The Problem with Seigniorage Shares


5


taylorb

In 2014 Robert Sams introduced the idea of Seigniorage Shares (https://github.com/rmsams/stablecoins/blob/master/paper.pdf), a two-token system that uses an elastic supply to stabilize the price of the "coin" token. When demand for the coin is falling, "shares" are minted and sold to repurchase coins. When demand for the coin is increasing, coins are minted and sold to repurchase shares. So, as long as there is expected future demand for more coins, shares are valuable. But the converse is also true: If there is no expected future demand for coins, shares do not have value.

This presents a major problem for the Seigniorage Shares design. Although the system may succeed in remaining stable for some period of time, it may reach a point where it satisfies existing demand for the coin. If the market believes this point has been reached, it will decide shares no longer have value. If shares do not have value, then any decreases in demand for the coin will result in the system being forced to mint precipitously dangerous quantities of shares in response.

To see why, consider that in order to produce value V, at a price P, the system has to mint Q shares, where Q * P = V. Let's re-arrange that to see how many shares have to be printed: Q = V / P. If we take V to just be some constant, then this is just a reciprocal function.

If you recall the shape of a reciprocal function, it's easy to see how this can result in two distinct regimes of behavior. In the first regime (the flatter, right-side of the graph), the market expects future growth. This means that small deviations in P result in negligible changes in Q . But when expected future growth stops and shares lose their value, the system enters a regime of behavior where it is forced to mint increasingly large amounts of shares to produce the same amount of value. Over time, holders of the share token become increasingly diluted, and eventually people conclude the share is not worth holding.

Now the system is prepped for its final death spiral. Upon recognizing shares have been diluted to the point of being worthless, holders of the coin begin to panic and start to exit the system. As demand for the coin falls, the system is forced to mint more and more shares. As the number of shares skyrockets, coin holders panic more...and so on.

While the Seigniorage Shares concept is no doubt interesting, those who implement it need to find a way to prevent the system from relying on expected future growth.