. Upon this swap process, LUNA is burnt and UST is minted. The increased UST circulating supply should naturally drive the UST price down toward $1 (and LUNA should gain value as it becomes more scarce due to burning).
If UST traded for, say $0.97, there's an incentive to swap out your UST for LUNA. The incentive exists simply because $0.97 UST is worth less than $1 worth of LUNA. You expect UST will rise toward $1, so you take your 3% profit now.

Source

_{My vision of the way UST was supposed to work.}

I believe that Maker Dai operates with a rather complex system, but that is also hinges on users' incentives where people act in their own best interest. And in this way, Dai gets driven back toward $1.

And here on Hive, HBD functions similarly, combining user incentives with a mathematical algorithm coded in with the goal of stability around $1.

HBD connection
I searched for "how does hbd hive backed dollar work", or similar parameters. This post by @taskmaster4450 helped. This post by @kevinnag58 gave deeper details. There's apparently quite a bit of math and if-thens and technicals like the HBD Stabilizer involved with HBD. I did like the sentence below in this this post by @crypto-guides.

HBD is actually backed by the code on the blockchain that converts it into HIVE.

Yet, it seems, the incentives of arbitrage are still at the core here, either by Hive users or by the "HBD Stabilizer" which is effectively an auto-trade bot.

In lieu of recent events, I'm not sure if I find all of this consoling or unnerving. Given the LUNA/UST debacle, this might be a good time and opportunity for someone knowledgeable to write such an explanation in layman's terms and explain how HBD is hopefully different. I know I'd appreciate it.

Lesson learnt

With UST, at least, what seems to have been the flaw in the system is that fickle human nature is not, in fact, removed. Though a DAO runs the math and mint-and-burn, the swap buttons are still pushed by people and our flighty whims. The simplicity of the profit incentive seemed to have worked for a while, until it didn't. For who-knows-why, the fight-or-flight panic-mode of people suddenly kicked in.

Trust wavered. The "death spiral" began and then trust was broken. Without trust in the system, the incentives were disregarded and it went to zero.

_{Technical Analysis of the Crypto Death spiral.}

An irony of this so-called "death spiral" is that it contains both (a) the emotional-and-reflexive parts of human nature, in addition to (b) the sober-and-logical parts of human nature. It's the emotional-and-reflexive that initiates the death spiral, saying, "Oh no! It's about to plummet! I'm outta here!" Before the spiral has clearly begun, this action is irrational. Later it's the sober-and-logical that says, "The death spiral has begun. I must cut my losses and get out now." Once the spiral has begun, this action is entirely rational.

We've seen this sort of thing time and again in crypto. Coin ABC suddenly, for who-knows-what-reason, rockets up to the moon in price. FOMO sets in and panic-buying ensues, and the coin moons ever higher. Then, the price wavers, then panic-selling ensues and the coin plummets back to zero. It is a well worn path.

So, because people are involved, I'm now questioning whether algorithmic/mathematical stablecoins can work.

The lesson I learned: the human element yet remains.

Ideally

I've often thought, how neat would it be to have a coin pegged to something tangible and universal. For some reason, an egg comes to my mind. Around the world, all people's know and easily understand the value of a chicken egg. Imagine one EGG coin to represent one chicken egg. And imagine that you could swap your EGG coin and be handed one real egg. Or, you could harvest a half dozen eggs from your hens, hand them over to the international egg reserve, and be issued 6 EGG tokens. In this way, EGG tokens are minted only when real eggs are laid. Real eggs can be swapped for EGG tokens. EGG is backed by eggs.

Here, it's worth noting the "T-word" again: trust. Always, it comes back to the fact that we must trust something has value, money or commodity. Everyone trusts that eggs have value. Even people who don't like to eat eggs know that an egg could be traded to get something else. Of course, the EGG-to-egg swap has a problem. Namely, eggs go bad. Any other commodity could be used: corn, salt, anything. This is one reason gold has been and is used. As an element, it doesn't break down.

When Facebook came out with the idea of Libra (later called Diem), I liked that it was to be backed by a "market basket." If I recall correctly, it was to be backed by a basket of international currencies, which I was not particularly thrilled about. I was hoping it would be backed by real items, like gold and corn and salt and chicken eggs. Of course, it never got off the ground and went kaput.

We could go gold-digging, or we could turn to digital gold...Bitcoin. And, again, we come back to trust. A favorite criticism of Bitcoin is that it's not backed by anything. I'd offer this correction, Bitcoin is not backed by anything tangible, like chicken eggs. But it is backed by the code and scarcity and mathematical underpinnings that run it, as well as the fact that no person or entity can manipulate this system. That hard-coded guarantee is the backing that can be trusted.

Again, that quote by @crypto-guides resonates:

HBD is actually backed by the code on the blockchain that converts it into HIVE.

If we don't yet have an ideal stablecoin yet, we have Bitcoin.

A very humble Hive connection, perhaps
This notion of token-backed-by-something is one reason I started Hivebits (HBIT) January 1. It came with the promise that every single HBIT would be backed by someone's actual effort. One HBIT is only released when a Hive user issues an HBIT command.

Parts of HBIT are hard-coded, like the maximum circulating supply being set at 21 million and the fact that it cannot be changed. Trust is still required though. Namely, you must trust that the backed-by-effort policy will not change. I'll say again, every HBIT will be backed by the fact that someone consciously "mined" that token. No HBIT will see the light of day any other way.

Conclusion

Given that people interact with a DAO, an algorithmic or mathematical stablecoin may not be entirely possible. Or, maybe, we just haven't figured it out yet. The lack of imagination doesn't mean something is impossible.

My gut tells me that a 100% DAO-run stablecoin can happen.

As I see it, the trick is to engage with human nature, as with incentives, but to also somehow remove human nature from the mechanics of the coin. How that's done, I don't know. The use of the HBD Stabilizer, or such a mechanism, seems promising because it is automated and therefore divulges from human whim.

An ideal algorithmic stablecoin would be entirely automated and completely divorced from the corrupting influence of flawed human nature.

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UST had been a good stablecoin, until it was not. From what I know, UST was behaving as expected until it encountered an extreme situation which caused the cascade failure which has been dominating the news.

Algorithmic stablecoins are designed to handle the most common situations as well as widely-known extremes. It's hard to code to prevent against something unforeseen.

As best as we try to idiot-proof something, it takes an idiot to break it. Maybe we need to incorporate idiots into the stablecoin coding and development process? We may never be fully successful in idiot-proofing any stablecoin, but maybe this approach can keep UST-like scenarios rare enough that we can feel good about trusting whatever stablecoin we want to use (including HBD).

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