OKX Research: the contest between algorithm and human nature-analytic algorithm to stabilize money

OKX:http://ok.b615.com/6/

It can be said that the attempt to develop an algorithm to stabilize money is a contest between algorithm and human nature. Algorithm pursues absolute rationality, presents preset rules in code form, and its running logic is not influenced by environment; Human nature often shows greed and fear under the "animal spirit", causing the market to skyrocket and plummet.

However, this has caused a common paradox at present: at the beginning, in order to expand the market scale, algorithmic stable coins must use human greed to issue more stable coins, but this is at the expense of price instability; When the stable currency market is large enough, the stability of the currency value has been improved, but people have left because of unprofitable, resulting in the contraction of the market size.

From the first generation of algorithmic stable coins AMPL last summer to the second generation of algorithmic stable coins Basis Cash and ESD, we can all observe that algorithmic stable coins are struggling and tearing repeatedly in the paradox of "market size-price stability".

1. The first generation algorithm stabilizes the currency-single currency system (AMPL)

Although algorithmic stable coins began to appear in the market as early as 2018, it was not until the appearance of AMPL in the summer of 2020 that algorithmic stable coins really attracted everyone's attention.

From the principle of algorithm, AMPL has nothing special, and its theoretical basis is the simplest and most important supply and demand model in economics: AMPL has no upper limit of total amount; When the price of AMPL rises above $1.06, the circulation of AMPL will be increased to reduce the market price; When the price of AMPL is lower than $0.96, the circulation of AMPL will be reduced to increase the market price, so as to keep the price of AMPL around $1.

There is a joke that parrots can become economists if they are taught to say the words "supply" and "demand". Although this is ridicule, it also shows the important position of supply and demand analysis in economics. Many people like to use two sentences in the analysis of supply and demand when analyzing AMPL:

"The rise in the price of stable currency leads to an increase in the supply of stable currency"

"The increase in the supply of stable currency leads to the decrease in the price of stable currency"

2. The second generation algorithm stabilizes currency-multi-currency system (Basis Cash).

Compared with the first generation algorithm, the stable currency has only one currency. In order to increase the stability of the system, the second generation algorithm, represented by Basis Cash and ESD, has increased the richness of the system.

Take Basis Cash as an example, there are three main roles in the algorithm: stable currency BAC (Basis Cash), BAB (Basis Bond) BAS (Basis Share. According to official propaganda, these three tokens correspond to US dollars, bonds and stocks respectively. Its stability mechanism is as follows:

When the BAC price is less than USD 1, users can use BAC to purchase the bond BAB(BAB a low price (Bab price = the square of BAC price), so as to reduce the circulation of BAC and increase the BAC price.

When the BAC price is higher than $1, users can exchange BAB for BAC; If you still need to issue additional BAC after the repurchase of BAB, the additional portion will be distributed to the holders of BAS as dividends; Increase the circulation of BAC in the above way to reduce the price of BAC.

3. The third generation algorithm is stable currency-semi-mortgage (FRAX)

In the current market, the representative of semi-mortgage algorithmic stable currency is FRAX. Different from the first and second generation algorithmic stable currency, the casting and destruction of FRAX are based on two kinds of wealth-traditional stable currency USDC and system finance "FXS", namely

Where, F is the quantity of newly cast FRAX, X is the quantity of FXS, which is the dollar price of FXS, Y is the quantity of traditional stable currency USDC, which is the dollar price of USDC, and R is the mortgage rate.

The mortgage rate R is adjusted according to the system algorithm: at the beginning of operation, the mortgage rate of FRAX is 100%, and it is adjusted every hour (determined according to the number of blocks). In the first hour, casting a FRAX requires a traditional stable currency of US$ 1 as collateral. Every hour from now on:

If PUSD > 1 USD, the mortgage rate will be lowered by 0.25% in this adjustment.

If PUSD is less than 1 USD, the mortgage rate will be raised by 0.25% in this adjustment.

In order to ensure that the actual mortgage rate is equal to the mortgage rate set by the algorithm, FRAX also designed a "Buybacks and remortgage mechanism". The first is the remortgage mechanism. When the algorithm raises the system mortgage rate, in order to make the actual mortgage rate equal to the system mortgage rate, the number of USDCs in the system must be increased. FRAX sets an incentive measure: anyone can add USDCs to the system and exchange for more FXS;; For example, a user can add USDC worth $1 to the system in exchange for FSX worth $1.2. The "buy-back mechanism" means that when the mortgage rate of the system is lowered, users can exchange FXS for USDC with the same value at any time, so there is no incentive in the buy-back mechanism.

The existence of "Buybacks and Recollateralization mechanism" ensures that users can cast or redeem the stable currency FRAX at any time according to the mortgage rate given by the algorithm, thus preventing the phenomenon of insufficient collateral of USDC. At this point, under the action of arbitrage mechanism, the stability of FRAX price is guaranteed:

When 1 FRAX is less than $1, the arbitrageur will buy FRAX, redeem USDC and FXS with frax, and make a profit by selling FXS. The demand for FRAX will increase the price of FRAX.

When 1 FRAX > $1, arbitrageurs will cast FRAX through USDAC and FXS, and sell it for profit, and the selling pressure will cause the price of FRAX to fall.

It can be seen from the above that although FRAX claims to be a "semi-mortgage" algorithm stable currency, it is actually a "full mortgage" algorithm stable currency-users can exchange 1 FRAX for USDC and FRX worth 1 US dollar at any time, and the algorithm only controls the mortgage rate of the system and the issuance rate of FXS, so the price of FRAX is extremely stable.

4. The algorithm stabilizes the future of money.

Under the condition of modern economy, there are two main channels for money supply:

First, the money-putting institutions put money in by purchasing money reserves or value anchors (such as gold, foreign exchange and other value stores) to determine the unit value of money and enhance the credibility of money.

The second is the money put in by the money-putting institutions by issuing loans to social subjects or buying their bonds. Both loans and bonds represent future wealth, which is out of the limit of current real wealth. Putting money in this way will ensure the timely supply of money and the basic correspondence between the total amount of money and the scale of wealth, so as to stabilize the value of the deposit.

Take China as an example. During 2000-2014, the issuance of RMB was mainly based on foreign exchange, because China's foreign exports increased rapidly during this period. In order to stabilize the exchange rate of RMB, the central bank had to buy a large number of foreign exchange assets such as US dollars, and then put in a large number of RMB, that is, the issuance of RMB was based on foreign exchange assets such as US dollars; Since 2014, China's foreign exchange holdings have been declining year by year. At this time, the issuance of RMB has evolved to be dominated by the increase of debts in the domestic banking system, that is, the issuance of RMB is based on debts.

Similarly, the first generation of stable coins, such as USDT and USDC, are the same: behind every stable coin issued, there is a realistic legal tender of US$ 1 as a reserve (although some non-compliant stable coins are tricky), so as to maintain the confidence of stable coins and ensure the stability of stable coins' prices.