INTRODUCTION
Long overlooked by the HIVE community, the Hive Backed Dollar is finally starting to garner the attention it deserves. In this subsection of the Hive Backed Dollars Guide let's investigate how Hive Backed Dollars work.
To further this investigation, we will also examine three mechanisms used by the system to control Hive inflation and to maintain peg, namely: the HBD debt limit; the HBD Stabilizer; and, the Haircut Rule.
HOW DO HIVE BACKED DOLLARS (HBD) WORK?
Hive Backed Dollars (hereinafter "HBD") are decentralized stablecoins pegged to the United States Dollar (generally 1 HBD = $1 USD). HBD is one of the native tokens existing on the Hive blockchain.
While the HBD is pegged to the United States Dollar, it is not backed by that fiat currency and the use of the USD is merely a valuation mechanism for the token. The HBD is backed by $1 worth of the Hive token. "The actually (sic) backing is the code on the blockchain that converts HBD to Hive. Thus, we have a stablecoin that is convertible into Hive yet is really backed by the code on the blockchain." [taskmaster4450. Hive Backed Dollar (HBD) Becoming A Stablecoin?. (Accessed October 21, 2021)].
To fully understand how HBD work, it is necessary to first explain where HBD comes from. HBD is the product of the regular inflation of the Hive token. Part of the regular Hive inflation is an allocation from posting rewards which are partially paid in HBD. A portion of the system HBD comes from the Decentralized Hive Fund which likewise receives some of the Hive inflation.
By operation of the mechanisms utilized to maintain the peg, HBD is added to and removed from the overall HBD supply. There are two smart contracts that come into play when the price of HBD deviates from its peg of $1. These two smart contracts are:
- CONVERTING FROM HBD TO HIVE: A holder of HBD can gain access to the collateral backing their HBD by using this contract. When the holder executes this contract after 84 hours they receive the dollar numerical amount of HBD converted in Hive tokens. The exchange rate for conversion is fixed by calculating the median price of Hive over the same 84 hour period. The Hive blockchain witnesses act as oracles to set the Hive price for conversion.
- CONVERTING FROM HIVE TO HBD: A holder of the Hive token can use this smart contract to immediately receive HBD. To use this contract, the holder must post collateral in an amount equal to 2x the HBD value calculated on the lowest HBD price listed in the past 3.5 days, as well as an additional 5% fee. The collateral is deducted from the holders account immediately and the HBD amount is likewise credited. After a period of 84 hours, the Hive is returned to the holder less the value of the HBD and the 5% fee.
When the price of HBD is below $1, market makers can enter converting HBD to Hive with the effect of reducing the market supply of HBD thereby causing an increase in price. Should the price of HBD be above $1, market makers can enter converting Hive to HBD with the effect of increasing the market supply of HBD thereby causing a decrease in price.
These conversion mechanisms operate to restore the HBD price to it's loose peg of $1 over a period of time. This restoration process is not instantaneous. This process is reliable to bring the HBD price back to peg eventually given time, however, there are times when the price deviation is too substantial and has been sustained for an inordinate period of time that other price restorative mechanisms must be relied upon.
THE HBD STABILIZER
The HBD Stabilizer is an automated trading mechanism funded by the Decentralized Hive Fund (DHF). This DHF exists to maintain a tighter peg upon the HBD token. The DHF is a well funded DAO existing on the Hive blockchain that is funded by stakeholders committing their capital for the good of the Hive network, by Hive posting rewards, and by donations received from the Hive community.
The HBD peg is maintained by the DHF through the utilization of one of two mechanisms. These mechanisms are:
- If the price of HBD falls below $0.97, the HDB Stabilizer executes the smart contract to convert from Hive to HBD. Once executed, after 3.5 days, Hive is utilized to purchase HBD from the market thereby reducing the supply of HBD and causing an increase in price. It should be noted that the margin of $0.97 should suffice to permit the DHF to earn a profit on the transaction. This profit is not guaranteed but should occur more often than not.
- If the price of HBD rises above $1, the DHF sells HBD on the native Hive Decentralized Exchange. In effect, this immediately adds HBD to the market supply driving the price of HBD lower. Likewise, this action yields an immediate profit to the DHF. The Hive received by the DHF in this transaction is instantly converted back to HBD and held by the DAO.
By operating this HBD Stabilizer, an incentive is provided to the market makers as they need less capital for provision of liquidity thereby keeping the price of HBD in close peg.
THE HBD DEBT LIMIT
From a technical standpoint HBD is a debt instrument. One of the ways HBD becomes available in the market is hard coded into the blockchain being the percentage of HBD to Hive in value. Within this code are constraints to aid in keeping the Hive economy healthy.
Being a debt instrument, there must be some system assurances that the debt-to-equity ratio does not get too high. Accordingly, one of these system constraints is the HBD debt limit.
The market cap of HBD must be below 10% of the Hive market cap. If and in the event the total value of HBD exceeds 10% of the total value of Hive, the blockchain automatically halts production of HBD. The 50/50 reward option for posting payouts in this circumstance would begin paying liquid Hive in lieu of the HBD component. The system will automatically continue these modified payments until such time as the below 10% threshold ratio is restored.
Likewise, if the debt-to-equity ratio exceeds 10% and a holder of the Hive token attempts to convert Hive to HBD, the system will automatically reject the transaction as the system is hard coded not to create HBD.
Anyone interested in the Hive blockchain and HBD may monitor the market value of Hive and HBD as well as the debt-to-equity status by clicking here.
THE HAIRCUT RULE
One of the ways HBD enters the Hive ecosystem is through the 50/50 reward option for posting payouts. There are three ways that this 50/50 reward may be paid dependent upon the debt-to-equity ratio of HBD to Hive. These are:
ratio < 9% payout is HP and HBD;
ratio between 9% and 10 % payout is HP, HBD, and Hive;
ratio > 10% payout is HP and Hive.
It is the period where HP, HBD, and liquid Hive is paid (ratio between 9% and 10%) that is referred to as The Haircut Rule. During this period, HBD is issued based on the following formula:
HBD Print Rate = 100% x (10 - current debt ratio)
The result is that once the debt ratio exceeds 9%, as that ratio moves upward to 10%, less HBD is issued and is replaced by liquid Hive.
THE RATIONALE BEHIND DEBT RATIO LOGIC
Should the debt-to-equity ratio rise too high, the entire system of blockchain native currency can become unstable. The conversion of system debt can greatly increase the supply of tokens in the system, which inflated token amount if sold would put undue stress upon token prices. Continued conversion of debt to equity adds even more tokens to the system which procedure, unchecked, leads to a collapse of the system currency leaving in its wake worthless equity and a mountain of debt.
To prevent this scenario from occurring, the Hive blockchain has put the debt ratio logic discussed above into play to assure that the debt-to-equity ratio never exceeds 10%.
CONCLUSION
While at first blush the mechanics behind the HBD and the three debt ratio mechanisms may seem cumbersome and complicated, if you consider the same in terms of basic supply and demand economics and its effects on price the picture becomes much clearer.
At their heart, these items are present in the system to provide stability and to protect the entire system from falling victim to the contingency of runaway debt and its consequences.
The system is getting closer to possessing the ability to maintain peg and provide a true stablecoin, but the same is made much more difficult due to the present lack of market depth. As the system continues upon a path of growth peg stability should become easier to maintain.