Introduction to Virtual Deposit Contracts (VDC’s) — A Revolution in Cryptocurrency
The recent explosion of Ethereum Virtual Deposit Contracts (VDC’s) has flown under the radar in professional circles — and not for good reason. If you are not already familiar with VDC’s, this article will serve to as an introduction.
Smart Contracts?
Consider first a smart contract, because a VDC is nothing more than an application of its technology. Blockchain platforms like Ethereum, EOS and Cardano provide Turing-complete scripting languages with which it is possible to digitally enforce a contract between two parties. In doing so the contract is immutable (meaning the parties cannot renege on their commitments by altering the code) and optionally transparent; it can be guaranteed that the contents of the contract are known to the whole world, minimizing uncertainty if it is a public contract with which any address can interact.
The benefits of these smart contracts living on the blockchain as opposed to some generic Software Development Kit are multiform. Access to the wide network of the blockchain’s assets is ensured, and decentralization ensures the contract’s immortality and security — for example, no longer will a simple DDOS attack on the smart contract’s UI threaten its use, as the application resides on the blockchain itself, not a web server.
VDC’s?
So what the hell is a VDC? It’s simply taxonomic, a term used to classify tokenized smart contracts which are their own exchanges. There is no need for Binance; nor a necessity to conform to the ERC-20 specification to be traded. The exchange is coded into the smart contract itself alongside the features of the token, or tokenized asset, to be traded.
There is a subtle tinge of revolution here. No longer do the mechanics of an exchange have to be determined by the brute forces of supply and demand! Instead, what typically occurs is that VDC’s are coded in such a way as to burn tokens when they are sold, and generate tokens when they are bought. The supply is now the direct determinant of the price, as opposed to an indirect variable of influence on it. See, in typical exchanges, the “price” of a cryptocurrency is equal to the lowest price of all accumulated limit sell orders. If this sounds obtuse, its only consequence is to mean that the price only moves when there is the corresponding volume to move it; clearly, when sell orders more abundant than buy orders, the price will plunge, and vice versa.
What’s Wrong With Traditional Exchanges?
The limitations of this “laissez-faire” design are two, in the main. First, it is not possible to trade a given token without sufficient volume to match your bid with an ask, or ask with a bid. Low volume exchanges are high latency — it takes a long time for sizable token orders to be processed through the market, as many cryptocurrency traders have no doubt experienced with obscure exchanges or the markets for low-cap cryptocurrencies.
Second, given the token’s supply is constant, its price is always linear with market capitalization. To illustrate with an example, if ten times the buy volume enters the market for a token and there is no change in the frequency of sell orders, then the price will be observed to have multiplied by ten.¹ This locks the token into a price function (the algorithm that determines how price responds to buying and selling) which has at best questionable merits. After all, linear price functions risk producing a grotesque amount of value for early investors, undermining the blockchain’s central promise of decentralization by funneling financial power to a few. Satoshi Nakamoto, for example, famously has 10% of the Bitcoin supply, and Bitcoin’s price is almost exclusively linearly determined. While the ghost of Adam Smith may smile at this approach, it is evidently sub-optimal without even the possibility of non-linearity.²
The Solution?
Flexibility is the offering of the VDC which is most valuable. The solution to the volume conundrum is to guarantee purchases are executed as soon as they are ordered, by an automated mechanism which burns and creates tokens on demand, as suggested earlier. And their simple resolution of the “linearity conundrum” is to allow engineers to directly manage their price functions, by virtue of Turning-complete languages and their dexterity in simulating all sorts of mathematical algorithms. The ability to code is the ability to innovate.
VDC’s create mechanical markets rather than organic ones. No longer does a tenfold increase in capitalization tend to correspond with a tenfold increase in price, and the price function could reasonably be logarithmic, exponential or polynomial.³ Real-life VDC’s, like P3D and Zethr, are of the latter type.
A closer look at these popular real-life examples serves to illustrate the VDC’s utility. P3D uses an inverse-cubic price function to power its network of decentralized games, games which contain transaction fees directed towards P3D holders. The Ethereum collected through the fees is used to purchase tokens through the P3D VDC, distributing “dividends” to P3D holders. How? Every P3D buy or sell is taxed at a rate of 10%, and the tax earnings are distributed to P3D holders proportionally. By any account an immensely successful economic model — the associated “3D ecosystem” has accommodated the most popular dapp on Ethereum, the psychological lottery Fomo3D. Zethr works similarly, with a flexible deposit tax chosen by the user, and a dapp ecosystem themed around casino gaming.⁴ Not only can one purchase P3D and Zethr tokens whenever it is so fancied, but as a result of their functions (which decrease the rate at which price increases when larger amounts of Ethereum are deposited), they are perhaps the most decentralized tokens in cryptocurrency, with developers and early investors holding a comparatively small share.
Conclusion
It is certainly a leap of faith for developers to sacrifice enriching themselves for a better user experience. But without the VDC idea, no one could take the leap anyway. Indeed, diminishing price functions offer benefits not even touched in this article — not as to undermine them but for a lack of space. At high levels of deposited funds, for example, token price stabilizes, rendering the token usable for its intended purpose without the disincentive of price volatility. Perhaps a detached VDC is the “stablecoin” Vitalik Buterin has assiduously wondered about.⁵ Their utility is clear, and it should be expected that their role in the cryptocurrency ecosystem will only increase as time does.
Notes
¹ This is not a steadfast observation. Market capitalization is a fictional number (obtained by multiplying supply and price), and the existence of unpossessed but supplied coins can mislead investors, as they are taken into account with this equation. A high-level elaboration of why this is can be found here.
² It is, of course, possible to code a smart contract which acts as a decentralized version of the exchanges alluded to above, with a linear price function. They exist in the form of IDEX, and are an upgrade to traditional exchanges by mere virtue of their existence on the blockchain.
³ Discontinuous and non-differentiable combinations of non-linear and linear functions are also reasonably foreseeable.
⁴ Zethr’s price function is inverse-square with a price floor, a more complex relationship than P3D, and summarized in this and this graph.
⁵ One of the problems with VDC’s is that they are “attached” to underlying crypto-assets which are traded in the standard, linear way, breeding volatility. The intention here is to imagine a blockchain and its associated token which is not.
