I’ve already touched on several issues I think are manifesting with the coupon system in the server. I’ll repeat the key points.
Fundamental issues with coupons as a deflation mechanism
1. If odds of an expansionary growth in the near term don’t look very high, which is when burning is needed the most, coupons are mathematically a bad deal. This is evident when you compare it to options trading or use any other bet pricing model.
2. It’s a very unstable burn mechanism. Burning to earn a premium means that there has to be a strong expectation that the required contraction will be followed by an even bigger expansion of the supply. (if we have to do -X, then buying a coupon is betting on +X*premium). This assumes every bearish period is quickly followed by not only a bullish period, but a record breaking one. If it’s not record breaking, then on average, for the -X contraction, less than +X in coupons has been paid out. The requirement for it to be record breaking can disappear when a lot of coupons expire, but this does not help their math. Furthermore, this effect is multiplicative, and even if it works out in one instance, it gets increasingly less feasible after every cycle.
3. One obvious idea might be to try to improve the lucrativeness of coupons by steepening the premium curve, i.e. promising a bigger payout. This does not improve the math at all either. Again, let’s say we have to buy out X in coupon value. Since we agreed premium1 is a bad deal, we’re doing it at a bigger premium2. Now, with the same math as the above, we still need an expansion worth at least Xpremium1. If that’s the amount of expansion we get, premium2 coupons will have ended up worth exactly as much as premium1 ones, except, instead of a fair distribution of the return, whoever uses the most tricks to redeem first will get the full payout. If we reach an expansion of Xpremium2, only then did the higher premium accomplish its goal of being more lucrative. However, as previously noted, the higher amplitude of the quick recovery assumption, the increasingly improbable a full reimbursement becomes. Each linear unit of increase in promised premium is exponentially less likely to realize. At some point increases in premium become nigh-worthless, if not an anti-feature, cause it introduces more random chance as to who manages to cash in on the limited expansion pie and who doesn’t.
4. Rolling coupons might be a good way to buy time, but selling a bad bet at an additional premium, to buy the same bad bet makes it even more negatively skewed.
Strategy Proposal
Draw inspiration from the traditional financial system. Ever since hard backing has been depracticed, careful peg balancing is what currency is. Governments have figured out a multitude of instruments of nudging their currency in the right direction. Of course, there are several fundamental differences between the two systems, but I believe a careful analysis into which strategies could be reused is necessary to achieve a more mature system.
The near term, practical design change
Replace coupons with a version of “treasury bonds” and systematic debt towards ESD burners. Instead of assuming a brief and explosive recovery in the near term, spread it out, and assume a net recovery over a longer period instead. Do this by creating debt that is paid out at a premium. Make it a stable reward for removing ESD out of the supply. A lucrative offer for both existing and, more importantly, new capital that only gets better if the market is in trouble. A guaranteed, if necessarily gradual return with interest is much more desirable in a bear market than a near-term bet. In traditional markets, bonds are valued more highly during recessions.
This still has an assumption of eventual inflationary growth, but a much safer one, and one that governments make and enforce with traditional currencies.
To be determined
How premium is calculated, and the full duration of the bond. How frequently yield is paid out. Whether it’s better to have a debt balance sheet, or tradeable debt tokens. Whether to have one kind of treasury bond or several. Whether to leave room for interest rates to also be adjustable according to market conditions, as they traditionally are, or not. My guess is it we’d go with the simplest option for most of these for now, but refining some of these parameters over the long term may be a good idea.
Also TBD is what happens with paying out yield during contractions. I would say keep them lucrative and guarantee a payout. If paying out during contraction is necessary, we’ll have to compensate by buying more bonds. If this is too much of a burden, I think we’ll have time to realize it and react. It’s a much less explosive system.
What this doesn’t solve - a fundamental issue for a different EIP
The system is way too focused on total money supply. The common misconception about currency is that this is the only driver of inflation/deflation. In reality, it’s a multi-parameter formula, and the only way to manage and adjust the peg is to monitor and react to every single parameter in the equation.
Even if deflation is fixed, if exclusively bonded money ends up being deflated, the accomplished deflation is 0 as the V in the formula below, for bonded money, is 0. There’s still a dependency on both positive influx of new capital and low selling pressure to keep the system stable long term. At some point, we need to focus a lot more on movement patterns of the ESD supply. I believe we could make it more resilient to stagnant markets, but this needs a much longer, separate discussion.