Money supply approaches
Last updated
Last updated
The supply of network money and whether this changes over time will have an ongoing impact on the incentives and potential outcomes that emerge from implementing demurrage. The four main money supply approaches that should be compared include contractionary, expansionary, fixed and elastic money supplies.
A large factor that contributes towards the decision of how the money supply should change is the need for a medium of exchange to maintain stable prices. Network money might not need to be a medium of exchange however it still can benefit from maintaining price stability.
A contractionary monetary supply would mean the supply of money reduces over time.
Advantages
Preserves purchasing power - Contractionary money would more easily hold it purchasing power as less money would be being used across the economy over time. The value of network money relative to goods and services would increase over time.
Lower risk of asset bubbles - Less availability of money should limit the amount of riskier borrowing and speculation in the economy.
Easier for maintaining a higher network coin tax - If the price of money was increasing due to the reduced supply it could help with maintaining a higher network coin tax to simulate demurrage.
Disadvantages
Incentivises money storage - A shrinking money supply means less money is available across the economy over time. This will result in ongoing network money price increases 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 unproductively due to ongoing price appreciation.
Increased debt burdens - Debts become more expensive to repay when the value of money is always increasing. This could limit the amount of lending and borrowing due to this added cost burden of repaying loans with more expense money. 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 money will keep increasing. If the rate of contraction was managed then this adds a large amount of governance and implementation complexity to handle 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 network money 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 money due to the reduction in prices of goods and services relative to the increasing price of money. A contractionary supply does justify a higher network coin tax however this isn’t a necessary approach for maintaining a higher network coin tax 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 money supply reduces over time.
An expansionary monetary supply would mean the supply of money increases over time.
Advantages
Price stability during economic growth - An expansionary money supply can sometimes mean the expansion rate is in line with the growth of the economy. When this is the case the price of money could remain stable if it is growing at the same rate of the economy. Although this is possible it is also very unpredictable as 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 money can eventually lose value over time. This is not always the case as if the economy is growing faster than the rate of the money supply money the price of money could still go up over time as the expansion rate is smaller than the growing demand for the money.
Reduced debt burdens - It would become cheaper to repay loans over time due to the reduced price of money in the future. This is good for borrowers and bad for lenders.
Added money supply could be treasury income - The new supply of money that is created by the expansionary monetary policy could be used as treasury income that 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 money suffer as the value of money falls year after year if the expansion rate is above the rate of demand growth for network money. This makes other assets more desirable to hold instead of money. An expansion rate that is higher than the demand growth rate for money makes it more difficult to maintain a higher network coin tax as there is already a large incentive to exchange the money for more storable assets. However the new coins that are minted can be used for ecosystem funding initiatives just like network coin taxes.
Asset price increases - An expansionary money supply that exceeds the rate of demand growth for network money 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 storable assets and those that don’t.
Difficulty with maintaining a higher network coin tax - Expansionary money is already less desirable to hold when the rate of expansion is greater than the demand growth for network money. 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 network money.
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 money could keep falling if the expansion rate exceeds the demand growth for network money. 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 lead to slower network money price appreciation as the expansion rate could better align the supply increases with the ongoing growth of the economy.
Summary
An expansionary supply when coupled with a demurrage money, such as through a network coin tax, could be effective for increasing the velocity of money and for maintaining more stable prices. Both the expansionary effects and demurrage rate could encourage usage or investment of network money. 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.
A fixed monetary supply would mean the supply would always stay the same.
Advantages
Simple implementation - A fixed money 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 money should remain the same in an economy that isn’t shrinking or expanding. However if the economy grows the price of money 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 money makes it easier to maintain a higher network coin tax as the price of the money would eventually increase over time when the economy grows.
Disadvantages
Incentivises money storage - If the economy is growing and the supply of money stays the same you could expect to see the price of money increase over time. This is because the same supply of money is being used across a growing number of goods and services. This price appreciation can incentivise the storage of money. This could be problematic for financial use cases such as for token exchange pairings or lending and borrowing using network money.
Increased debt burdens - Loans taken out with money that increases in value over time increase the burden on borrowers. This is bad for borrowers but good for lenders.
Summary
A fixed money supply is the simplest approach for handling the supply of money. 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. Assuming the global economy grows over time by a small percentage each year on average, a fixed supply of money would mean ongoing price increases of that money. 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 money that is 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 money and means token exchanges would constantly need to be rebalanced. If a Web3 network implements a fixed supply policy for its network money it could limit the network moneys 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 could become due to the larger price instability when using it as a form of financial collateral.
An elastic monetary supply would mean the supply of money 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 money could expand and contract in alignment with the economy and demand for network money. If this is achievable then this could mean that purchasing power is preserved as the money would be accommodative to economic growth and contraction and wouldn’t gain or lose value when compared to goods and services.
Stable prices - A money supply that is pegged against the expansion or contraction of the economy could help with achieving stable prices. Implementing this approach should make network money more suitable as a medium of exchange. Although, as already covered in other resources, network money 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. So this advantage is not highly important in a scenario where network money is not actively used as a medium of exchange.
Disadvantages
Highly complex governance - Adopting an elastic supply change mechanism could result in community governance that is highly complex. It is already difficult to try and maintain stable prices for national currencies let alone a global economy that is both physical and digital. The decision complexity involved would be excessive for a global population to handle and delegating this responsibility to a small handful of people would also be highly risky considering the scale and global 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 to attack the algorithm or data sources. These attacks could lead to outcomes that are beneficial to certain people or it could create an opportunity for malicious actors to attack and exploit 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 the transaction deadweight loss. This basically means that transactions that might have happened will likely not happen due to increased fees. The lower the fees the less the deadweight loss. Web3 networks will compete on providing the lowest fees. Extremely low fees makes it easy 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 inside a transaction can be easily manipulated. These types of metrics are less suitable for determining global network money 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, making it less profitable and viable to try and influence any meaningful supply changes maliciously. Adopting this approach could mean the supply would lag behind the actual growth or contraction of these networks, as the network would respond with only small supply adjustments.
Network money price - The value of network money can be loosely understood by looking at the price of network money relative to the other on-chain tokens that the network money is being exchanged with. This could be easily exploited as anyone can create a token and distribute it to as many fake wallets as they want and then complete 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 network money price using these created tokens. If the price of network money 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 a 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 network money relative to other assets is not a very compelling rule based money 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 network money 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 money 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.
Population changes - Global population data would not be available on-chain and would require oracles to make this information available. Alternatively if it was just network user population changes, it would require accounts to go through some verification check to know they are a human. Either of these approaches introduces governance or implementation complexity that could create systemic risks for the network. However if these approaches become reliable enough it could be useful for increasing or decreasing the supply of the network coin to accommodate the expanding or shrinking populations. These changes could help with maintaining stable prices.
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 network money 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 will often 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 could end up having a lot of influence over the network's money supply.
Importance of stable prices - Maintaining stable prices is highly important for a medium of exchange. If money is going to be frequently used in financial protocols, such as for borrowing and lending and for token exchange, price stability is still important for these use cases. Network money 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 network money, what this means is small changes in the price of network money shouldn’t be problematic over the long term, however fast and sudden changes could make it less suitable as the preferred collateral for liquidity in different financial protocols. Where possible network money should aim to maintain stable prices and also to reduce price volatility.
Simplicity of a fixed money supply - A fixed money 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 network money would increase over time, as the same amount of money would be spread across a growing number of goods and services. The price appreciation should mean that the network is able 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 correct that problem. A fixed supply of network money 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 what the rate of demurrage should be on the network.
Opportunity of an expansionary money supply - An expansionary money supply approach still has a compelling argument for it to be adopted. If the wider economy grows on average a certain percentage each year there is a possibility that a smaller expansion rate that is reliably below this average could be effective. If the supply of network money was slowly increasing it would help to prevent excessive price increases of the network money over the long term. This can help to dampen the negative impacts that price appreciation has on the suitability of network money as a form of financial collateral. Making even a small attempt to keep up with economic growth could make network money 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 fairly reliably over the long term. The newly minted coins could be sent straight towards the ecosystem's treasury for funding public goods. The obvious problem with this approach is that it would not always work predictably 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 network money should stabilise and increase more slowly than if the supply was just fixed. The faster an economy is able to grow on average due to a demurrage monetary system the more important it will be to consider the benefits of an expansionary money supply to better stabilise the price of network money.
Considerations towards an elastic money supply - The complexity of trying to create an accurate approach to follow the expansion and contraction of the global economy is extremely 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 money supply implementation for network money. 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 money supply change approach for a Web3 network is dependent on how influential a demurrage money 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, this will be reliable and secure at scale. If the economy and demand for network money 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 network money from rapidly increasing in price due to growing demand and causing too much price instability. And finally if the average economic growth is on the high end of the scale 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 and metrics are generated, considerations towards an expansionary or elastic supply mechanism could be warranted.