Question from Pseudonymous Chatterbox, accompanied by a donation of 0.0001 BTC

A thought occurred to me regarding a technical solution to the central bank problem under ancap.

In cryptocurrencies without a center, extreme volatility is noticeable.

It exists in the real world too—but central banks regulate it, trying to smooth out dips and spikes.

In a blockchain cryptocurrency, I can imagine the following as a replacement for a central bank, based on basic Bitcoin:

1) There are two types of value: main coins and “leprechaun” coins.

2) Leprechaun coins are born from transactions with main coins and are given to both parties. This rewards operations—making the asset more useful as a currency—and also (consequently) reduces volatility.

3) The lifespan of leprechaun coins is pseudo-random—the checksum of the next block determines which of them are destroyed and which continue to live. This is necessary for stability.

4) Owning leprechaun coins affects the chance that the owner will get the next block of main coins, or better yet, new emission is split: half to the miner, half distributed proportionally (but with pseudo-random sparsity for a game element and visibility—for example, 15/16 leprechaun coins give nothing, 1/16 give a 16x result) among leprechaun coin holders at the moment. This is necessary so that leprechaun coins have value.

This point is debatable; it means that such a mechanism cannot be grafted onto Bitcoin already, a new cryptocurrency is needed. But without linking the value to the main asset, no cushioning of spikes will be possible.

5) This system must work quickly. Likely, a single blockchain, like in Bitcoin, is not very suitable for this, but a partitioned blockchain might work, which merges into a general one at certain intervals so that main coins of different partitions do not have different values (this is a real danger).

6) This is essentially just a regulator—any operation becomes less speculative; the speculative effect is smeared out.

What do you think of this nonsense, author?

Answer from Ancap-chan

I’ll say right away: the effect of implementing this nonsense will be strange. How would it look? Every transaction has a cost depending on the mempool congestion. Every transaction generates leprechaun money for the sender and the receiver. Leprechaun money generates base protocol money with a certain probability. Accordingly, as long as the expected reward in base coins exceeds the cost of paying transaction fees, people will run bots that infinitely transfer coins between their own wallets. Since the fee does not depend on the transaction amount, but the reward does, it will be profitable to juggle larger sums for “leprechauning.” So we will simply get an additional way of staking base coins, which will differ from classic staking by a number of unpleasant side effects: the use of leprechauning will drive up transaction fee costs, thereby worsening the user experience for ordinary users.

How will leprechauning affect volatility? The volatility of the market price of a coin depends on the change in supply and demand for it. Suppose demand for the coin increases. The price rises. Leprechauning becomes profitable with a smaller number of coins. More people start engaging in leprechauning. The mempool overflows. Fees rise. The profitability of leprechauning decreases. Demand for coins decreases. The price falls. That is, the feedback loop seems to work, and the coin price becomes less volatile, but this is achieved at the expense of the inconvenience of using the coin for anything other than leprechauning, and we are supposedly designing money.

I can provide another example of low-volatility money—according to David Friedman, adjusted for modern technology. Anyone wishing can freeze the necessary number of tokenized warehouse receipts for goods from a standard basket in a smart contract, which is selected so that its components hedge each other during price fluctuations due to external conditions. In exchange for the frozen tokens, the smart contract mints coins; let’s call them, say, “deives,” so that Satoshi isn’t lonely. At any moment, the owner of such a coin can turn to the smart contract and break it down into its components, receiving commodity tokens in return, and then sell them individually or exchange them for the actual goods. Or not break the coin and buy goods with it.

Money guarded by leprechauns would reduce the volatility of its value by increasing the transaction price; deives, however, would mean costs for their owner for the very fact of ownership, because if there are receipts for physical goods, someone bears the costs of storing these goods, and these costs will be factored into the price of the receipts. If deives are backed by futures, the coins will have a limited circulation period, after which the coin will be frozen until the owner extends the delivery date of the goods under the future. Again, the further from the physical warehouse a coin circulates, the larger the discount at which it will be accepted for payment, because its backing loses value by the amount of the cost of transporting the goods to the place of demand. Nevertheless, such tokens backed by commodity baskets could certainly be in circulation, especially around local trading hubs with significant warehouse areas.

So, we have at least two decentralized mechanisms for reducing volatility by increasing the costs of storing or circulating coins. There is in principle no such thing as free stability; one can only choose which costs are preferable. Or you can simply buy Bitcoins and accept that their price will fluctuate within fairly wide limits, hoping that the upward trend they previously demonstrated will continue in the future.