Bitcoin (BTC/USD), Ethereum (ETH/USD) – Monetary Mechanisms: Cryptocurrencies may need to have robust systems to balance or implode

Cryptocurrencies like Bitcoin BTC/USD and ether ETH/USD have given many investors a freedom. These new forms of money have expanded what is possible and for whom it is possible.

But still in their relative infancy, crypto economies remain volatile. Many projects soar to dizzying heights only to implode soon after.

Traditional economies, for all their flaws, have mechanisms that help them function and remain relatively stable. This is playing out as Americans feel the weight of inflation as the cost of gasoline, groceries and other commodities soar rapidly.

The US has a central banking system where the Federal Reserve can adjust interest rates to fight inflation. The interest rate adjustment is like putting a finger on the scales and influencing the behavior of lenders and borrowers and thus the flow of money. Slowing borrowing and lending tends to contain inflation, but at a cost.

Many cryptocurrencies lack these systems, whether intentional or omitted. And still others lack robust systems that work as designed. Take for example the recent collapse of the popular Terra classic LUNC/USD.

The crypto had a mechanism that helped it preserve the value of its stablecoin, UST. When the value of UST fell below $1, LUNC was minted with the same value, theoretically causing the price of UST to rise back to $1. However, when this system became overloaded, the value of LUNC fell too fast and too much LUNC was minted, leading to hyperinflation that created a death spiral negative feedback loop from which the system was unable to recover.

It is clear that redundancies must exist. Therefore projects like seasonal stamps — consisting of four tokens Summer SUMMER/USD, autumn AUTUMN/USD, winter WINTER/USD and spring SPRING/USD — exist, the project has built in four mechanisms designed to maintain ecosystem health.

The first is the inherent balance of proof-of-work. As a coin’s mining power increases, the difficulty of compensating for it increases and vice versa. This keeps production rates constant at a reward every 10 minutes.

The second is the theoretically rational behavior of miners. If a token’s price drops, many miners will likely choose to start mining another season, increasing the rewards for those who stay mining and compensating for the price drop.

The third is the inverse of the second. Miners will want to switch to mining during the most profitable season, but when some of them do, it becomes harder to produce that token, potentially offsetting mining profitability.

And finally, the fourth comes from investor behavior. As the prices of the tokens rise and fall cyclically, traders will want to exchange their overvalued tokens for undervalued ones in order to increase the number of tokens they hold and to even out the price movements of the four seasons.

If you want to learn more, visit https://seasonaltokens.org/.

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Featured photo by Christophe Hautier on Unsplash

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