Steem Dollars have Limits

Safety, security, stability, and sustainability are very important design characteristics that our team is always attempting to maximize. We must balance many variables when creating cryptocurrencies, smart contracts, and economic incentives. In particular it is important to design systems that remain robust and predictable in all market conditions.

Steem Dollars have Limits

The idea behind a Steem Dollar is that it should almost always be worth about one US dollar. We have set rules in place to make this statement true 99% of the time by making the Steem Dollar convertible to a dollar worth of STEEM.

Anyone who promises you that any asset will always be worth something is either ignorant to some risks or a liar. This is true for bank deposits, gold coins, and crypto currencies. Banks can seize your funds, go bankrupt, have a bail in, or hyper inflate the currency until it is worthless. In other words you are never guaranteed purchasing power.

When it comes to the Steem Dollar, their purchasing power depends upon the market demand for STEEM. The Steem Dollar is really nothing more than a smart contract for a variable amount of STEEM depending upon an oracle. If STEEM is worthless than the Steem Dollar will also be worthless.

As the value of STEEM falls, the amount of STEEM required to represent a U.S. dollar worth of value approaches infinity. If left unchecked, the Steem Dollar could render STEEM worthless and when that happens all Steem Dollars become worthless too.

Black Swan Events need a Plan

It isn’t possible to prevent all black swan events, but it is possible to establish a fair set of rules for handling them. It is always best to define the rules before they are necessary so that everyone can take full responsibility for the consequences of their trading decisions.

There are two major black swan events that the Steem community and traders should have a contingency plan in place for. The first black swan is if the value of STEEM crashes so far that Steem Dollars represent an insurmountable burden on the STEEM price that sets off a chain reaction pushing the value of STEEM toward zero.

The second major black swan event is when the US dollar hyperinflates and becomes worthless as a day to day currency. In my opinion this is the more likely outcome.

Price Feed defines Value of Steem Dollar

The price feed can be viewed as a mathematical function that traders and speculators can trade against for determining the value of the Steem Dollar at any time. Right now we have defined the function to always equal the approximate marginal price 1 STEEM fetches on the open market.

There are two extreme cases, black swans, that must be considered. In one extreme the price goes to 0, in the other extreme the price goes to infinity. It is in the interest of everyone involved that the value of a Steem Dollar never hits either extreme. This can be implemented in objective terms by setting hard limits on the exchange rate range that is allowed.

We can set a maximum and minimum Steem Dollar price as follows:

maximum price = SteemSupply / (10 * SteemDollarSupply)
minimum price = SteemSupply / (10000 * SteemDollarSupply)

With these rules in place, Steem Dollar holders are protected against US dollar hyperinflation and Steem holders are protected against US dollar “hyperdeflation”. The witnesses are trusted to publish a honest price feed relative to dollars at all times, but the blockchain will enforce these hard limits.

In other words, the market cap of all Steem Dollars will always be between 0.01% and 10% of the Steem market cap. This will become a mathematical reality with the addition of two lines of code to the method that calculates the conversion price.

Sustainable and Fair

These rules would make the economic system of Steem sustainable and fair in all circumstances by clarifying the meaning of a Steem Dollar. With the clarified meaning, a Steem Dollar is allowed to have values above or below a U.S. dollar under certain market conditions. All traders can be aware of those conditions and trade accordingly.

By implementing these rules long before the STEEM / USD price gets near either extreme all market participants have ample opportunity to adjust their positions.

No Promise of Value

Steemit, Inc cannot and will not promise that the STEEM token, Steem Power, or Steem Dollars will have any value now or in the future. We aim only to create fair rules to approximate the relative subjective value each member of the Steem community brings to the table. Any value these tokens have will at all times be set by the free market through voluntary exchange.

Benefits over Alternative Approaches

In a prior post I outlined a solution that would covert 1% of Steem Dollars to Steem Power as a means of correcting the imbalance. This solution had the nice property of only exposing 1% of a person’s steem dollars to volatility at a time, but had the down side of making the life of exchanges and smart contracts everywhere very complex. Every smart contract would have to factor in the potential that a liquid asset like Steem Dollars could be partially converted to an illiquid asset such as VESTS. This great complicates things such as escrow transactions and side chains and exchange deposits. In other words, it had all of the negative properties on 3rd parties that could be associated with negative interest rates.

Some people suggested things like bootstrapping an economy around Steem Dollars or buying them back with Ad revenue. It isn't a matter of finding buyers for Steem Dollars, it is a matter of maintaining a debt ceiling. Simply moving Steem Dollars from person to person does not solve the problem.

Thanks for Feedback

We would like to thank everyone for the feedback they have provided and invite additional feedback. We are all in this together, lets make Steem the best platform for everyone involved.