Value Creation in WeiDai
Part 1: The Burn Externality
If you missed the announcement, WeiDai is an ERC20 wrapper of Dai designed to protect it from inflation. It belongs to a new type of stablecoin known as a thriftcoin because it is ideally suited for savers.
Redemption
A global redeem rate determines the price at which WeiDai can be created and redeemed for Dai. The redeem rate is simply the ratio of Dai in reserve to WeiDai in circulation. If one of those numbers changes, the redeem rate automatically adjusts.
WeiDai can never be created without the required Dai input. This means that whatever the redeem rate is at a given point in time, there is no way for it to be reduced.
Burning Mechanism
WeiDai can be burnt without being redeemed. This reduces the circulating supply without affecting the reserve of Dai. This of course would push up the redeem rate. Putting this together means that the redeem rate can only ever stay the same or increase. This at once confers the stability of Dai on WeiDai by protecting it from downward volatility while offering it the chance to grow in value.
Burning as a positive externality
Suppose Alice and Bob each own 10 WeiDai and that the redeem rate is 0.5, meaning that the value of each is 5 Dai. For this example suppose that Bob and Alice are the only owners of WeiDai which means the total supply is 20 and the total Dai in reserve is 10. Bob decides to burn 4 of his WeiDai. The total supply is now 16 and the Dai reserve is still 10, implying that the redeem rate has now risen to 0.625. At this new rate, Alice’s 10 WeiDai are now worth 6.25 Dai and Bob’s remaining 6 WeiDai are worth 3.75 Dai. Note that the total Dai value of the WeiDai hasn’t changed.
Bob has incurred a private cost and is 1.25 Dai poorer. For his efforts, he has made Alice 1.25 Dai richer. Suppose there were more WeiDai holders in this scenario. Bob would have benefited all of them through his burning. If people like Bob continually burnt WeiDai, everyone else would benefit from a rising redeem rate. Unfortunately Bob has no incentive to burn. When the actions of one group benefit a third party as a consequence, we have a situation economists refer to as a positive externality. If we could have some way of creating an incentive for Bob and others like him to burn, then the WeiDai community would benefit. Unfortunately, compensating Bob for his lost WeiDai with the original amount would be fairly pointless so there needs to be another way to benefit Bob without just shuffling the deck around, so to speak.
This is a two part article examining the economics of WeiDai. The first part will explore the process of bringing about a constant burn (increase in redeem rate) in the WeiDai ecosystem by internalizing the burn externality in 3 phases of maturation. The second part will outline the economics of thriftcoins in general and why they promise to bring a new level of productivity growth and efficiency to the economy as a whole.
Phase 1: Genesis
When designing WeiDai, one of the central aspects emphasised was the importance of rewarding a culture of saving for the future. In a world where credit is cheap and savings vehicles are tepid, the virtues of saving for a rainy day, for retirement, to achieve a personal goal or just for the thrill of knowing you’ll have more money in the future have been undermined by systemic incentives that make it at times irrational and self harming to save. Traditional cryptocurrencies do reward patience but in a dramatic step function. That is, below a certain period of time, saving by holding Bitcoin is highly risky but once your window exceeds about 4 years, it becomes the best possible investment choice you can make. This is because from moment to moment, day to day and month to month, Bitcoin goes through some wild price swings but if you bought at the peak of the 2012/2013 boom and sold at the trough of the crash in 2019, you’d still have made a massive profit. Unfortunately, the ability of people to sit on large mounds of savings for large periods of time is proportional to their income. This creates a natural barrier to entry for achieving financial independence that is almost impossible to overcome below a certain income level and might add to the explanation for why so many Bitcoin millionaires are young males with few or no family responsibilities.
Note that in the above diagram, the threshold becomes shorter in time the more inflationary your national currency which is why hyperinflation is the greatest marketing device for Bitcoin.
Thriftcoins have the twin properties of being stable relative to the reference currency while offering a mechanism to grow in value. Ignoring fixed costs such as gas fees, thriftcoins are a safe bet the moment they’re bought, even if they don’t experience the radical upside of Bitcoin. For those who live from paycheck to paycheck, this is the perfect way to save from moment to moment without losing sleep over financial market perturbations.
In phase 1 of WeiDai, the creation and redemption of the token were crafted to transfer maximum reward from those who hold out and wait from those who are impatient. However, unlike Bitcoin, this gradient is linear so that the more you wait, the more you benefit and doesn’t require a multi year threshold before becoming rational. To understand the deeper mechanics of how this is achieved, see this article.
Phase 2: Governance
The four core smart contracts of WeiDai are autonomous and do not require day to day intervention from human actors. However there are a few governance decisions that need to be made. The most important is handling the upgrade process. MakerDAO is set to release a new multicollateral version of Dai and for this reason, the old Dai contract will eventually be disabled. When this happens, WeiDai will disable the creation of WeiDai with old Dai. Only redemption will be possible. Only once users have redeemed their old Dai, can they participate in creating WeiDai with their balance of new Dai. Unfortunately the new Dai address has to be manually inputted as a call to the VersionController smart contract. In the future, the plan is to hand over all of this functionality to a DAO so that the system can continue in perpetuity without the presence of a central human actor.
Instead of going with a boring majority-vote DAO, the intention is to develop governance games that will be both enjoyable for WeiDai holders and will encourage burning of WeiDai in order to gain permanent governance privileges within the system. The governance games will be trialled first and should be enjoyable regardless of the governance decision made so that outsiders completely disinterested in WeiDai would still desire to participate without their disinterest negatively affecting the operation of the dApp. The games should also be designed to encourage and reward thriftiness in the players. The games are expected to attract more users to the ecosystem and to bring about fairly regular burns. Both the presence of new WeiDai holders and the activity of the governance games should act to increase the redeem rate fairly regularly.
The final step in phase 2 will be when decentralized exchanges begin to host WeiDai. At this point, users who don’t wish to wait for the Patience Regulation Engine can buy WeiDai at a premium from users who are willing to wait it out. The difference between the open market price and the redeem rate will effectively represent a patience premium that patient users can exploit for time arbitrage profits, further increasing the churn and burn.
Phase 3: Opportunity Cost as a Service
Once a semi regular burn is achieved, new use cases come online that were not possible when the redeem rate was not as likely to go up. One example of such a use case is a lossless lottery such as Pooltogether. In Pooltogether, users stake Dai in a pool in return for lottery tickets. The Dai is collected and converted to cDai which gains interest. After 3 weeks, the cDai is converted back into Dai and the ticket holders all receive their original principal Dai. One randomly selected ticket holder receives the entire interest earned. The result is that no one loses but one person wins. This model can be applied to many other areas such as crowdfunding of public goods, governance applications and microtransactions.
In traditional purchases, the entire principal is lost to the purchase. An accountant would say that the cost of the purchase is the money spent. An economist would say that the cost is not just the money spent but also what the money could have earned as the best possible investment had it not been spent. For instance, if you have $100 and you could earn 10% interest on it but instead purchase a widget for $100 then the full economic cost to you is the (100 + 10=)$110. This extra $10 dollar portion is known as the opportunity cost because it was the cost associated with the lost opportunity of foregone interest.
The lossless lottery model is only lossless in accounting terms because your principal is intact but in economic terms you lose the opportunity to invest you money elsewhere. If 1 Dai can earn you 0.01 Dai of interest on Compound.finance in 3 weeks and you enter Pooltogether and don’t win then the extra economic cost of entering in addition to the acounting cost was 0.01 Dai which is just the opportunity cost. This is why a more accurate name for a lossless staking system of this nature is “opportunity cost as a service” because the opportunity cost of multiple users are tapped in order to achieve the funding of a private or public good.
Since phase 2 ushers in regular burning, not holding WeiDai will be associated with an opportunity cost. This means WeiDai can be used as the backing asset to achieve opportunity cost as a service dApps. For instance, imagine a crowdfunding platform where users stake Dai on projects they like. In the background, the staked Dai is swapped for WeiDai at the prevailing redeem rate. When any user wishes to unstake their Dai, a portion of WeiDai equal in value to the original staked Dai portion is redeemed for Dai and sent to the user. If the redeem rate has increased during the interim, this means that there will be some WeiDai left over in the crowdfunding contract. When the funding round ends, all of the left over WeiDai is redeemed and given to the project as funds raised. No one loses any Dai but projects are funded by pooling the opportunity costs. The crowdfunding dApp could add another step and burn a portion of funds raised before handing over in order to give a further bump to the redeem rate and thereby benefit the other projects still in funding phase as well as all WeiDai holders.
It is hoped that as multiple dApps are rolled out, WeiDai will act to improve the overall savings rates in the economy and will provide a mechanism for those with uncertain financial circumstances to save, reducing both asset and income inequality in the economy at large. Beyond the immediate benefit of increased private savings, there are secondary effects that thriftcoins like WeiDai will have in further boosting the productivity in the broader economy, the exploration of which can be found in part 2.
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