Demurrage implementation approaches

Network money needs to be highly liquid and always available so that people can always use it to pay for transactions they submit on the network or to pay for any other forms of taxes. Demurrage is an important solution for ensuring that network money is not hoarded over the long term. Demurrage would help to prevent wealth from concentrating into the hands of a few people due to the incentives it creates to not hoard money. People are instead incentivised to be more productive with their money by investing it or exchanging it for goods and services rather than holding money that loses value over time. Demurrage could be implemented in a number of ways in a Web3 network.

Implementation approaches

Coin expiry

A coin expiry based approach would mean that at a certain date the coin becomes unusable. This could create the desired effect of the money becoming less valuable over time as it slowly approaches this expiry date. However it also would be reliant on every contract and application handling these coins in a similar way as otherwise people could look to exploit the differences in how people value coins at different times as they start to expire. Some people might accept coins until a certain point and then reject them and others might do the same but use a different date. Others might request larger amounts of coins after a certain date due to the reduction in value. Differences in approach to handle this problem introduces more complexities for people that develop protocols and applications in the network, these added complexities are not necessary to simulate the effects of demurrage.

Coin burning

Coin burning means the coins would become unusable or be permanently discard. Burning could be achieved through a form of wealth tax or using transaction fees. From a wealth tax it would mean coins would be taxed and then burnt. For transaction fees, a portion of the fees earned from a transaction could be burnt. Coin burning can help to create a demurrage currency however it also means reducing the money supply. This would create deflationary money. This could increase the value of the money and lead to situations where people expect prices to fall, this then could result in many people delaying purchases, which would reduce overall consumer demand. This slowing of consumer spending could lead to lower business revenues and discourage investment. Persistent deflation can lead to a deflationary spiral, where falling prices lead to lower production and incomes, reducing demand further and causing economic stagnation. So coin burning would not be a very desirable or effective solution for implementing demurrage.

Incentivised activity

Instead of direct demurrage, incentives could be introduced for reaching certain transactional milestones. This method could passively discourage hoarding by offering profitable opportunities for engagement. Under this approach those that hoard wouldn’t be penalised for hoarding their asset beyond the incentives that they miss out on. If the incentives were inflationary for the money supply the existing money would become less valuable over time due to the increasing supply. This is not an effective way to simulate demurrage as it will lead to ongoing asset price increases. This is the common issue that exists with the existing fiat monetary systems.

Wealth taxation

A wealth tax means that every account and contract in the network would be taxed a percentage amount periodically. The benefit of this approach is that it doesn’t need to impact the money supply. The taxation could simply be used as income for the network's treasury meaning the taxed amount would be circulated back into the economy. Wealth tax income could then be used to fund highly impactful initiatives.

Wealth taxes are one of the most egalitarian and flexible solutions for simulating demurrage in a Web3 network. You could use any preferred supply mechanism and everyone would be treated equally based on wealth. For generating treasury income, a wealth tax approach was also identified as the most promising solution for generating long term income.

Problems with utilising supply change mechanisms

Simulating demurrage with ongoing supply changes means there would be a constant need to increase the money supply. An ever increasing amount of money expansion leads to ongoing price increases. Harder assets would constantly experience price increases due to the increase in money supply. Inflation that is caused by money expansion can disproportionately affect different segments of society. Those with assets that appreciate at or above the rate of inflation may benefit, whereas those with fixed incomes or cash savings might suffer losses in real wealth. Inflation can exacerbate wealth disparity since individuals with more ability to invest in income-producing or appreciating assets can protect their wealth better than those without such opportunities.

A Web3 network could try to prevent the problems of ongoing money expansion by burning an amount of coins when transactions are made. However the problem with this approach is it means demurrage is not always being simulated. If the burn rate is matching the rate of any supply increases the net impact would be a fixed supply. This means demurrage would not be simulated and instead the money would become hoardable again as there would be no cost in just holding the money. If money is hoardable it then recreates the same issues that existed with historical forms of money such as reduced economic activity and becoming a root cause for interest.

Supply changes either mean a constantly expanding money supply with the problems of inflation or a balance between supply increases and burn mechanisms that make money unpredictable and ineffective at simulating demurrage. Neither of these approaches are desirable or necessary.

The easiest way to constantly stimulate demurrage is through a wealth tax. Using a wealth tax the money supply mechanisms can operate in whichever way is most effective for the network. Networks could adopt a deflationary, fixed supply, inflationary or elastically changing supply approach depending on their requirements.