Network coin supply approaches
The supply of the network coin is an important part of a Web3 network because it could directly affect activity in the network, price stability and whether there’s rising prices (inflation) or falling prices (deflation) in the network's economy.
Under the existing fiat banking system, central banks commonly target a 2% inflation rate and manage a central bank interest rate to influence the economy. If prices are falling and the economy is slowing down or unemployment is rising the central bank might lower the interest rate to reduce the cost for people to borrow. This can help with stimulating the economy. If prices are rising too quickly and causing inflation the central bank can increase the interest rate to increase the cost of borrowing - which also makes saving more attractive. The problem with targeting an inflation rate is this will deliberately increase asset prices over time. Inflation rewards people who already own assets and harms those who don’t. If wages increased at the same rate of inflation there would be less concern about increasing asset prices as people could proportionally still afford the same assets. In practice this does not happen, wages commonly stagnate behind the inflation rate, making it harder and harder for people without assets to purchase them in the future. Inflation causes unearned income as those that already have assets are not contributing anything else to the economy yet they are being rewarded for just owning the assets that are increasing in price due to the monetary system.
Demurrage when implemented using a network coin tax does not result in any limitations in how the supply of the network coin is managed. At a high level, the supply of the network coin, or for any other fungible asset, could be contractionary, fixed, expansionary or elastic.
The network coin & stable prices
A large factor that contributes towards the decision of how the network coin supply should change is the need for a medium of exchange to maintain stable prices. The network coin might not need to be a medium of exchange however it still can benefit from maintaining price stability:
The network coin & stable pricesContractionary
A contractionary monetary supply would mean the supply of the network coin reduces over time.
Advantages
Preserves purchasing power - A contractionary coin supply would more easily hold it purchasing power as a reducing amount of network coins would be used across the economy over time. The value of the network coin relative to goods and services would likely increase over time.
Lower risk of asset bubbles - Less availability of the network coin should limit the amount of riskier borrowing and speculation in the economy.
Easier for maintaining a higher network coin tax - If the price of network coin was increasing due to the reduced supply it could help with maintaining a higher network coin tax to simulate demurrage.
Disadvantages
Incentivises network coin storage - A shrinking coin supply means less network coins would be available across the economy over time. This will result in ongoing price increases of the network coin due to the increasing value of money relative to the same goods and services. This leads to price instability and incentivises people to store money and leave it idle due to ongoing price appreciation.
Increased debt burdens - Debts become more expensive to repay when the value of network coin is always increasing. This could limit the amount of lending and borrowing due to this added cost burden of repaying loans with a more expense network coin. This outcome is bad for borrowers but good for lenders.
Rate of contraction complexity - If the rate of contraction was fixed it would be predictable but inflexible to changes in the economy, people would reliably know the price of the network coin will keep increasing. If the rate of contraction was managed and changes over time then this adds a large amount of governance or implementation complexity to handle this at a global scale.
Summary
A contractionary supply approach could help with preserving purchasing power but not in a way that maintains price stability, as the price of the network coin would increase even faster than if the supply was just fixed. This might reduce the risks around asset bubbles however the benefits of a contractionary supply approach could also be achieved using a fixed supply. A contractionary approach can excessively incentivise the storage of the network coin due to the reduction in prices of goods and services relative to the increasing price of the network coin. A contractionary supply does justify a higher network coin tax however this isn’t a necessary approach for maintaining a higher taxation rate as this can still be achieved with a fixed supply. A contractionary supply rate would also introduces the problems around governing and managing the rate in which the network coin supply reduces over time.
Expansionary
An expansionary monetary supply would mean the supply of the network coin would increase over time.
Advantages
Price stability during economic growth - An expansionary network coin supply can sometimes mean the expansion rate is in line with the growth of the economy. When this is the case the price of the network coin could remain stable if it is growing at the same rate of the economy. Although this is possible it is also very unpredictable. In reality the economy will likely grow at different rates and for different periods of time, so this might only be momentarily true during certain economic growth periods.
Incentivises usage or investment - Spending or investment is encouraged as the network coin can eventually lose value over time. This is not always the case as if the economy is growing faster than the rate of the network coin supply the price of the network coin could still go up over time as the expansion rate could be smaller than the increasing demand for the network coin.
Reduced debt burdens - If supply changes cause inflation it would become cheaper to repay loans over time due to the reduced price of the network coin in the future. This might be good for borrowers but it is bad for lenders.
Added network coin supply could be treasury income - The new supply of the network coin that is created by the expansionary monetary policy could be introduced as treasury income which then benefits the ecosystem. Demurrage using a network coin tax could be adopted in parallel to an expansionary monetary policy.
Disadvantages
Erodes purchasing power - Holders of the network coin suffer as the value of the coin falls year after year if the expansion rate is above the demand growth for the network coin. This makes other assets more desirable to hold instead of the network coin. An expansion rate that is higher than the demand growth rate for the network coin makes it more difficult to maintain a higher network coin tax as there is already a large incentive to exchange the network coin for more storable assets. However the new coins that are minted can be used for ecosystem funding initiatives just like how network coin taxes can be used.
Asset price increases - An expansionary network coin supply that exceeds the demand growth for the network coin will lead to increasing asset prices. When wages aren’t rising as fast as asset prices, this can lead to growing wealth inequality between those that already have assets and those that don’t.
Difficulty with maintaining a higher network coin tax - An expansionary network coin supply is already less desirable to hold when the rate of expansion is greater than the growth of demand for the network coin. If asset prices are increasing in price it incentivises people to hold those assets instead. This could limit the rate of demurrage that is achievable with the network coin.
Rate of expansion complexity - If the rate of expansion was fixed it would be predictable but inflexible to changes in the economy, people would know the price of the network coin could keep falling if the expansion rate exceeds the growth of demand for the network coin. If the rate of expansion is managed by the community this adds a large amount of governance and implementation complexity to handle at a global scale. One way this complexity could be reduced is by targeting a low expansion rate that reliably doesn’t exceed the average economic growth rate. This could prevent asset price increases and also lead to a reduced amount of network coin price appreciation as now the expansion rate could be better aligned with the ongoing growth of the economy.
Summary
An expansionary supply when coupled with a network coin tax based coin could be effective for increasing the velocity of the network coin and for improving price stability. Both the expansionary effects and demurrage rate could encourage usage or investment of the network coin. However the introduction of an expansionary rate can also introduce complexity around how this is going to be managed and governed. The ecosystem would now need to be concerned with both the network coin tax rate and the supply expansion rate.
Fixed
A fixed monetary supply would mean the supply would always stay the same.
Advantages
Simple implementation - A fixed network coin supply is the simplest to implement. This approach wouldn’t introduce any added governance complexity. It also means the ecosystem can focus solely on governing the rate of demurrage by changing the network coins tax rate.
Preserves purchasing power - The purchasing power of the network coin should remain the same in an economy that isn’t shrinking or expanding. However if the economy grows the price of the network coin should increase as it would be used across a growing number of goods and services. Purchasing power would be preserved however prices would not remain stable.
Easier for maintaining a higher network coin tax - A fixed supply of the network coin makes it easier to maintain a higher network coin tax as the price of the network coin would eventually increase over time when the economy grows.
Disadvantages
Incentivises network coin storage - If the economy is growing and the supply of the network coin stays the same you could expect to see the price of the network coin increase over time. This is because the same supply of the network coin is being used across a growing number of use cases and goods and services. This price appreciation can incentivise the storage of the network coin. This lack of network coin price stability could be problematic for financial use cases such as for token exchange pairings or for lending and borrowing.
Increased debt burdens - Loans taken out with the network coin that increases in value over time increase the burden on borrowers. This is bad for borrowers but good for lenders.
Summary
A fixed network coin supply is the simplest approach for handling the supply of the network coin. This is highly appealing for a global Web3 network where the cost and risk of governing any supply changes could be extremely high and risky. If the global economy grows over time by a small percentage each year on average, a fixed supply of the network coin would mean an ongoing price increase of the coin. This can be useful for maintaining a higher network coin tax over the long term as that can be used to counter act the incentives of storable coins that are appreciating in value. The main problem with a fixed supply is it punishes borrowers as they would need to pay back loans with a more expensive network coin and means token exchanges would constantly need to be rebalanced. If a Web3 network implements a fixed supply policy for the network coin it could limit its usage within lending and borrowing protocols or for facilitating token exchanges. The faster the growth rate of the global economy the more of a problem that a fixed supply approach would likely become due to the higher amount of price instability.
Elastic
An elastic monetary supply would mean the supply of the network coin would expand and contract over time, often depending on certain rules or conditions.
Advantages
Preserve purchasing power - If the supply is elastic the supply of the network coin could expand and contract in alignment with the economy and demand for the network coin. If this is achievable then this could mean that purchasing power is preserved as the network coin would be accommodative to economic growth and contraction and wouldn’t gain or lose value when compared to goods and services.
Stable prices - A network coin supply that is pegged against the expansion or contraction of the economy could help with achieving stable prices. Implementing this approach should make the network coin more suitable as a medium of exchange. Although, as already covered in other resources, the network coin does not need to fulfil the responsibility of being a medium of exchange due to the ability to use tokens as a form of money that are custom made for each community. Stable prices will be beneficial for use cases such as financial liquidity or when the coin is being used as contract collateral.
Disadvantages
Highly complex governance - Adopting an elastic supply change mechanism could result in community governance that is highly complex. It is already difficult to maintain stable prices for national currencies let alone a global economy. The decision complexity involved would likely be excessive for a global population to handle, delegating this responsibility to a small handful of people would also be highly risky considering the scale and adoption of these networks.
Highly complex implementation - Adopting a rule based monetary supply change mechanism would be very complex to implement. It would need to take into account global sources of data and information about what is happening in the economy to make an informed calculation about whether the supply should expand or contract. If this is implemented into a global Web3 network it could introduce ways for people to attack the algorithm or data sources. These attacks could lead to outcomes that are beneficial to the attackers or it could create an opportunity for malicious actors to harm the network by exploiting any vulnerabilities.
Rule based supply change mechanism considerations
The rule based approaches for handling elastic supply changes deserve some further consideration. There are a number of potential issues and flaws with these potential supply change mechanisms:
Transactions - Web3 networks benefit from making transaction fees as cheap as possible. The higher the fees the more you cause transaction deadweight loss. This basically means that transactions that might have happened might now not happen due to increased fees. The lower the fees the less the deadweight loss. Web3 networks will need to compete on providing the lowest fees. Extremely low fees makes it easier to increase the amount of transaction volume for a meaningful period of time. People can also easily transact with other anonymous wallets and send high value token based assets between these wallets. On-chain data about transaction volume and fees and the value of the assets involved in those transactions could be easily manipulated. These types of metrics are less suitable for determining global network coin supply changes. One approach that could help to minimise this issue is by making sure the changes to the supply are less meaningful than the costs to generate the manipulated outputs, which could make it unprofitable and unviable to try and influence any meaningful supply changes maliciously. Adopting this approach could mean the supply might lag behind the actual growth or contraction of these networks, as the network would respond with only small supply adjustments.
Network coin price - The value of the network coin can be loosely understood by looking at the price of the network coin relative to the other on-chain tokens that the coin is being exchanged with. This can be exploited as anyone could create a token and distribute it to as many fake wallets as necessary and then submit fake exchange activity. They could then pair this up with the network coin in a token exchange pairing and make it look like the token is worth a lot when compared to the network coin. People could own all of the supply for different tokens across multiple wallets and simulate changes in the network coin price using these created tokens. If the price of the network coin is going to be compared with other assets in the wider economy, the tokens it is being compared with would need to be verified by the community in someway as otherwise anyone could just create a new token or representation of an asset on-chain and influence the pricing data. Adopting community governance or oracles could add significant complexity and risks for handling a managed data source. The price of the network coin relative to other assets does not appear to be a very compelling rule based supply change mechanism.
Financial metrics - The amount of liquidity in the networks protocols and how it is being used could provide useful information for understanding when the network coin is gaining or losing demand. This could then be used to influence the network coin tax rate that is simulating demurrage or when the supply could increase or decrease. Although this data might be useful it can also easily be manipulated by people that purposefully add or remove liquidity or that create transactions to influence how liquidity is being used.
Economic growth - Broader economic growth metrics would be a highly useful data source for determining network coin supply changes. All the required information would not be available as on-chain data, meaning oracles and other solutions would be needed to get a broad enough picture about what is happening in the global economy. The usage of oracles or external data sources would introduce a potentially systemic risk into the network. Now malicious attackers would be able to look at how they could manipulate and influence these data sources in a way that could benefit them or harm the network.
Active users - The number of active users does not necessarily correlate with increasing or decreasing demand for the network coin. The number of active users could increase but the demand for the network coin could remain as it is or even potentially contract.
Summary
If an elastic supply mechanism can be implemented in a way that is accurate enough to be useful, whilst also being sufficiently secure and reliable, it could represent an effective approach for trying to maintain price stability. Demurrage would still be effective at increasing the velocity of the network coin whilst the prices also remain stable. Accurate supply changes could limit the rate of demurrage that is possible which is something that needs to be taken into account. Although an elastic and accurate supply change mechanism might be desirable for some networks, the real problem is around the implementation complexity that is involved with achieving that outcome. This complexity would likely be enormous. For a global network there is no room for error in the implementation, they need to increasingly become mission critical systems that society can depend on. Any elastic supply mechanism should only be introduced if there is a reliable and secure way to determine how the supply should change. If this can be manipulated or exploited it could compromise the entire network. An implementation will ideally be both reliable and automated as much as possible to prevent the need for delegated governance - where a small group of people could end up having excessive influence over the supply of the network coin.
Key takeaways
Importance of stable prices - Maintaining stable prices is highly important for a medium of exchange. If the network coin is going to be frequently used in financial protocols, such as for borrowing and lending or for token exchange, price stability will also be important for these use cases. The network coin does not need to be a medium of exchange however it would be beneficial for it to be used within financial protocols, especially for facilitating token asset exchange. For the network coin, what this means is small changes in the price of the network coin shouldn’t be highly problematic over the long term, however fast and sudden changes could make it less suitable as the preferred collateral for liquidity in these different financial protocols. Wherever possible the network coin should aim to maintain stable prices and reduce price volatility.
Simplicity of a fixed network coin supply - A fixed network coin supply is the most simple implementation for Web3 networks. It reduces both implementation and governance complexities. If the wider economy grows the price of a fixed supply of the network coin would increase over time, as the same amount of the network coin would be spread across a growing number of goods and services. The price appreciation can make it easier to maintain higher network coin taxes over the long term, which is thanks to the gradual price increases that incentivise storage. A higher network coin tax helps to capture this unearned income and reduce the incentive to store the coin due to price appreciation. A fixed supply of the network coin is the most simple, robust and predictable solution for a Web3 network to adopt. Web3 networks would be able to focus solely on perfecting and automating how the rate of demurrage should change over time.
Opportunity of an expansionary network coin supply - An expansionary network coin supply approach has a compelling argument for it to be adopted in the future. If the wider economy grows on average a certain percentage each year there is a possibility that a small expansion rate that is reliably below this average economic growth rate could be effective. If the supply of the network coin was slowly increasing it would help to prevent excessive price increases of the network coin over the long term. This can help to dampen the negative impacts of price appreciation and the effect this has on the coins suitability as a form of financial collateral. Making even a small attempt to keep up with economic growth rate could make the network coin far more predictable and effective for borrowing and lending or for token exchanges due to better price stability. This approach assumes the economy does grow on average a small percentage on a fairly reliably basis over the long term. More data will be needed on the impacts of a demurrage based system to increase confidence this is the case. Newly minted coins from an expansionary policy could be sent straight towards the ecosystem's treasury to fund ecosystem initiatives and public goods. One of the problems with this approach is that it might not always work reliably as the rate the economy expands and contracts can change over time. As long as the expansion rate is below or matching the economic growth rate, the price of the network coin should be somewhat stable and slowly increase over time. The faster an economy is able to grow on average due to a demurrage based system the more important it will be to consider the benefits of an expansionary network coin supply to better stabilise the price of the network coin.
Considerations towards an elastic network coin supply - The complexity of trying to create an accurate approach to follow the expansion and contraction of the global economy is very high. On-chain data is often unreliable due to the ability for people to manipulate it. If economic data can be made available reliably on-chain there is an opportunity to explore an elastic network coin supply implementation for the network coin. However a large amount of certainty is required in the robustness and security of these implementations. Without this it would be difficult to consider an elastic supply approach as a viable approach for a global and mission critical Web3 network.
Most promising solution - The most promising network coin supply change approach for a Web3 network is dependent on how influential a demurrage network coin system is at increasing overall economic growth. If economic growth is relatively low then a fixed supply approach will be the easiest and most simple supply mechanism to adopt over the long term, as this will be reliable and secure at scale. If the economy and demand for the network coin grows fairly modestly there might be a need to have an expansionary monetary policy using a low but consistent expansion rate. This would help to prevent the network coin from rapidly increasing in price due to growing demand - something that would cause more price instability. If the average economic growth is on the high end of the scale and more varied then this is where it will make more sense to try and implement an elastic approach, providing this can be done in a secure and reliable way that does not create systemic risks for a mission critical network. Overall, a fixed supply is likely the most suitable starting point for any Web3 network due to its simplicity and reliability. But over time, and as more data points and metrics are gathered, considerations can be made towards an expansionary or elastic supply mechanism if they are required to better stabilise the price of the network coin.
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