On Quantitative Easing Pt. 2: The Tale of Ampleland
Modern currencies fall within two categories: either it must be inflationary with a rising supply or deflationary with a decreasing or hard capped supply.
Both of these approaches have problems and each system's opponents are quick to point out the failures. These attacks often fall into one of the three core functions of money: medium of exchange, store of value, or unit of account.
Deflationary currencies are a strong store of value, but a terrible medium of exchange because nobody wants to spend it.
Inflationary currencies are a great medium of exchange because they inspire spending, but a terrible store of value because they inevitably lose purchasing power.
The problem with these two methods is their supply. Deflationary currencies have too little supply to keep up with growth while inflationary currencies run amuck with massive boom and bust cycles. The Federal Reserve can’t take dollars away from people unilaterally to control the supply of currency. Instead, the Federal Reserve increases demand for the dollar to rein in inflation. They raise interest rates, forcing the sale of assets to gather cash. This in a deflationary force as there is now more demand for the dollar because it is how debt is paid. However, this current method of demand and supply manipulation has its short comings.
PROBLEMS WITH CENTRAL BANK INFLATION
1. It creates uncertainty in the markets about future interest rates
Even the slightest hint of rising interest rates will send the stock market diving down. This is because everyone (banks, hedge funds, anyone with money) uses assets as a hedge against inflation. Nobody (except those in the privileged and elite circles) knows when the Fed will announce interest rate changes. If everyone in the markets knew exactly why and when interest rates would change this would help growth be steadily upward, not the how this centrally controlled economy moves: way up, crash down, up more, crash a little less, so on forever. That's just on the increasing demand side.
On the other hand, speculation that inflation is coming can cause unhealthy asset bubbles as investors scramble to save their money from debasement. Even if the Federal Reserve perfectly responds to changes in demand--which is impossible, although I do have great respect for the brilliant minds that work there--the uncertainty of how they will do so and when can damage the economy with irrationality in either direction. An obscured central force guiding the economy, however well, leads to irrationality in the short-term.
2. The economy eventually becomes dependent on 0% interest
By preventing crashes with bailouts and guillotined interest rates, the US economy begins to build up deadwood. The presence of low-cost debt allows companies to survive longer on low or negative profits. Sometimes, this is a good thing. After all, many of today's greatest companies didn't turn a profit for years. However, the continual presence of zero or negative real interest rates allows for weak and inefficient companies to survive or even grow.
Companies that employ thousands and represent a percent of peoples' retirement savings slowly start expecting free cash. The moment the Fed decides the economy needs a reality check these companies are brought to their knees. This would be alright, if it weren't that all these companies would fail (or take a large loss, doesn't have to be as dramatic as bankruptcy) at the same time. This collective reliance on free cash is a danger. It forces the Fed to decide, let inflation in the markets go unchecked or crash the economy?
3. The method of supply unfairly benefits the rich
Those that own assets benefit from a debasing currency. In fact, our system of Central Bank controlled supply has dramatically increased the share of money in the top 50%, to say nothing of the 1%. Inequality is a serious issue when it's the system itself not the talent and decisions of unfortunate people that causes it. It's a system that is stacked against minorities and the poor who can afford fewer investments that increase in value during our inflationary cycles.
The purpose of this article is not to just criticize inflationary currencies, but to propose a solution
Supply elastic currencies are a more fair, stable, and efficient monetary system that deserve more attention and adoption.
SUPPLY ELASTIC CURRENCIES
Instead of the Federal Reserve one-way supply system, there is now the technology necessary to institute a supply elastic currency that can adjust its supply in a non-dilutive way to match increasing/decreasing demand. It could cycle between inflationary and deflationary.
There are many projects that are working towards this exact thesis, but I'm only going to cover one here. Meet the proof of concept: Ampleforth.
Ampleforth is a supply elastic stablecoin. Let's take those terms one at a time.
Supply elastic: The AMPL Protocol uses an Oracle to aggregate 24 hour volume weighted price of Ample and then will automatically adjust supply in response to demand. When the price per Ample is too high, the protocol automatically increases the supply of Ample. When price of Ample is too low, the protocol removes Ample from the system. This is called rebasing.
AMPLE is also non-dilutive. This means that while the supply expands and contracts in response to demand, the percent of total Ample you own never changes. For example, if there were 100 Ample and you had 10 of them. A 10% increase in supply to match increasing demand means you now have 11 of the 110 Ample. The supply will rise and fall, but your percent of the total amount of Ample will never change.
Stablecoin: Ampleforth has a target value of 1 Ample:1 USD (2019). This means it uses the CPI to calculate what the 2019 dollar was worth compared to today's and sets its target price to that. Keep in mind, Ampleforth is technically an unstable-stablecoin because its price will go through some cycles up and down, it is not perfectly stuck at $1.00 as many dollar-back stablecoins are. But, it will always work back towards the target price equilibrium.
Here are the details on how this works. Every 24 hours, the AMPL protocol checks the current price of Ample. If it is within 5% of its target peg, the protocol does nothing. If the price of AMPL is outside of the target range, the protocol will begin a 10-day period of supply adjustment. This means everyone who owns AMPL will see the amount they own change. Remember, it's non-dilutive so everyone still owns the same % of all AMPL they did before, it’s a different amount than before.
Keep in mind Ampleforth is just a proof of concept. At time of writing, its market capitalization is around $300 million with 294 million AMPL. In future models of supply elastic currencies, the peg, how drastic the response can be, and any other aspect of Ample can be changed to be even more efficient, fair, and stable.
This responds to the weakness of deflationary currencies that are vulnerable to economic slumps and low aggregate demand. On the other hand, it doesn't increase in value so there's no point in hoarding. Rebasing means holders of the currency don't have to immediately swap their cash into assets, causing an asset price bubble like modern inflation does. People can't hoard it as a store of value. In fact, theoretically you could program inflation into the stablecoin where it changes its peg to debase itself against an asset over a period of time.
CENTRAL BANK vs. AMPLEFORTH
To illustrate the advantages of elastic supply, we can compare how the two respond to inflationary/deflationary incidents with a medieval example. Pretend the villagers in Ampleland are shockingly developed and have access to Ample.
Let's start with the central bank economy.
In Dollarland the King controls how many dollars are made. The King isn't a bad man, he truly loves his citizens and wishes the best for them. In Dollarland, Rich Jill has 1,000 dollars and the 100 villagers have 1,000 dollars split between them evenly. As the villagers begin to have babies, buy new products, and save for future retirement it becomes clear that there isn't enough money in the system. While Apples at the beginning of the century cost 1 dollar, they now cost only 50 cents. Rich Jill and the villagers see the dropping prices and begin to save more and more of their money, hoping they can buy more apples with it in the future if they just live frugally now. This deflation is smothering the economy as no one is spending anything. People are living in poverty. The King sees that Dollarland is in trouble and wants to help. He knows that increasing the supply of dollars will get things running again, so he sends 1,000 dollars to the Bishop of Dollarland to distribute these dollars through loans to the people.
Now, Rich Jill is a clever woman. She hears from her friends at court that the king is sending more dollars to the village. She knows that when the new dollars arrive the dollars all the villagers are saving will be worth less, since there are so many new dollars for everyone to use. She realizes that apples will probably end up going for 1.2 dollars instead of the .50 they are. So instead of holding on to her 1,000 dollars until they lose value from the new money, she starts buying up as many apples as she can to sell back later when people have more dollars. After Jill buys up a few dozen apples, the villagers start getting curious--nobody has been buying this many apple for years!
Soon after, a messenger from the king arrives informing every one of the good news from the King. 1,000 Dollars are on their way, ready to get the economy running again. The villagers also don't want their savings wasted compared to the new dollars, so they start buying apples too. Pretty soon, the price of apples has risen to .75 a dollar before the King's money has even arrived. Now, when the King’s money does arrive, everyone is scrambling for a loan to immediately buy apples so they can sell them for more dollars later.
The Bishop doesn't want to see anyone go hungry, so he charges the people only 1% interest on his dollar loans. Everyone in the village now has more Dollars and the price of apples rises to 1.2 dollars. And then 1.3 dollars. And then 1.4 dollars. So many people are buying apples so they can sell them later when more money comes that it's driving up the price. 2 dollars, 4 dollars!
The economy has gotten moving again and that's good, but the King realizes they have a problem. So many people are buying apples to guard against inflation that normal poor villagers can't afford enough apples they need to live on. At first the king tries to solve this by sending more money, but that only makes the price of apples rise even higher. Rich Jill is doing better than anyone because she can dedicate 90% of her dollars to investing in apples and use the other 10% to buy things she needs. The poor villagers on the other hand need to spend 90% of their dollars to afford food to eat. They're getting left way behind as more money comes in, it's Rich Jill who can afford the Apples before anyone else. Just rumors that the King might be sending more dollars sends the apple buying market into a frenzy.
At 5 dollars an apple, the King realizes they need to stop sending so many dollars. The Bishop comes up with the bright idea of raising the interest rates on the loans they gave out. They raise the rates to 3% and all the villagers realize they need to get dollars back so they can repay these more expensive loans. Everyone starts selling apples, which causes the price to sharply drop. Apples down to 3 dollars. The Bishop raise rates now to 5%, the price of apples drops more and more as the demand for dollars replaces demand for apples.
Eventually, the apple is back to costing just 1 apple just as it was before, but let's look at what has changed. The Bishop and Rich Jill have almost all the dollars. Rich Jill with her savvy trading and high disposable income was able to profit proportionally much more off volatile apple prices than the low-income villagers who needed their dollars to pay for college and rent. The 100 villagers who used to collectively own half of all dollars now own only a fifth of all dollars.
Let's look at how a supply elastic currency like Ampleforth handles these issues of inflation and deflation.
Here's an example of savers removing money from circulation (deflationary effect) and apply it to Ampleforth. In the village of Ampleland 1 Ample is pegged to 1 Apple. When 1 Ample = more than 1 Apple, the system adds more Ample to people’s account. When 1 Ample = less than 1 Apple, Ample is removed from everyone's account.
Now Rich Jack, has 1,000 Ampleforth and the rest of the village has 1,000 divided equally between the 100 of them. Now Rich Jack wants to stow away his wealth so it will grow for just himself instead of investing it in the village. Now 1,000 Ampleforth that was being used to buy goods at the fair from the peasants is out of circulation and locked in his castle. There isn't enough Ample to go around. This is a deflationary shock. People are now only charging .75 Ample per Ample. People don't have enough to go around.
The Ampleforth program sees that .75 Ample = 1 Apple and initiates an adjustment. Soon, everyone has 10% more Ample in their accounts, yes even Rich Jack. But, this increase in supply means there's now 1,100 Ample in the village, vs the 1,1000 locked away in Rich Jack's Vault. People now have more Ample, they can afford to buy Apples again and soon 1 Ample = 1 Apple again. The program handled the supply shock of half the supply being removed from circulation.
What happens when Rich Jack decides he'd like to buy up all the Apples for himself so he can sell them to the peasants at a profit? After all, the village economy has gotten used to operating at a supply of 1,100 Ample. What will happen when Rich Jack comes back? He starts buying and buying and soon this makes the price of Apples rocket to 2 Ample = 1 Apple. This is terrible for the poor village folks who only have 11 Ample each. The Ampleforth program sees this inflationary shock. Over the next 10 days, Ample takes away from all accounts equally. Soon, Rich Jack is down to 1,000 Ample and realized he can't keep paying 2 Ample for one Apple--he'll go bankrupt. Everybody is back to the same Ample they had before. AMPL successfully responded to both inflation and deflation.
Some key differences between the two systems.
1. Ampleforth is more fair
The system didn’t result in more wealth being concentrated at the top. All holders of Ample were affected equally by the changes. Even if savers try to increase the value of their Ample by hoarding, the protocol immediately begins to devalue their wealth by distributing more Ample. There’s no scenario where being selfish is advantageous and those that own assets aren’t as fair ahead as they are with the dollar.
2. Ampleforth is more stable
The AMPL protocol is predictable, public, and very simple. Everyone can know when a change is coming, how much of that change is coming, and how it affects them. There’s no guessing game on interest rate changes and no asset bubbles from the crowds fleeing inflation. This allows stable and sustainable growth that isn’t subject to the necessary busts of inflationary currencies.
3. Ampleforth is more efficient
The response time for Ample is a huge advantage. The Central Bank system is often too slow or too fast to respond to inflationary and deflationary threats. Of course, this is understandable since they work in an institution run by people. People aren’t computers that tirelessly run 24/7. Nevertheless, the AMPL protocol does run 24/7 and is able to rapidly make changes to regain equilibrium.
In conclusion, Ampleforth works as both a store of value and a medium of exchange, something currencies that are stuck as either inflationary or deflationary cannot do. The fairness, stability, and efficiency of Ampleforth merits more discussion and adoption within and outside the cryptocurrency community.
Next week I will cover the issues with supply elastic currencies like Ampleforth and how they might be solved. This will include subjects like Oracle manipulation, accessibility, cross-chain development, and gaining acceptance outside the cryptocommunity. I will also cover the fascinating protocols of Pria and Metawhale and how they fit into the discussion of supply elastic currencies.
To learn more about Ampleforth, visit their website, discord, or github.
Github: Ampleforth · GitHub
Discord: Ampleforth Official (discord.com)
(Thumbnail credit: Ampleforth · GitHub)