Intro
In this paper, we introduce the Poly, the native currency of the Topl protocol. The design of this currency is informed in large part by what has come to be known as the Friedman rule1 as well as the Seigniorage Shares model2. The first inspires our close consideration of the effects of inflation on individual economic actors, while the second serves as a starting point for our considerations on how to handle changes in currency supply, even though we abandon the signature two-token model of Seigniorage Shares.
Current Landscape
Although the space is still nascent, we can largely divide "stablecoin” efforts into three distinct groups: Homogeneous Collateral Coins, Heterogeneous Collateral Coins, and Seigniorage Shares. While the Poly can only be described as a derivative of the third model, we first introduce the other two models as points of contrast.
Homogeneous Collateral Coins
Stablecoins in this category are the simplest to design and understand since the asset whose price they are intended to track is also the asset held by the issuer as collateral. By example, we can imagine that we wish to issue a stablecoin that will always be worth 1 USD. To accomplish this, we could simply hold a number of actual USD as collateral that is always equal to the number of stablecoin units outstanding. Those familiar with the space should recognize this as the model used in Tether’s USDT stablecoin.
Weakness
These Homogeneous Collateral Coins have two major weaknesses. First, since collateral such as USD or gold cannot be held directly on a blockchain, there is still the custodial risk of the issuer. Users of such a coin must be able to trust that the issuer actually has the collateral they claim to possess. Second, it can be argued that systems in this category require an expensive and wasteful hoarding of assets, making such a system of money parasitic to the existing economy.3
Heterogeneous Collateral Coins
Instead of using the same asset as that of the tracked price, stablecoins of this variety use a different collateral asset. Usually, this is a cryptocurrency such as Ether or Bitcoin. The advantage of crypto-collateral is that there is never any risk that the issuer of the stablecoin does not have sufficient collateral to cover all outstanding liabilities.
Weaknesses
Given that the collateral and tracked assets are not the same, an excess of collateral must be held to cover relative price swings. This is likely to aggravate any parasitic effects such a currency might have in comparison to homogeneous collateral coins. This required excess of collateral makes such approaches extremely expensive in practice while still likely insufficient to head off black swan events.
Seigniorage Shares
Often considered the most theoretical class of stablecoins, the systems that follow the Seigniorage Share model involve no use of collateral. Instead, they use a two-token system of shares and coins. A Seigniorage Share system begins with some number of coins, \(x\), distributed across the ecosystem. When the price of the coin rises by \(y\%\), \(x\cdot y\%\) new coins are created. These new coins are distributed in some manner to holders of the second token, shares. Then in the event that the price of coins falls by \(z\%\), new shares are created and sold in exchange for coins (which are then destroyed), until the number of coins falls by \(x\cdot z\%\). The basic theory states that by increasing or decreasing the supply curve to match changes in demand, the price can be continually adjusted back to a single chosen equilibrium.4
It may be noticeable from the above description that, on one level, the Seigniorage Shares model closely resembles that of current fiat systems. In fiat systems, the money supply is increased or decreased through interactions with a limited list of “accounts”. More specifically, money is injected into the economy only to banks which hold accounts with the Central Bank and to individuals or entities from whom the Central Bank purchases government securities. In a similar way, new coins in a Seigniorage Share system are only distributed to holders of shares. Additionally, in both systems, the injection group is likely to be the same. Since wealthier individuals are more likely to borrow from banks and purchase either government securities or seigniorage shares, new currency is likely to be injected to the same (wealthy) segment of society through a seigniorage shares system as in our current fiat systems.5 Under assumptions of long-term economic growth (and a correspondingly increasing money supply), such systems will result in increased economic inequality because those individuals and entities most exposed to increases in currency supply are those least exposed to the wealth erosion produced by the corresponding inflation.6
An important note to make here is that we understand and respect the investment being made by seigniorage shareholders. The above criticism on grounds of increasing inequality are meant not to argue that those who make such investments and accept increased risk are not entitled to the appropriate returns. Rather, we merely argue that such a system itself is flawed and detrimental to society. For this reason, we propose an alternative.7
Poly Proposal
We herein propose a new model of stable currency built on the tri-pillars of Fisher's Equation of Exchange, the robust asset tracking ability of blockchain systems, and the ideal of equitable seigniorage. At the most basic level, this model resembles that of the seigniorage shares model in that it increases or decreases the currency supply as necessary and excludes the use of any collateral. However, our model diverges from seigniorage share efforts and more closely resembles fiat systems in that it considers both volatility control and economic stimulus (or impedance) as motivating factors for adjusting currency supply. Finally, the Poly is designed to follow an novel distribution scheme in its seigniorage, incorporating concerns regarding systematic and unnecessary drivers of inequality.
Protocol Requirements
Before introducing the specific mechanisms of the Poly currency system, it is necessary to outline the requirements of the Protocol through which the Poly will be offered as a currency.
- Transactions must be carried out and stored on a blockchain ledger.
- The blockchain ledger must be able to uniquely identify assets from each other based on their history, with the ledger having a UTXO (or similar) model.
- All transfers involving financial assets or transactions must be marked as such.
- Fees on transactions must be applied as a percentage of the price, in Polys, of the involved transfer.
- The mechanism responsible for adjusting the supply of Polys must have access to transaction and transaction fee data.
- Polys collected as transaction fees must be capable of being "locked up" for a specified period of time.
The reason for each of these above requirements will be covered through our introduction of the Poly system.
Tracking the Equation of Exchange
Resting at the base of nearly all attempts at monetary policy is Irving Fisher’s algebraic formulation of the Equation of Exchange: