PAX: stable, decentralised crypto
Thursday 08 October 2015
There have been several different attempts to stabilise crypto by ‘pegging’ it to real-world commodity values. Here’s a new solution that looks set to stand out.
One of the major barriers to crypto adoption is its volatility. People might like the idea of trustless cash that can be used outside of the control of a bank or other central authority, but they don’t like the idea of market forces slicing their balance in half overnight.
Several different crypto projects have attempted to address this issue, including NuBits and BitShares. 'PAX' (Pegged Asset eXchange) is the brainchild of BitcoinDark (BTCD) developer jl777. Unlike some of the other solutions out there, it’s fully decentralised and requires no collateral (like BitShares). It’s currently in development, being put through its paces on testnet - so it hasn’t experienced the pressure of trying to make it in the real world, yet. But the theory is interesting, and it’s worth unpacking it a little further here.
It starts with a decentralised price feed, which takes the exchange rate between BTCD and, say, gold, from several different sources, comparing and smoothing them to give a reliable value that is included in every block. Then, when you want to lock funds to the price of gold, you burn the equivalent amount of BTCD in a special transaction, specifying when you want to redeem those coins and sending the hash of a secret phrase. At the redeem date, you submit the secret phrase to prove ownership, and new BTCD are created from the coinbase (where all coins come from) equivalent to the value according to the price feed. As a simple example, if BTCD = $1 and gold is $1,000 per oz, you might lock 1,000 BTCD as 1 oz gold. Suppose that at redeem BTCD = $1.50 and gold = $900, you would receive back 600 BTCD. Simple.
Burn coins at one exchange rate, recreate them at another.
The issue, of course, is that this alters the supply of the coin - potentially catastrophically. Suppose that lots of people bet on gold increasing in value, and it does. Suddenly, at redeem, the supply of BTCD has skyrocketed to accommodate this. Not good.
This is addressed in two ways. One is by restricting the number of contracts available for each currency or commodity. But more cleverly, the supply is balanced by incentivising someone to take the opposite position.
Each contract includes an interest payment, calculated monthly and paid on redeem. These rates vary depending on what has previously been locked. So if someone has bought a lot of +gold, believing that gold will appreciate against BTCD, the interest rates on -gold rise to reward those who hold the opposite opinion and put their money where their mouth is. Money for interest payments is generated by short-term traders, who pay the spread but don’t receive any interest payments themselves.
The effect is - in theory - to bring everything back to a state of equilibrium. The coin supply can never exceed its maximum. The more the system gets out of balance, the higher the interest rates become to pull it back towards the centre.
It’s simple in theory. And in practice, it’s hard to see what could go drastically wrong in such a self-correcting and self-limiting system. (But then, that’s the problem about unforeseen circumstances. You don’t see them coming.)
Stable, decentralised crypto is one of the hardest and most important problems to crack if crypto is to appeal to the masses. I’m going to be following this one closely.
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