Holo Fuel Economics 101

Alastair Ong, Art Brock, Mary Camacho, David Atkinson

In this presentation we will walk through the practical design considerations and components of the Holo fuel system. Holo fuel is the native digital asset of the Holo hosting network. It is designed based on mutual credit principles, and represents a third path to cryptocurrency design that is neither based on the highly volatile design of traditional cryptocurrencies nor imports the US dollar, warts and all, as a stablecoin.

What follows are the slides and speaking notes for a presentation done by Alastair Ong prepared in collaboration with Art Brock, Mary Camacho and David Atkinson.

Welcome. My name is Alastair Ong and I’m part of the Holo team. Today I’d like to give an introductory presentation on Holo fuel Economics.

In this presentation, I will talk primarily about the conceptual design, that is how we want the system to behave and the design choices we make to achieve this. In doing so, the behaviour we are most interested in defining are the economic signals produced under different conditions, and ensuring that these facilitate a healthy ecosystem.

What we care most about is being able to effectively facilitate and record transfers of value across the Holo network, since these transfers of value represent the process by which hosting is provisioned correctly across a decentralised network. To do this, we defined several requirements in the green paper.​

From a technological perspective, we need to be able to handle extremely high levels of micro-transactions, on the order of millions of transactions per day, since that is the nature of of how distributed hosting will be provisioned. This requires cryptocurrency-like technologies, since existing payment networks are not able to handle micro-transactions economically.

From an economic perspective, we need price signals that are both stable AND accurately reflect underlying activity, so that users and hosts can make long term plans with confidence. We assert that this requires a currency that is backed by the hosting capacity of the network.

I would then further assert that making it hosting backed requires agent-centricity, and therefore a cryptocurrency built on Holochain, that is: Holo fuel

Let’s dig deeper into that assertion that we require agent centricity. For Holo fuel to be backed by hosting, hosts either individually or collectively have to always be willing to provide hosting services in return for fuel. This could be done by promising to allow hosts to redeem fuel for something else, but that just means that Holo fuel is backed by something else, e.g. gold, and then the economic signals within our Holo network are driven by gold’s economic signals rather than hosting.

To make it truly hosting backed, Holo fuel should be created through lending to hosts. In this way hosts will always demand Holo fuel, since they need it to pay back their debt. It also means that new Holo fuel is generally created when the network can produce more hosting, and vice versa. This is in fact how modern money works.

If we want to lend to hosts, we must understand how credit-worthy they are and be able to enforce it. Doing that requires agent-centricity since it requires understanding the identity of nodes participating in hosting. At this point I want to point out that while this requires the removal of anonymity from hosts, that is needed anyway to comply with global AML/KYC regulations.

As an added advantage, Holo fuel created in this way is more likely to be actually used, since a host wouldn’t take a loan if they didn’t intend to use it for something

Now that we understand why we need an agent-centric Holo fuel, let’s talk about how it works in practice.

As we’ve already discussed, Holo fuel will be backed by hosting in that holders of Holo fuel can always redeem it directly for hosting services on the Holo network, and the issuance of Holo fuel is decentralised to individual hosts decisions on when to borrow Holo fuel. In addition, we make 2 other practical design choices.

Firstly, we intend to implement a cap on the overall amount of fuel that can be created, proportional to the hosting capacity of the network. We do this to manage the overall risk exposure in the system and to ensure that the value of each individual unit of Holo fuel cannot be inflated away by hosts working together.

Secondly, we implement special accounts called “Reserve Accounts”. Reserve accounts add structural resilience by amplifying certain economic signals from hosts and acting on their behalf to sell/redeem Holo fuel, influencing price and supply in the process. It is important to understand that reserve accounts do not “manage” Holo fuel since that implies some form of agency and an objective function of sorts.

Reserves are accounts that can sell Holo fuel against their credit limit as long as three conditions are met: first, the total amount of Holo fuel is below a system-wide cap. Second, the amount of recently sold Holo fuel is below a periodic cap. And third, they have to receive an accepted reserve currency such as USD or BTC.

​Anyone can buy Holo fuel at a reserve account, but only Holo fuel earned through hosting can be redeemed there. This creates a circular flow where new Holo fuel bought from a reserve enters the general circulating supply until it is spent on hosting. At that point a host could either sell it on an exchange or redeem it, depending on pricing. If they sell on an exchange they still keep their receipt of hosting so they can redeem Holo fuel at a reserve later.

The first reserves will be created by Holo. This is done purely for practical reasons. First, reserves need liquidity to function well, so we want to ensure that critical mass is achieved before additional reserves are created. Second, there will be a regulatory complexity involved and we want to clarify these on behalf of the community first. Third, reserves obviously have systemic impact by design, so we need to be careful with the roll out.

The Holo fuel price at a reserve is a critical management variable since it acts as a stabilisation price. Reserves do not have agency and act on behalf of hosts. Therefore the price on the reserve accounts will reflect the pricing preferences of hosts. Specifically, hosts are able to set their personal floor price for Holo fuel in their management software. So for example a host could set it so that Holo fuel will not be redeemed below $0.1. Reserves will collect data on all hosts individual floor prices and then set a reserve price, for example top quartile pricing. This price would of course refresh to take account of new data. There may be additional feedback loops. For example if Holo fuel is consistently sold out on reserves the price could automatically increase.

​In contrast, Holo fuel is redeemed based on LIFO prices, or the most recent price it was bought at. This ensures hosts receive a price that is close to market/spot. It also means that all fuel from a reserve is fully backed and that we are not artificially propping up prices.

​Finally, reserves do not replace exchanges, since only fuel earned from hosting can be redeemed.

I want to quickly consider how this pricing works in an extreme case of there only being a single host. In a single host situation, the price of Holo fuel on the reserve is exactly the same as the price from a host directly. Therefore from a price perspective there is no difference between new Holo fuel issued directly by a host vs on an exchange, except that a reserve is preventing a host from unilaterally refusing to sell Holo fuel. Extending that to the community generally, reserves represent the hosting community as a whole, but also prevents them from blocking Holo fuel’s dynamic supply

​​

Here’s a simple example of how LIFO works, using numbers that are easy to deal with.

​We start with an empty reserve account that currently sells Holo fuel at 75 cents each.

Now someone decides to buy 100 Holo fuel for $75

There is now $75 in the account and the redemption price is 75c.

Let’s say that the market changes and the price of Holo fuel on the reserve goes up to $1, and now someone else buys 200 Holo fuel at that price.

​The redemption price is now $1

If we assume no further Holo fuel is sold by this reserve, hosts collectively can redeem up to 200 Holo fuel at a price of $1. At that point the price will fall back down to $0.75 and there will be 100 Holo fuel available. If that 100 Holo fuel is then redeemed, the reserve account is empty and no further fuel can be redeemed at this account.

The reason why we implemented these reserves is to add structural resilience and ensure that Holo fuel is an effective tool for facilitating hosting. In particular, it helps solves several major problems.

​As shown in the example a slide back, hosts could choose not to draw against their credit limits. In the absence of reserve accounts this creates a credit freeze effect that prevents the supply from being dynamic. This increases volatility and may also make it difficult for users to get hold of Holo fuel.

​It also helps us ensure that Holo fuel is driven by hosting dynamics. Reserves allow anyone to buy Holo fuel for any need, including non-hosting needs. This allows the supply of Holo fuel to adjust to non-hosting use. However, since reserve pricing is always linked to hosts, any supply change is still based on those host dynamics.

​Finally, it reduces volatility of Holo fuel prices, which makes it easier for our ecosystem to make long term plans.

The result of these design choices is that the supply of Holo fuel is affected by the maximum potential supply or credit extended, and the actual usage of that credit.

The max supply of Holo fuel is controlled algorithmically by the network’s code. This is analogous to how Bitcoin or Ethereum’s supply is based on a block reward algorithm but clearly more complex since Holo fuel itself is a more complex, dynamic system. The management algorithm will set a “credit factor” that extends credit and allows hosts to spend to a negative balance, based on their track record. It will also use network statistics to set the Holo fuel price on reserves and the amount of Holo fuel available. We will cover how prices are set later, but as I said in the last slide it is a reflection of hosts preferences.

Within this maximum, the actual amount of circulating Holo fuel at any point of time is driven by 3 things:

​First, the Holo organisation has a credit limit that can be drawn down to fund network development and is backed by the network transaction fees that we collect. We used this credit when we sold HOT during the ICO, so the Holo org’s debt right now equal to all HOT in existence — or more accurately will be equal to the amount of fuel once HOT is swapped.

Secondly, hosts themselves can spend on credit, which they may do to finance new hosting, if they think that prices are too high, or many other reasons.

​Finally, reserve accounts can sell Holo fuel on credit, in exchange for funds (e.g. USD, BTC) which will later be paid to hosts who have provided hosting and want to redeem their Holo fuel.

​Holo fuel use that does not result in changes to borrowing, including trading on exchanges, does not change the supply.

In this next section we will talk about some of the factors that influence fuel prices. I want to reiterate that nothing here constitutes price predictions, guidance, or investment advice. All prices and price movements discussed are chosen purely to help communicate Holo fuel economic concepts effectively.

​In addition, we also discuss an abstract “unit of hosting”. In reality there will be no such thing. Rather, there will be prices for different hosting-related services such as prices for CPU-hours, network bandwidth, and storage, and that there will not be a single price, but different prices for different tranches based on hardware specs, geography, certification, reliability, and so on.

When thinking about Holo fuel and prices, there are 3 different things to consider:

​First is the actual hosting price offered to users on the network. For the foreseeable future this is denominated in terms of USD or other national currency per unit hosting. This is the price that both hosts and users most care about most since it host’s costs will be in national currency, and most competition such as AWS is also denominated in national currency. The price of hosting is driven by typical supply-demand dynamics.

​Hosting price is the product of two other factors — Holo fuel price and Internal Price.

​The Holo fuel price is the price to buy/sell a unit of Holo fuel on either exchanges or reserves, while the purchasing power is the internal price of hosting denominated in Holo fuel — for example, 1 fuel per hour of hosting.

​The Holo fuel price and purchasing power are primarily impacted by internal competition and supply dynamics. For example, price competition on the network is in terms of internal price because Holo fuel price is universal. Therefore if there is intense competition between hosts the internal price will fall.

Let’s delve deeper into the hosting price dynamics. Since the price of hosting is driven by supply and demand, it is ultimately driven by adoption and innovation. Let’s look at a few examples.

​The chart shown here shows prices on the Y axis and quantity of hosting on the X axis. We have a demand curve D1, where the quantity of hosting demanded increases as price falls, and a supply curve S, where quantity of hosting supplied increases as price rises. The equilibrium situation happens where the two points cross, and Q1 amount of hosting is supplied and used, with a price of P1.

​If holochain adoption grows then more hosting will be demanded at the same price, shifting the curve from D1 to D2. A similar dynamic would happen if Holochain-based projects are more profitable, since they can then pay a higher price for the same amount of hosting. When the curve shifts from D1 to D2 the new equilibrium price is P2. As prices increase to P2, new hosting capacity will join the network since it will now be profitable for them.

​Conversely, if network efficiency improves then hosting hardware can provide more hosting. For example a single HoloPort might be able to host twice as many apps. If this happens then the supply curve S would shift to the right, the new equilibrium price could be lower, and this would attract more demand.

​However, this increase or decrease in hosting price does not automatically translate into fuel price movements. This depends on network-specific dynamics.

Ok, so at the end of the last slide we looked at how an efficiency increase would decrease the price of hosting, all else being equal, since there is more competition. However, there’s another dynamic going on which is the internal competition between hosts on the network.

​Imagine if efficiency increases doubled the effective capacity, and as a result let’s say the new equilibrium price of hosting is 25% lower and there was 50% more demand. Internally hosts would have 100% more capacity chasing 50% more demand, so competition would be really aggressive. In this scenario hosts would keep dropping their internal price, say from 10 fuel to 9 fuel, to 8 fuel, and so on, in order to get more utilisation. This is because they individually don’t have significant control over the price they get for Holo fuel.

​What’s the floor for the internal price? The floor is the breakeven price. So in this case where efficiency means that hosts can provide twice as much hosting for the same hardware the breakeven price would be half the previous one, as long as Holo fuel prices stay static.

​So if total hosting price was 25% lower but the internal price can fall by half, then Holo fuel price would go up by 50%. Of course, this creates a second order effect where because Holo fuel prices are now higher, hosts can push the internal price even lower, which again pushes Holo fuel prices up, and so on, until it reaches a new equilibrium.

​Now these numbers are all illustrative, but the takeaway is that a key driver is how much the internal price changes vs. the price of hosting.

​The other dynamic is the price signal from the reserve price. Since anyone can buy Holo fuel at the reserve price, and hosts can redeem at that price, the reserve price acts as a stabiliser that prevents the Holo fuel price from moving too fast. So going back to our example, the internal price may initially fall by 25%, but aggressive hosts may push it down further, while setting minimum Holo fuel prices (and taking the risk of having to hold). This will nudge Holo fuel prices up, and the cycle continues.

The other factor involved is the supply dynamics of Holo fuel. We have mechanisms that create a dynamic supply in response and counter to economic signals. Generally speaking, we want supply of fuel to expand when prices are going up and to contract when prices are going down, so that price changes are in response to underlying needs rather artificial scarcity or overabundance.

​Generally speaking, we expect market prices to move faster than reserve prices, so when prices increase, they will be higher at exchanges vs reserves, and vice versa.

As a result, there are several passive mechanisms in place that automatically incentivise counter-cyclical supply.

​The other factor is velocity, which we don’t consider in detail in this document. Generally, we would expect velocity to amplify price movements. For example, as prices increase it creates deflationary pressure and incentivises users to hold Holo fuel longer, effectively taking it out of general circulation.

We think Holo fuel represents a sea-change in digital asset design by enabling a decentralised, dynamic system that tends towards stability while being driven by its own internal economic needs. We achieved this through several key innovations that we think can be leveraged by others.

​First, Holochain’s high TPS and agent-centric approach allows more responsive, accurate, and targeted supply management from a technical perspective. For example being able to understand each node’s earnings history and redemption preferences.

​Second, the reserve design enables the system to target which economic signals to listen to, without becoming an actively managed system that creates space for arbitrary human decision-making or worse. While we use it to “listen’ to hosting needs specifically, there is no reason reserves couldn’t be designed to be responsive to other signals.

​Finally, since there is no PoW, PoS, or interest payments on Holo fuel, the Holo fuel system does not favour centralisation.

We’ve now reached the end of this presentation. Thank you for listening (or reading), and I hope it’s been helpful.

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