Decentral banking with HEX

The complex game theory elements of HEX can give rise to use cases beyond the nominal use case of blockchain certificate of deposit that is encoded in the smart contract. Here is described a potential emerging use case that may be the most promising blockchain application for changing the world as we know it. The ambition is to demonstrate that HEX has potential to replace central banking.

Central banking

Central banks run the monetary policy concerning a specific currency. They mint money, they set interest rates, they give concessions to commercial banks, and set banking regulations. However, central banks are institutions with political and/or economic agendas that may or may not be aligned with interests of the people using their currency. By their nature, central banks are not only centralized, but also antidemocratic, and in some countries under oligarchic control. 

On the first glance, it may appear at least some of these functions could be replaced by blockchain solutions, but just the technology is not enough. Change requires a new and improved narrative rooted in the paradigm that collectively aligned actions lead to a better outcome than what individuals having a totalitarian control over a central banking system can produce. However, narratives live and die depending on how useful and archetypical they are, and how well they fit the game.

Hexican monetary policy

The nature of HEX staking is amazingly well suited for decentralizing the power for minting new coins and regulating the supply issuance. New coins can be minted exclusively by stakers. As a collective, stakers have sovereignty over monetary policy, but as individuals they are bound by the rules of the game theory integrated in the smart contract. 

The total supply of HEX inflates by a maximum of 3.69% each year (based on theoretical daily compounding by 0.00974%). In practice, this value is somewhat lower, because the inflation basis (the total supply) lags from the delay in minting the credited interest (only ever minted coins get included in the inflation basis, so daily compounding does not apply). In fact, even this total supply inflation is affected by staking behavior and presents its own sublayer of game theory. It is expected that the actual total supply inflation will most likely range somewhat below 3.60%, rather than ever reaching its 3.69% maximum. Bitcoin had a similar average supply inflation during the 2016-2020 period. Any supply inflation significantly higher than that may cause a value collapse, while lower inflation may result in loss of economic incentive and the inability to use a currency in a growing economy.

A crucial mechanism in the HEX contract that equilibrates the banking powers of stakers is the system of HEX shares. This is possibly the most innovative aspect of HEX that counteracts circulating supply inflation. One can either accrue more minting power by staking big, or by staking long. Staking longer is inherently more risky due to volatility, but the risk is strongly offset by bonus shares obtained for longer stakes and even much more so by the deflationary nature of total shares. In practice, this means a less wealthy staker can achieve equal banking powers by investing more time rather than more value.

Fractional reserve banking is not endogenous to the HEX contract. In traditional banking, certificates of deposit are used for fractional reserve banking to print several fold higher amounts of new money since day one of the deposit. In contrast, staked HEX cannot be used to mint more HEX before stake maturation and even then only principal and interest can be minted. Stakes cannot be sold or trustlessly used as a collateral, as the contract does not allow transfer of stakes. 

Technological basis

Decentral banking is an amazing use case of code immutability that cannot be attained by any other means. A blockchain client code only allows for data immutability (e.g., transaction records), while the rules in a client code that runs the network have to be socially enforced (rules such as the consensus protocol, miner rewards, supply cap, etc.). Collusion resulting in change of rules is always a risk to consider. Attempts at collusion generally end up in so-called forks where one blockchain database splits in two and the user base has to collectively decide which one inherits the initial ticker symbol and is thus “the real thing”.

HEX solved this by running on a smart contract on the currently largest and most secure blockchain network, the Ethereum network. The contract doesn’t have an admin key, so there are no switches or backdoors. This allows the immutability of both, the encoded rules and the accounting data (e.g., transactions, balances, stakes, interest). 

While all this assures that no one can ever change what HEX is, it leaves the possibility that someone could try to copy the contract system state into another contract, and this way lure the user base and its network effect to a new set of rules. The HEX contract code is protected through copyright law, but one could obviate law enforcement by writing a new code that performs similar operations. Still, appropriating the system state is made extremely difficult, if not impossible, by the Origin Address mechanism in HEX that can destroy any such “contract fork”.

Also, a proper currency must not be constantly devalued by those who maintain the blockchain network on which the currency relies (e.g., miners constantly dumping its value down). Maintenance costs need to be externalized, else there is no price discovery independent of the cost of the technological basis.

Breaking free of centralized control and social enforcement, code immutability, immunisation against contract forking, and externalisation of network maintenance costs, is thus the basis for such currency to stay functional and independent. Decentral banking was thus made possible only recently with the blockchain networks supporting smart contracts being developed (e.g., Ethereum network).

Delayed inflation and deflation

In HEX, the total supply inflation does not enter the circulating supply directly. Since stakers regulate inflation by several means, total supply inflation in HEX remains only a potential inflation until stakers release it in circulation by minting the credited coins. Alternatively, stakers can deflate circulating supply by burning coins in exchange for HEX shares. 

The major obstacle for inflation hitting the circulating supply is the stake maturation time. All inflation is allocated into stakes in the form of interest, but this interest can only be minted upon stake maturation. Emergency end staking is possible, but the further away the stake is from maturation, the more penalized it gets. Half of the penalties are distributed into all active stakes and cannot be minted until these mature. Only the other half of penalties are minted, but these get minted into the Origin Address which is not releasing coins to the market. By half of penalties being minted into the Origin Address, coin scarcity is increased while at the same time inflation basis is immediately increased to reward all future stakes (causing the so-called “diamond economy” to increase value).

There are incentives for regulating inflation in a value beneficial way. The most significant incentive is the share price that can only go up over time, as its price is irreversibly increased by stakes with record breaking returns on investment. This means that short stakes are at huge disadvantage as their share ratio mostly stays low and thus their interest rate is lower. In addition, short stakes get up to 3-times less shares because of the LongerPaysBetter bonus shares (LPB). This means that most of the supply inflation is given as interest to longer stakes. The more adoption is achieved, the more delayed the inflation becomes.

Truth engine

HEX staking allows public knowledge of the future market supply. The information on stakes and their maturation time is public, so everyone can check the approximate value of supply increase for a specific day. Obviously, the further away in future, the less precise the data is, because stakes can always be created in the time period from present onward. But for the near future, the information serves as a powerful indicator of future coin minting.

Graph of future expiring shares in HEX stakes (from hex.vision).

Price balancing mechanisms

An interesting consequence of staking in HEX is that when the price is low, stakers can choose whether to sell at a lower price, or to restake for better times when they can sell with additional interest. Since there is no sell pressure from miners, there is no concern of devaluation from externalities other than the ones connected with the use case and from the inevitable traders speculating on future price. Lower price is also an incentive to create new stakes, thus deflating circulating supply, as it is less expensive to buy HEX and there is no reason to keep it liquid. These incentives provide upward pressure on price.

There is also the opposite option where a staker tempted by the high price can choose to emergency end stake, sacrifice part of it, but still profit in some other currency, regardless of the loss in HEX. When the price is high compared to other currencies, it is more reasonable to sell a larger part of the matured stake. These incentives provide downward pressure on price.

Therefore, the staking mechanism has a stabilising potential, as long as HEX keeps being used for its use case. This means that with time the boom and bust cycles during the price discovery process may not be as extreme as is common in other cryptocurrencies. Price discovery is given a buffering mechanism that allows it to increase without the price volatility spiking to extremes.

Table: Staker class incentives under different conditions when assuming a collective of rational actors (e.g., democratic incentive alignment).  

ConditionContract responseStaker class incentiveConsequencePrice pressure
Low staking ratiohigh interestBuying and staking, minting and restakingCirculating supply deflationup
High staking ratiolow interestMinting and sellingCirculating supply inflationdown
Low pricenoneBuying and staking, minting and restakingCirculating supply deflationup
High pricenoneMinting and sellingCirculating supply inflationdown
Share price always increasinginevitable long term total share deflationStaking longer than average weighted lengthDelayed circulating supply inflationup
Average staking length increasingshare price increasing fasterStaking longer than average weighted lengthDelayed circulating supply inflationup
High adoption ratenoneMinting and selling of old stakes, buying and staking of new stakesHigh liquidityup
Low adoption ratenoneMinting and restakingLow liquiditydown or neutral
Increase in emergency end staking (EES)penalization and redistribution of penalties resulting in increased interestUncertain (depends on reasons)Circulating supply inflationdown or neutral

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Conclusion

HEX smart contract code incorporates mechanisms that allow execution of a democratic monetary policy in a trustless maner. Each participant is free to act completely independent of others, but incentives drive alignment of actions that provide value maintenance and growth. High inflation reduces unit value, thus potentially resulting in lower price, which in turn increases the demand for staking. Low inflation increases scarcity, and with it price appreciation that motivates stakers to mint coins into circulation. Such a system can become independent of fiat money intermediacy once the price in fiat is translated into direct pricing of commodities and assets, eventually resulting in a HEX based circular-flow model of economy.

By @Benzenoid

Disclaimer: None of the above is meant to be a financial advice. Never rely on a single source of information and do your own research before any investment. Don’t trust, verify!

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