Network money & stable prices

Maintaining stable prices is a common and ongoing goal for existing fiat currencies. As economies expand or contract the amount of money required in circulation can change. Increasing or decreasing the amount of money in circulation can help with maintaining stable prices in a changing economy. Stable prices are an important property for a medium of exchange for a number of reasons:

• Preserving purchasing power - Stable prices mean that the money people hold today will have about the same purchasing power in the future. High inflation erodes the value of money, while deflation can increase the real value of debt and discourage investment.

• Reducing uncertainty and volatility - Price stability reduces uncertainty for both consumers and businesses. When predicting future prices is easier, people and firms can plan spending, saving and investment decisions with more confidence. High levels of volatility can increasingly make money less attractive as a medium of exchange.

• Promoting investment & economic growth - Stable prices encourage investment by making future returns more predictable. Volatile inflation or deflation can deter long-term projects.

• Efficient functioning of financial markets - Financial contracts, including wages, loans and bonds are denominated in money. Unstable prices can disrupt financial markets by making real returns unpredictable and result in an increase in the risk premiums.

• Reducing volatility - An inflexible money supply policy can be susceptible to significant price swings, since any change in demand (e.g., due to network upgrades, regulatory changes or adoption surges) cannot be offset by changing the supply. Maintaining stable prices can help with reducing the amount of economic volatility.

Network money doesn’t need to be a medium of exchange

Web3 networks create an open and permissionless environment for mediums of exchange to emerge and compete with one another. Network money does not need to compete in being a medium of exchange and can instead focus its efforts on facilitating transactions and the exchange process.

Other reasons why network money should maintain stable prices

If network money wasn’t used as a medium of exchange it would still benefit from having stable prices. The first reason would be for transaction fees. If the price of network money drastically changes all the time the cost of using the network would become more volatile. This could create usage patterns that are detrimental to the network. Concerns around transaction fees are reduced by the fact that a network coin tax could help with subsidising transaction fees. If transaction fees are already very low the volatility in price might not be a large factor towards influencing or limiting any usage behaviours.

Another reason that network money benefits from stable prices is due to its usage as financial liquidity. Network money could be used as collateral for lending and borrowing or as a liquidity pairing with other tokens for facilitating token exchanges. Higher price volatility could lead to larger losses for the liquidity providers and less predictable returns. Volatility could limit the adoption of network money as a primary form of financial collateral for certain financial use cases. As an example, if the price of network money was rapidly increasing this would mean that token exchanges for every token that is paired with network money would need to be constantly rebalanced. For borrowing and lending it would mean borrowers would be burdened with increasingly expensive loan repayments due to the ongoing price appreciation of network money.

Complexity of maintaining stable prices with network money

Maintaining stable prices for network money would have an even higher complexity than existing fiat currencies being used for nation states. These issues include:

• Global economic complexity - A Web3 network would need to take into consideration global economic changes to try and maintain stable prices. This drastically increases the complexity as different economies can be expanding or contracting at different rates and for different periods of time. Network money needs to arrive at a final price, meaning it could only achieve the average price based on global growth or contraction. This means that local economies could see price instability due to growth or contraction that is far outside this averaged price change.

• Implementation complexity - A vast amount of data would be required to determine whether the money supply should increase or decrease to stabilise prices. This would likely require human curation as it would be easy to create fake transactions that influence any on-chain metrics. Using external data would introduce the systemic risks of introducing oracles into the design of how the network manages money supply. The costs of moderating and maintaining these systems for updating the money supply at a global scale could be significant.

• External systemic risks - Numerous external data sources could be relied upon and a subset of the community could end up being responsible for moderating some of those sources. Both these factors can create systemic risks for the network where the data sources get hacked or negatively influenced or the supply change decisions could be influenced maliciously by people that moderate those data sources. Any potential systemic risks for a global network are highly undesirable as Web3 networks will increasingly become mission critical systems as they achieve global adoption.

• Governance complexity - Due to the variety of data sources that need to be maintained and moderated there could be a large amount of governance complexity that is involved with maintaining a system that can effectively stabilise prices at a global scale. This could either mean delegation to a group of individuals or a governance process that is burdened with poor decision making due to the overall complexity of involving a global user base.

• Spam attacks and fake usage - A supply change system that responds to global economic activity changes could be susceptible to attacks from people who spam the network with fake transactions and data.

Approaches for reducing price volatility

As well as considering how network money prices could be stabilised on a global scale, network money could also attempt to reduce short term price volatility. One way it could achieve this is by using liquidity lock up incentives where someone's network money is locked for a number of weeks or months into a protocol that would help to keep prices more stable. If prices started to rise or fall the amount of network money that could react to that movement would be reduced and locked up liquidity could be available to handle any periods of stress. Locked up financial liquidity could help to reduce extreme price movements in either direction. Reducing price volatility could help with making the financial markets more stable and predictable.

Summary

A medium of exchange highly benefits from price stability so that people can easily use it on a daily basis for buying goods and services without the concern for suddenly changing prices.

However, as network money doesn’t need to fulfil the responsibility of being a medium of exchange, one of the primary reasons to maintain stable prices is removed. If the price of network money changed gradually over time this would not compromise the network or network money.

Although network money doesn’t need to maintain stable prices to function. It is still highly desirable to maintain price stability if network money is going to be commonly used as financial collateral. The more that the price changes over time the less desirable network money becomes as a reliable and predictable form of collateral within financial protocols.

Reducing volatility will be useful for both mediums of exchange as well as for network money. Network money could decrease price volatility by introducing incentives that lock up network money for periods of time in financial protocols.

The cost and complexity of implementing a system that can maintain stable prices at a global scale is not very compelling due to the complexity and risk of attempting to implement these solutions in a globally adopted network. Web3 networks need to be as robust and resilient as possible, so introducing extreme levels of complexity at the network level could come at the risk of letting the network fail in periods of volatility and stress.

Web3 networks still benefit from trying to stabilise prices in a way that doesn’t introduce systemic risks. In practice, this means there is likely some tolerance for slow price changes of network money over time, assuming this means the security and robustness of the network is always maintained and never compromised.

It is difficult to predict whether long term price stability of network money will be achievable or not due to the complexity of trying to respond to global economic activity, and doing this in a way that doesn’t introduce systemic risks into a mission critical system.