One of the main general points of critique on cryptocurrencies has been their extreme volatility. I’ve often tried to find some mechanism or algorithm that could be build into a cryptocurrency to combat volatility and give more stable value, without giving a third party the power of influencing the supply (like a central bank). Although in classic cryptocurrencies it’s easy to enlarge the supply of coins, significantly shrinking the supply at the right moments could be extremely desirable to combat devaluation due to disastrous events (like what happened after Mt. Gox defaulted). At first I thought this was impossible without literally taking coins away from coin owners (which would be ridiculous), but with SafeCoin I believe it is possible.
As David Irvine explained to me a short while ago, when someone buys resources in the network the SafeCoins are not directly paid to farmers. Instead they are effectively destroyed until they are farmed again by the farmers. The rate at which farmers farm SafeCoins is determined by an algorithm that (as far as I know) isn’t exactly defined as of yet.
With this thread I’d like to point to the fact that when resources are bought and SafeCoins are destroyed, the total supply of SafeCoins has temporarily shrunk until the destroyed SafeCoins are created again through farming. If SafeCoins are destroyed faster than they are farmed, the SafeCoin supply is consistently shrinking.
This means that the issuance algorithms can both expand and shrink the supply, creating inflation or deflation depending on circumstances. With the right algorithms, this ability to cause inflation or deflation can be made into an automatic SafeCoin value stabilization mechanism. If the value is falling significantly, SafeCoins would be farmed slower than they are destroyed, when the value is exploding, SafeCoins would be farmed faster than they are destroyed. For ease of use I’d like to refer to this farm/destroy ratio as the recycle ratio (if there’s already a better term, let me know).
For this to be possible the algorithms used need to be able to get some measure of changes in value of SafeCoin. I’m currently thinking mostly about the possibility to derive this from the total amount of resources available to the network. Since the reward of providing resources to the network is issued in SafeCoin, the total amount of resources available will grow until the the lowest possible cost of providing those resources (power, hardware wear) is in equilibrium with the (expected) value of the reward in SafeCoin. A drop in SafeCoin value would hence cause a reduction in total resources available, because farmers would suddenly be paying more to provide those resources than they gain in SafeCoin, and will thus turn them off. Hence it could be said that stabilizing the total resources available would indirectly also stabilize the value of SafeCoin, at least as long as the resource market of the MaidSAFE network is a significant factor in the trading volume of SafeCoin.
It should be noted that the recycle ratio, since it is a ratio, can be changed by adjusting either or both factors ( farming reward and resource cost). Reducing the farming reward in SafeCoin in times of devaluation seems counter productive to me, since it would only cause a bigger reduction in total available resources. Hence increasing the costs in SafeCoin to buy resources seems most logical to me. An additional factor would be that the value of resources would be more stable as well.
The existence of a value stabilization algorithm would also cause a self-fulfilling prophecy. Since owners of SafeCoin know this algorithm is in place, they will panic less when the value drops, in the knowledge that the algorithm will start shrinking the SafeCoin supply. This reduces the incentive to start dumping their SafeCoin in fear of irrecoverable losses.
Of course, this approach is based on the assumption that the network is or can be aware of the total resources available. I don’t understand MaidSAFE well enough yet to answer that question, so it would be great if a developer could shine some light on that.
What do you think?