A stable currency on top of a scalable and decentralized DLT: can it work?

1,326 reads

Radix is not a blockchain. Radix is trustless and decentralized. Radix supports smart contracts. Radix has a low volatility currency.

I have no vested interest in Radix, I am just fascinated by the project.

Radix is a speedy and scalable alternative to Blockchains and DAGs. Is the result of 6 years of research and development and is the solution to the problems of scalability and decentralization. Please read my article “Is Radix the Coolest Thing Happening in Crypto Right Now?” if you want to know about the Radix tech.

For sure it’s a very ambitious project, not only because the Radix team want to deliver a truly decentralized and scalable DLT but also because on top of this platform they want to create a low volatility token, the Rad (XRD), that will be algorithmically minted and burnt to maintain an approximately stable value with respect to a weighted basket of assets.

The objective of this project is to ensure that the cost of using the Radix network is predictable and to create a store of value that gets safer with adoption.

The Economic Whitepaper was very awaited by the community and after being under development for almost as long as the Radix project has been and after a very large number of iterations and feedbacks the paper has been finally published.

But, do we really need stable value?

Actually yes, for a lot of reasons. To the average businesses wishing to make use of a DLT network for applications, they just want to know that they can budget the costs of network usage for the next quarter. To the average individual, they just want to know whether they can pay their rent with it when they get it. For mass market adoption, value stability is, therefore, a strong requirement.

There are other problems connected to Blockchain development and Decentralized Application (DApps) usage. On one side now is quite expensive for developers to build DApps on top of current Blockchain platforms. On the other side is expensive for people to use DApps too: if you want to use a decentralized Twitter you could pay a different amount of fee depending on the day or the hour you are using the DApp: it could be 0,02$ now, 1$ tomorrow and 0,01$ the day after.

Finally, another important reason why you need a stable currency is that price volatility makes, in some circumstances, smart contracts useless. Let me explain. The cool thing about smart contracts is that it enables a new way to do business in a transparent and secure way. You can use simple escrow services, with a binary outcome (either done or not done) that can be determined by code alone (i.e. no arbitration/opinion input needed). You can put funds into a smart contract where anyone can go and see, on the public blockchain, both that the funds are available, and also, how they can earn/win some/all of the funds.

However, there is a problem: to put the funds into the smart contract, I need to fund the contract in crypto assets. Now comes the uncertainty of value. Not only am I hoping that the asset doesn’t crash, so is everyone who is considering taking on the project. It is this value stability that is fundamentally critical to the wider adoption of smart contracts; removing value uncertainty and radically broadening the real-world applicability of cryptocurrencies in general.

The rise of the stablecoins

To address this price volatility, a certain subset of cryptocurrencies started to emerge, i.e. stable coins. Being defined by Brigitte Luginbühl, CEO of SwissRealCoin:

“Unlike cryptocurrencies such as Bitcoin, which are highly volatile, stable coins provide people with the pragmatic, helpful benefits of a cryptocurrency, without having to worry about distressing price changes since they are grounded in the real world.”

A stable coin is designed to have a stable price or value over a period of time, therefore, less volatile.

These coins aim to mimic the relative price stability of fiat currencies on one hand, but still keep the core values of cryptocurrencies such as decentralization and security, on the other hand.

Fig.1: Some stablecoins out there.

There are a number of so-called stable coins on the market trying to achieve this, with varying degrees of success. All of them will fall under one of three, broad categories (see Fig.1).

To learn more about Stablecoins please read “Stable Coins Analysis: Is There A Viable Solution For The Future?” by Chrisjan Pauw.

While stablecoins are at the forefront of the mind of crypto enthusiasts and bolstered by the success of Tether, this is not a new idea. There are currently 66 countries that peg their currency to the US dollar and 25 that peg theirs to the Euro.

Radix: goodbye price volatility?

When you want any currency to be price stable you need to decide what it is going to be stable against. Governments use a consumer price index. In Radix it’s used the Index Token ( XRI ).

The Index Token will be backed by a “basket”, or collection, of 3rd party tokens that have been built on Radix. Rather than being stable against just the US dollar the Index Token would group several tokenized currencies together to help reduce this risk.

When the value of the native currency of the Radix platform, the Rad, changes, in relation to this basket, the Economic Algorithm causes the system to take action:

When the price of Rads against this basket rises , the system automatically creates new Rad tokens and sells them on the Decentralised Exchange. It puts any Index Tokens it receives into its Reserves.

against this basket , the system automatically on the Decentralised Exchange. If the price of the Rad on the Decentralised Exchange hits the Price Floor, for example, there is a drop in demand for Rads or a user has sold a large number of their Rads cheaply, the Economic Algorithm then triggers the system to buy Rads using its Reserves of Index Tokens, and then burns the Rads it buys, creating a price floor for the Rad .

So the platform runs an Economic Algorithm which is designed to tend the system towards stability as the Reserves grow, building the Reserves and slowly bringing the Price Floor up towards the Price Ceiling, reducing the scope for any price volatility. This process is expected to be a long term process (circa 10 years).

How you can see there are 5 important functions to create this stable currency, which are:

1) The Decentralized Exchange

The Decentralised Exchange is part of the Radix network. It allows willing buyers and willing sellers to be matched together so that a Market Price may be found for any token/coin/asset created within the Radix system.

Thanks to Radix tech it should have really good performances, in the whitepaper they say a throughput of 80,000 transactions per second for a single token pair.

2) The Index Token

On Radix, the Economic Algorithm uses the Index Token as the price reference for the Rad on the Decentralised Exchange. This target can be stated as:

Keep the price of Rads in Index Tokens approximately 1:1

Where the Index Token’s value is determined by the content of the basket of Assets that backs it. For example, let’s assume that the Basket contains three tokens that have been selected for inclusion in the Index Token Basket:

Basket ( B ) = 50%( A 1 ) + 25%( A 2 ) + 25%( A 3 )

This Basket is then tokenized to create the Index Token, which represents a fractional claim on the Basket:

XRI = X / Basket , where X is the total supply of Index Tokens.

The Index Token administration will form a very important part of what the decentralized governance mechanism will be used for, to be covered in a future paper.

3) The Economic Algorithm

The objective of the Economic Algorithm is to automatically execute buy & sell orders for the Rad on the Decentralised Exchange (all external markets are ignored) to try to stabilize the price of the Rad against the Index Token. It does this between an adjustable Price Floor and Price Ceiling at which it will intervene in the market.

The supply of Rads is controlled by the Economic Algorithm and will go up or down depending on the price of Rads on the DEX against the Index Token: if the price is high more Rads will be printed if Price is low Rads will be bought and burned.

This does not prevent buyers and sellers operating between the Price Ceiling and Floor, but it is designed to build a steadily increasing Price Floor, reducing the Rad price volatility over time, and also making sure that the Rad is instantly available, at a reasonable price, to all users that need it.

The rules of the Algorithm are written inside users node’s code and every time someone would want to change the rules a consensus among all nodes will be needed.

4) The Reserves

At the center of the Economic Algorithm is the Reserves. It is where the Economic Algorithm will store all the Index Tokens.

Any Index Tokens the platform receives from selling Rads will be held in Reserves and may be used by the Economic Algorithm to buy Rads in the future. Any Rads received by the platform will be burned.

Index Tokens held in the Reserves are not held or controlled by any entity or organization; they are controlled on the distributed ledger by the Economic Algorithm. All transactions and Reserves are publicly visible, auditable and transparent.

5) The Price Ceiling and the Price Floor

An approximative draw of the Economic Algorithm objective.

The Economic Algorithm will have buy and sell orders boundaries: the price ceiling (that will always be the same) and the price floor that will start from a very low value and will rise gradually in time.

Whatever happens in between Price Ceiling and Price Floor is up to the market. The Economic Algorithm just creates boundaries that get narrower as it fills the Reserves with Index Tokens and can increase Price Floor.

The objective is to create a price floor of 0.9 and a price ceiling of 1.1.

Radix Economic Stages

The behavior of the Radix Economic Model is likely to vary as the maturity, utility, number of Rads in circulation, and the number of transactions increases. In the beginning, the Reserves are at zero, and the Economic Algorithm has little ability to support the market. As the network grows in strength and value, the way in which the economics operates needs to adjust. These adjustments are split into three stages:

Stage 1: Bootstrapping

Bootstrapping is designed to make onboarding onto the network and buying the Rad as easy as possible. This is enabled via a network of USD-backed token Approved Minters.

During Bootstrapping, these Approved Minter issued USD-backed tokens flow directly into the Reserves.

Although the user will be able to use these Rads immediately, the Decentralized Exchange and Price Floor IS NOT operational during Stage 1.

Stage 2: Price Stabilization

At the end of Stage 1, the Economic Algorithm will create the first Index Tokens in the Reserves.

The goal of Stage 2 is to increase the Price Floor on the Decentralised Exchange to 0.9 Index Token to 1 Rad, ending the stage with the Rad trading between a Price Ceiling of 1.1 and Price Floor of 0.9.

Stage 3: Mature Growth

Once Price Stabilization of the Rad against the Index Token has been brought between the narrow boundaries of 0.9 and 1.1. the system switches over to the Mature Growth Stage. This is designed to sustain the network for the long term and make the transition from an externally focused economy to an internally focused one.

Can it really work?

How we saw it before there are a lot of stablecoins in the cryptosphere and a lot of them failed and many others could fail in the future. You can read here a very well written article by Preston Bryne on why stablecoins are doomed to fail.

The most common reasons why stablecoins are/ risk failing are:

They don’t have the 100% cash to collateralize the system if everyone is selling. Algorithmic stablecoins use third parties data to buy and sell, this makes them fragile and centralized. Stablecoins that are pegged to another cryptocurrency (e.g. Ethereum) risk that in the event of an Ethereum black swan event the value of the underlying collateral, and therefore the value of the stablecoin, will also be wiped out. They are not transparent at all (e.g. Tether) and this makes them very risky because you don’t really know if every stablecoin is pegged by a real dollar.

Radix seems to have taken notes of those problems and found different solutions:

They solved the problem of 100% collateralized token by starting with the reserve and the price floor at 0, this way while the Algorithm builds the reserve it also slowly creates a price floor that it is certain to be able to handle all tokens in circulation. All buy & sell orders will be made only on the Decentralized Exchange built on top of Radix and the rules are public and transparent. Long term, the value of the Rad is intended to be set against no single currency, but against a basket of tokens which will increasingly reduce risk through diversification of currency, supplier and asset class.

With time, it is anticipated that the Index Token will expand to other external assets such as commodities, should the Radix economy get large enough, start to build its own consumer basket from tokens within the Radix ecosystem, eventually replacing fiat-backed tokens entirely. Transactions of the Economic Algorithm and Reserves are publicly visible, auditable and transparent.

Radix Economic model looks good, in theory. We’ll have to wait and see how things will work on Economic Go-Live when the Economic Algorithm and Decentralized Exchange will be launched.

If Radix succeeds they will be able to deliver the whole package: you’ll get a stable currency, messaging, DEX, DApps. Everything fast and lightweight.

For now, the concept of Approved Minters introduces a concept of Governance in the Radix platform, that is neither negative nor positive. Governance in a decentralized system is a difficult thing to get right: it must make sure all stakeholders are considered when making decisions, and that no single stakeholder or organization holds too much sway without checks and balances on that power or influence. But we’ll have to wait for the Governance whitepaper in order to objectively judge it, with the hope that decentralization will remain a key point of the project.

Of course, Radix is a very ambitious and atypical project, a sort of a DAO ( Decentralized Autonomous Organization), driven by an Autonomous Economic Algorithm on top of an amazing scalable and decentralized tech. So best of luck to the Radix team.

You can find the Economic Whitepaper here, and the team is welcoming every critique and suggestion, so if you think you can suggest some improvements to their economic model let them know on their telegram group.

Resources

Radix Economic Whitepaper

Radix Economic FAQ

The Importance of Value Stability — Piers Ridyard

Stable Coins Analysis: Is There A Viable Solution For The Future? — Chrisjan Pauw

Stablecoins are doomed to fail — Preston Byrne

On The (in)Stability of Stablecoins — Bob McElrath

Tags