Reference thread: [Discussion] Tier 7 liquidity: Volume-dependent transaction fees and "Restricted Network Access" status

Motion RIPEMD160 hash: Revoked

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Tier 6 shall be redefined as the following paragraph and added to the liquidity operations model:

Tier 6 (Restricted Network Access)

This liquidity is unlocked through substantially increased transaction fees during periods of extreme crisis. It has zero maintenance costs but may impair the perceived quality of NuBits in the short-term. When Tier 6 is used, Nu is in a state of “restricted network access”, which is a form of capital control.

Shareholders will exercise individual discretion, but should consider setting transaction fees at a level that enables Restricted Network Access status when buy-side liquidity is at 10% or lower of total network liquidity. It would be expected that if Tier 6 (Restricted Network Access) is used, transaction fees would be initially set at a very punitive rate and then slowly lowered as the crisis passes.

This new Tier 6 would not be introduced to liquidity operations until volume-dependent transaction fees are enabled in the protocol.

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Introduction

To preface this discussion, I believe this concept – Tier 6 (Restricted Network Access) - will finally allow perpetual network stability. It is infinitely scalable, perfectly decentralized, and a logical complement to the existing macroeconomic policy used in Tier 5 (Parking rates). It will operate best with volume-dependent transaction fees, but can be applied with our current static variable transaction fees. Tier 6 (Restricted Network Access) is a Nu-specific innovation that further adds to our prestige as a network on the cutting edge of digital monetary policy.

I believe it is critically important for the network to vote for this motion, for many reasons that I will outline below. To begin with, here is the proposed definition:

Tier 6 (Restricted Network Access)

This liquidity is unlocked through substantially increased transaction fees during periods of extreme crisis. It has zero maintenance costs but may impair the perceived quality of NuBits in the short-term. When Tier 6 is used, Nu is in a state of “restricted network access”, which is a form of capital control.

Our liquidity operations model has evolved over time, with each iteration improving the network over its previous form. From the very beginning, shareholders have expressed a desire to implement features that protect the peg of NuBits. That has been both an ethical decision as well as a business one, because every currency requires trust and safety to be widely adopted. Tier 6 (NSR sales) introduced a significant new protection mechanism that allowed shareholders to attempt the withdrawal of value from the market capitalization of NuShares to reduce the circulating supply of NuBits.

Unfortunately, while Tier 6 provides some additional security, the underlying economic incentives are deeply flawed. It is likely these flaws are hindering adoption of NuShares.

Why is Tier 6 (NSR sales) flawed?

Tier 6 (NSR sales) requires us to sell an asset (NSR) at the bottom of its valuation to support NBT, requiring greater dilution. It requires us to trust a multisig group. It may require multiple auctions and multiple custodial grants to “mop up” all the excess NBT in a severe crisis, creating a disincentive to purchase NSR when the crisis first begins if the crisis is perceived to be catastrophic. Even in good times, Tier 6 (NSR sales) threatens the perceived scarcity of NuShares because any investor knows the NSR supply could quadruple overnight through a NSR custodial grant in an emergency. It is slow, it is centralized, and it is inefficient.

Why is Tier 6 (Restricted Network Access) a better solution?

Tier 6 (Restricted Network Access) can be applied in whatever block duration it takes to adjust a transaction fee, which could be very rapid if we design volume-dependent transaction fees with that capability. It has no scalability limits, in that we have full control of setting a transaction fee between 0%-100% with volume-dependent transaction fees. It requires no centralized trust of a multisig group. It improves the perceived scarcity of NuShares, which will increase the number of users advocating for our network. And, it is a tried and tested macroeconomic tool for currencies, just as interest rates (Tier 5) are. It is fast, it is decentralized, and it is efficient.

Example of a scenario where Tier 6 (Restricted Network Access) is applied:

To begin, here is an example of an “extreme crisis”:

It is September 23, 2019. The NuBits network has been operating for five full years and has gained popularity across a wide variety of retail and banking users. Daily US-NBT transaction volume has exceeded Bitcoin, and the price peg of US-NBT has maintained a perfect $1.00 US. There are 100,000,000 US-NBT in circulation.

Sensing a threat from the growing popularity of US-NBT, regulators from a major world government declare US-NBT illegal on October 1, 2019. There is immediate market panic. NuShareholders predict that users may attempt to sell up to 50% (50,000,000 US-NBT) of all NuBits over the next few days, overwhelming the ability of Tier 5 (Parking Rates) liquidity to support the peg in the short-term. The value of NuShares plummets, which would have reduced the effectiveness of the original Tier 6 (NSR Sales) anyways.

Shareholders are aware that setting unreasonably high interest rates with Tier 5 will inflate the circulating supply of US-NBT past what is sustainable in the long term. Shareholders will have to make the difficult choice of setting rates so high they may never sell another new US-NBT again, or letting the peg fail and hoping speculators will purchase discounted US-NBT. These US-NBT discounted purchases may eventually restore the $1.00 US price, but US-NBT would have lost much of its credibility during that period. There is a chance the US-NBT price peg may be lost permanently. The network no longer has the USD reserves to satisfy all NuBits users, and must now prioritize liquidity according to NBT users’ willingness to pay.

Variable transaction fees – and especially volume-dependent transaction fees - provide shareholders with one final course of action through Tier 6 (Restricted Network Access). After the major world government declared US-NBT illegal, shareholders realize that an extreme crisis is taking place. They immediately begin to vote for an emergency transaction fee proportionality constant that will significantly raise transaction fees at all volume levels. Within perhaps 1000 blocks, the transaction fee for a 1500 NBT transaction has increased from the standard 0.25% to a staggering 50%. Transferring 1500 NBT through the network will now cost (and destroy) 750 NBT. Over the following weeks, as NBT are destroyed by those users who value access to the network most, shareholders gradually reduce the proportionality constant until transaction fees are back to historical network norms.

This example demonstrates just how powerful volume-dependent transaction fees could be in maintaining NBT asset pegs. During times of emergency, the network can differentiate among its users to prioritize those who are willing to pay the most to reduce the supply of NBT for us. Over time, shareholders would slowly vote the proportionality constant back to normal rates as the circulating supply of NBT reduces to match the decreased US-NBT demand. This is similar to parametric order books, a mechanism that penalizes users who quickly sell large amounts of NBT.

In theory, this new Tier 6 (Restricted Network Access) mechanism will allow US-NBT to remain $1.00 US forever in the very long-term. However, during an extreme crisis only those users who are willing to pay a significant transaction fee to move their $1.00 US-NBT through the network will be using Nu’s fast and efficient blockchain. Nu can guarantee US-NBT users that a US-NBT will be worth $1.00 US forever, but with the caveat a user may have to wait an uncertain length of time to access its full value if a serious emergency is occurring. This is not a normal state of operations, where tight liquidity is prioritized. It is an emergency where there are no other options.

It is likely that optimal proportionality constant rates will be determined in advance of emergencies through a set ratio of buy-side liquidity to sell-side liquidity. As a simple example, if buy-side liquidity fell below 10%, a recommended emergency proportionality constant of X would be voted for, whereas if buy-side liquidity fell below 5%, an increased recommended proportionality ratio of 2X would be voted for.

Tier 5 (Parking Rates) and Tier 6 (Restricted Network Access) are complementary macroeconomic policy tools

Shareholders would have complete control to vote according to prior recommendations or take no action at all – just like all other Tiers of liquidity. A fundamental principle of Nu is that external actors cannot coerce shareholders into making decisions that are contrary to their individual interests. Shareholders can choose not to utilize Tier 5 (Parking Rates) during times of crisis. Likewise, Tier 6 (Restricted Network Access) would only activate if a majority of shareholders support it. However, given that it has zero impact on their NuShare equity holdings, shareholders may be more inclined to use Tier 6 (Restricted Network Access) than the old Tier 6 (NSR sales). This is an important fact to point out - that this Tier 6 is more likely to be authorized by shareholders.

Tier 6 (Restricted Network Access) is a form of capital control. However, it should always be temporary in nature. No user who holds NuBits would be forced to sell at a discount, and it would be expected that the network returns to its normal transaction rates over time.

Economists support the concept of Tier 6 (Restricted Network Access)

The International Monetary Fund (IMF) has published an extensive series of articles and papers on capital inflows and outflows. In the case of Nu, our largest risk comes from capital outflows (ie. NBT being sold for fiat). One excellent IMF paper that is relevant to our network is here: http://www.imf.org/external/np/pp/eng/2012/111412.pdf beginning on page 25. In particular, points 42, 45 and 51 are very relevant to our network. This paper shows there is empirical evidence that capital flow management measures such as Tier 6 (Restricted Network Access) are perfectly acceptable as part of a toolkit for managing a currency, as long as they adhere to certain criteria, such as being temporary in nature.

Summary:

Want to make your NuShares more attractive to invest in? This motion should significantly help the desirability of investing in NSR. With the implementation of this motion, there will no longer be a risk of unlimited NSR dilution to buy back NBT in an emergency.

Tier 6 (Restricted Network Access)’s form of capital controls will make our network perform more similarly to national currencies that are managed by professional economists. It is a perfect complement to the parking rates of Tier 5. It transfers part of the risk of using NuBits to NuBits users, just like most other currencies.

It is a much more powerful, decentralized, and efficient tool than the existing Tier 6 (NSR Sales).

While we hope to never use it, it would be an important piece of our liquidity operations model. We could safely make the claim that 1 US-NBT will always be worth $1.00 US in the long-term, as long as a user is willing to forgo access to the network during times of extreme crisis. This should sound familiar to anyone who has ever used a national currency.

I truly hope shareholders consider all aspects of the logic I have provided, and address any shortcomings they identify. I have kept the motion text vague enough to allow a great deal of discretion in its application, but will consider changing the text if there are improvements to be made.

I am very enthusiastic about the power this new Tier 6 would deliver to our network.