Monetary Policy and Fiscal Policy Governance of Decentralized Stablecoins

Editor's Note: This article comes fromBlue Fox Notes (ID: lanhubiji), Author: Evan Kereiakes, Translator: HQ; Odaily reproduced with authorization.

, Author: Evan Kereiakes, Translator: HQ; Odaily reproduced with authorization.

Summary

Preface: How to achieve a decentralized stable currency? How should monetary policy and fiscal policy be formulated and implemented? This paper presents a framework that attempts to remove the need for human involvement to enable programmatic decentralized stablecoins. The author of this article is Evan Kereiakes, translated by "HQ" of the "Blue Fox Notes" community.

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In the long run, good governance is one of the most defining characteristics of a healthy ecosystem (political, economic, social). As ecosystem participants continue to join and exit, they must adhere to a set of rules and ideals that have long existed through the governance structure.

In the blockchain world, decentralized governance is critical, but it can be difficult to get right. Appropriate incentive structures must be in place to enable change in a disciplined manner. To achieve this, many blockchain ecosystems start out becoming more centralized, but over time, move towards more decentralization.

This article challenges some of the monetary and fiscal policy governance that is characteristic of decentralized, price-stable cryptocurrencies, offering some ideas on how to make core components of the stablecoin ecosystem autonomous, thereby reducing the need for human intervention. input needs.

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Who controls the currency?

As the saying goes: "Cash is king", that is to say: "Whoever controls the cash flow is the boss".

To determine whether a stablecoin ecosystem is decentralized, one can look at who controls the funds or collateral, and has this responsibility become more decentralized through governance? Monetary and fiscal policy are arguably the most powerful leverage mechanisms in the stablecoin ecosystem, balancing the stability of mortgage lending with the growth momentum of fiscal spending.

With more centralized ownership of the governance process, control over monetary and fiscal decisions may be more centralized to begin with. In the early stages, centralization is justified because of the need for fail-safe ownership so that development can be accelerated and system upgrades can be made quickly to allow time for the more important monetary and fiscal policies to be disseminated and enforced.

Any fiscal or monetary decision can be influenced by a governance vote, where X% of validators or miners agree on a certain outcome of the network. This is a traditional method of governing a blockchain, and it works for some projects.

However, users and investors must trust people, not networks run by mathematics, leading to poor decision-making about the future of the protocol and a departure from the more programmatic origins of the decentralization movement. If insiders collude or control a majority of tokens and vote for their own benefit, then voting outcomes will be game-affected, however, a more autonomous approach to decision-making can be subject to unforeseen risks in system modeling.

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Monetary Policy Governance

Provision of Endogenous and Exogenous Asset Reserve Ratio

In order to maintain the value of stablecoins during economic contractions or shocks, a counter-cyclical stabilization mechanism is required. The dual-token stablecoin mechanism, where one is the stablecoin and the other is the collateral, is the most promising design for decentralized stability.

They rely on some form of endogenous stability (i.e., endogenous revenue streams such as seigniorage, transaction fees, or mining rewards) whose value reflects the need to participate in the stablecoin economy. Most decentralized stablecoins more or less rely on some form of external stability, such as anchored underlying assets. Both forms of stability include reserves to support stablecoins, and the total collateralization ratio requirement is always greater than or equal to 100% of the stablecoin supply.

If the exogenous reserve ratio is consistently maintained at 100% of the size of the stablecoin economy, then there is no need for endogenous reserves. But this type of stablecoin can be subject to centralization and censorship risks. However, during periods of severe decline in demand for stablecoins, the value of fully endogenous reserves can spiral downward, and these types of stablecoins have failed.

Therefore, a mixed approach is advocated here, that is, when the exogenous reserve ratio deviates from 100%, a decision point arises: what level of exogenous reserve requirement is appropriate to ensure stability.

The underlying asset anchored by the stablecoin is the highest value exogenous correction mechanism, which can be used to shrink the economy at an anchor price, or to supplement the value of endogenous reserves. For most stablecoins, cash or cash-equivalent instruments are the underlying assets of this peg mechanism, and as the economy grows, they may have substantial opportunity through the power of seigniorage.

Other exogenous assets, including cryptocurrencies, can be used to achieve greater decentralization, minimizing volatility and downside risk through proper portfolio management methods. In this analysis, it is assumed that changes in the value of each reserve asset do not depend on portfolio management decisions but on other causes, such as market behavior or changes in expectations.

Assets made up of endogenous reserves are typically volatile, with their value relative to the money supply fluctuating over a wide range based on economic cycles or growth expectations. In extreme cases, endogenous reserves can enter a recursive downward spiral, decreasing in value when they are most needed. To compensate for this, discounting the value of endogenous reserves through appropriate expansion conditions can more accurately capture its true stabilizing capacity.

First, rather than using the market value of endogenous reserves, it is possible to define an effective endogenous reserve value, denoted here as "epsilon", that offsets endogenous Downward fluctuations in reserves. Second, use the exogenous reserve requirement rate to discount the endogenous reserve requirement rate to adjust the reality: the endogenous reserve fund brought by the lower exogenous reserve requirement ratio bears more economic stability burden.

Index factors help further discount the value of endogenous assets because they are not direct substitutes for exogenous assets. This factor also accelerates the supply of exogenous reserves in the event of economic shocks, an effective level of redundancy. The above adjustments yield the following equation, which is the seigniorage percentage equation allocated to exogenous reserves based on the effective endogenous reserve value and the exogenous reserve ratio:

The diagram below shows how a decentralized, programmatic reserve supply equation works. The first graph shows the output of the above equation. Seigniorage can only be used for fiscal expenditures after the protocol stabilization funds (miners and exogenous reserves) are properly provisioned. Note that miner or validator rewards are outside the scope of this operation. Monetary and fiscal decisions come into play only after miners and validators are compensated for the fixed and variable costs of maintaining the blockchain.

The second graph shows how the exogenous reserve ratio varies over time as an output of the seigniorage distribution function and the business cycle. Note that the model for endogenous reserves shows very high volatility.

The third chart shows the seigniorage balance available for fiscal spending. Since fiscal expenditures may fluctuate, a simple smoothing algorithm can be used to make fiscal expenditures consistent with the passage of time. Fiscal policy is discussed in more detail later in this paper.

Use of Intervention Reserves (Exogenous vs. Endogenous)

Both endogenous and exogenous reserves operate while absorbing changes in stablecoin demand. Reserves are a scarce resource that must be managed properly in this service.

Endogenous reserves are an important tool for achieving stability and adoption in a decentralized format, and are the first line of defense in maintaining the peg of a stablecoin. Exogenous reserves represent a second (and more advanced) stability defense mechanism, since they are theoretically less correlated with stablecoins' economic cycles and price cyclical changes.

The farther the exogenous reserve ratio is from 100%, the greater the potential risk of diminishing marginal impact on sales of endogenous collateral. Who gets to decide when to use endogenous reserves, or exogenous reserves, or both, in order to maintain a stable anchor price during an economic contraction?

The countercyclical mechanisms that provide greater stabilizing power to endogenous reserves during deflation are different for each stablecoin. During a period of reduced or contracted demand for stablecoins, a decline in the price of endogenous reserves, increased volatility, and reduced demand... This is a dangerous triangle where multiple forces work together to erode the stability of endogenous assets.

Then at a certain inflection point, the price of the endogenous asset enters a death spiral and never rebounds. Only two forces can avoid the emergence of the death spiral, one is the lower limit of demand (uncertain), and the other is exogenous assets (determined). This is why decentralized stablecoins often maintain an exogenous reserve, as it can certainly break the price spiral of an endogenous reserve more effectively than any other protocol mechanism.

Assuming reserves are properly provisioned (as described in the previous section), the decision about when to use each type of collateral should come down to optimizing system resources. Therefore, endogenous reserves are the first line of defense, as long as they are "all in".

This framework, if implemented properly, makes it very costly for an attacker to break the anchor. The more endogenous reserves are used to tighten the economy: 1) the higher the exogenous reserve ratio before it needs to be used as a last line of defense; 2) the more the economy operates independently of exogenous assets - this is ultimate goal. The formula for determining the level of exogenous reserves to sell based on the endogenous reserve ratio (NRR) is defined as follows:

The decision to use endogenous reserves or exogenous reserves is determined by whether the endogenous reserve consumption rate is greater than or less than the stablecoin supply deflation rate. If the endogenous reserve destruction rate is lower than the money supply deflation rate, then the endogenous reserve rate will continue to be used to deflate the economy until it reaches 100% of the exogenous deposit reserve ratio, at which point the system can be converted to exogenous deposit reserve.

Conversely, the above equation shows how exogenous reserves should be used to supplement endogenous reserves. The "x" index is an input value that can be set in advance or programmatically so that exogenous provisions can be spent at a faster or slower rate than the model suggests, and can include other inputs such as The initial or current exogenous reserve ratio.

In summary, if dNRR is negative, then sell exogenous reserves. The greater the decline in NRR, the more exogenous reserves will be sold to subsidize the stabilizing capacity of its endogenous reserves. Although there are many scenarios and special cases that cannot be described by a simple formula alone, this is an effective framework for solving complex problems. If the stablecoin economy reverts to expansion, then using the algorithm described in the previous section, the reserves can be automatically rebalanced at a certain rate.

Below are the results of a stablecoin intervention simulation using endogenous and exogenous reserves. While this situation is highly unfavorable, it is necessary to ensure that the protocol can fully deflate the economy with a pegged stablecoin price.

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Fiscal Policy Governance

Fiscal policy is the engine of resource allocation in the system, just as the government directs resources to stimulate growth and benefit voters. Fiscal resources can be any form of protocol revenue and can consist of seigniorage, other revenue, taxes, transaction fees, etc. The fiscal governance logic in this section applies only if monetary reserves are fully supplied, since stability is a fundamental requirement.

The goal of programmatic decentralized fiscal policy is to facilitate the efficient allocation of fiscal resources while eliminating the need for voting or human input. Likewise, incorporating major decisions such as fiscal spending into governance votes will pose problems inherent in risks arising from the centralization of governance token distribution and reliance on people rather than algorithms.

In these cases, bad actors may try to bankrupt fiscal reserves, so various additional precautions can be taken, all of which are long-term guarantees that the agreement becomes a prerequisite for fiscal spending. Voting based on streamlined and transparent mandates for "whitelisted" or "blacklisted" entities within the fiscal regime is an effective enhancement.

These tasks can also be implemented as boundaries, automatically triggered in the event of suspicious activity, thereby limiting fiscal spending. The "stability-as-a-service" approach is to do this programmatically. Further discussion of this and other ways of securing financial resources would result in cost savings.

A programmatic framework works well for a federal fiscal spending model where various decentralized service providers (companies) with unique value compete with each other to optimize capital allocation.

In this way, resources can be allocated more efficiently, and it means that the marginal propensity to consume and the fiscal expenditure multiplier of the stable currency are higher than that of the fiat currency government. As mentioned earlier, fiscal expenditures can be smoothed by a simple algorithm to ensure that fiscal resources are available even during periods of little or no agreed revenue.

The following formula illustrates the change in the weight (w) of each firm's access to financial resources in the economy based on a normalized volume multiplier momentum (T) and a normalized money supply holding ratio (M), where (gamma ) is the programmatic level of leverage associated with dividing the benefit of resources based on economic conditions and currency usage.

Regarding the decomposition of the (T) variable, the inputs are: 1) the firm's relative total transaction volume, 2) the fiscal expenditure multiplier (i.e., expenditure efficiency), expressed as transaction volume (TV) divided by fiscal expenditure (F), and 3) Multiplier Momentum. In this example, (TV) stands for GDP.

The composition of the multiplier momentum rescales the spending multiplier for each period to more evenly reflect the contribution of early-cycle and late-cycle businesses. Weighted moving averages (TV) and (F) help smooth out fluctuations over time, since both can fluctuate at times.

The money supply part of the equation, which takes into account the velocity of money per company relative to the velocity of the broader stablecoin economy, then rewards companies with lower velocity as they contribute significantly to seigniorage. Returning with a longer holding period will help stabilize the allocation of funds over time and improve returns on low-velocity companies.