When it comes to stablecoins, the first examples that usually come to mind are Tether, a dollar-backed token, or Maker’s DAI, an Ethereum-collateralized stablecoin.
There are also some with no collateral at all. We’ve previously reported on Kowala, a mineable stablecoin. But among the most promising is Basis, which does not have any assets to back it, but instead an algorithm and three-token model that manages supply.
Basis (originally called Basecoin) is the product of Intangible Labs, an American-based software company launched by three Princeton graduates. On June 20th, 2017, Intangible Labs released the whitepaper for Basis, outlining the company’s objectives and the methods by which the coin will maintain stability. In the white paper, Basis is described as a cryptocurrency whose tokens can be “robustly pegged to arbitrary assets or baskets of goods while remaining completely decentralized.”
Basis’ central bank algorithm must have seemed like a worthy investment, as the startup was able to raise US $133 million in April of 2018. Per Basis, the investor group included Bain Capital Ventures, Google’s venture arm GV, Andreessen Horowitz, and Lightspeed Foundation Capital, among others.
An Algorithmic Central Bank
In its whitepaper, Basis states it uses “the same economic principles relied upon by central banks around the world.” These principles are based upon the Quantity Theory of Money, which states if the nominal amount of money has changed, the true value of the good will be the same. Basis believes it can manage inflation by increasing supply and selling extra stable coins when exchange rates are high, and buying them back when rates are lower.
To do this, the Basis protocol identifies a target asset to which to peg its value, which could be a fiat currency or an index like the Consumer Price Index (CPI). The protocol then utilizes an oracle system to monitor exchange rates to determine the price of the coin.
In order to manage supply, Basis uses a three token system comprised of the Basis token, bond tokens, and share tokens.
The Basis token is the one that is actually pegged to USD, and serves as the primary medium of exchange. When the price of the Basis token is greater than US $1, new Basis tokens will be released into the market. These newly minted Basis tokens are first distributed to bond token holders, then whatever is left over is distributed to share token holders.
If the price of the Basis token is less than US $1, bonds will be sold at an open auction, which removes Basis from circulation. The bonds, which are sold for less than a dollar, “have the potential to be redeemed for exactly 1 Basis when Basis is created to expand supply.”
Basis believes this model will “incentivize speculators” to buy bond tokens, in the hopes that their bond tokens will pay out in the future.
Basis Requires New Speculators
The three token system Basis will use to manage market fluctuations is highly dependent on user participation in the system. The crux, as fervent stablecoin opponent Preston Byrne states, is that “every bet being placed by every user of the system goes one way.” Up.
If the three token system begins to fail and bond token issuance isn’t stabilizing prices, the whole system could fall into a downward demand spiral.
In this instance, if buyers stop purchasing bonds and the bond queue builds up, it will take longer to redeem bond tokens for Basis tokens. The depressed bond price could effect newly minted bonds, and the new bonds would be pegged to lower and lower prices. Ultimately, this could create a downwards feedback loop: a death spiral.
Basis claims it can mitigate the death spiral by implementing a bond price floor, a fixed price at which the protocol stops creating new bonds. Additionally, the team established a bond expiration timeframe, which is tentatively established at five years. It’s unclear how effective a five year expiration time will be, as the bonds may remain unpaid at their expiration.
Can a continual demand of bond tokens maintain the price of the Basis tokens when that price is below US $1? It may be that, without a constant influx of new bond purchasers, the algorithmic central bank model is unsustainable.
One can only hope that Basis has thought through these potential demand-driven issues, and has all its bases covered.
The author is invested in Ethereum, which is mentioned in this article.
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