This is another post of my "DeFi with Science" series. The idea of this series is to try and show some of the "science" behind crypto and DeFi to help people make more informed decisions.
It won't be super in-depth stuff with a lot of mathematical formulas or blocks or code because the idea is to make it accessible to just about anyone. My main goal with this is to show a little bit of how things work "under the hood" so my readers can do a couple of things.
The first is being able to make their own decisions based on actual data instead of going with their "gut" or following what some guy on YouTube or Twitter told them to do.
And the second thing is having a foundation to build on, should they want to look for more in-depth knowledge.
While I'm not opposed to the old adage "It's better being lucky than good", the fundamental problem with luck is that it's very hard to replicate, and I, for one, prefer to make decisions that I can replicate and expect a positive outcome more often than not. I have written about this concept a few times, and I invite you to check out my blog if you want to learn more.
Today's topic concerns one of the topics that probably sparks the most doubt among Hive users: the Hive Backed Dollar (HBD).
Quick HBD overview
The Hive Backed Dollar, or HBD for short, is the stablecoin of the Hive blockchain. Like most stablecoins, it was designed to be 1 USD worth of Hive at any point in time. However, unlike some stablecoins such as USDT, for example, which uses an actual reserve of US Dollars to maintain its value, HBD is an algorithmic stablecoin, meaning that its value is maintained by an algorithm that manages its supply and demand to achieve stability.
There is much more that can be said about HBD but it's not the scope of this article. The main idea today has to do with its price.
Every now and then, I see someone losing their mind over a situation like this:
This makes some people freak out because the price of HBD shouldn't fluctuate as much. The good news is it doesn't. Sure, the stabilization is not perfect but it's gotten significantly better recently.
One important detail that many people miss is that this bigger value that's shown in the picture is based on CoinGecko price feed. The one that really matters to us on Hive is the smaller one, which is the HBD price on the internal market. I'm not sure why PeakD highlights the external price instead of the internal one, but that's not important at the moment.
That's good to know and all but it leads to the question: why the price of HBD is sometimes so different in the external and internal markets?
We need to take a step back and understand how CoinGecko calculates its price feeds.
CoinGecko methodology
The methodology used by CoinGecko is quite comprehensive but I'll focus on the parts that matter the most to this article. Feel free to check the full documentation if you want to know more.
Simply put, to determine the price of a coin, CoinGecko does a Volume Weighted Average price check on all exchanges connected to it, meaning it checks the price of such coin on all exchanges and multiplies it by a parameter which corresponds to the volume traded on the said exchange compared to the total. This is to prevent distortions in the final price.
It works quite well for coins such as Bitcoin, for example, because it's traded in massive volumes across most exchanges, which means if a distortion in the price happens on a few particular exchanges, it will not propagate to the final price because the volume of the distortion would be insignificant when compared to the total.
The problem is, with HBD, things are a little different. CoinGecko only checks the price on two exchanges where HBD is listed and the volume on both is very low (less than 5 thousand dollars combined in the last 24 hours, at the moment of writing). Because it has so few data points, the price feed calculation can lead to inaccurate results, even with CoinGecko's outlier exclusion method.
That doesn't necessarily mean the price action on external markets is always irrelevant to the context of HBD; you just have to take into consideration that it's a very low liquidity market, and therefore, even small transactions can cause disruption. Make sure to check the internal Hive market, which is where the bulk of HBD transactions take place before you draw any conclusions.
Final thoughts
The price of HBD on external feeds such as CoinGecko is often discrepant in relation to its price on the Hive internal market. That happens because CoinGecko uses a Volume Weighted Average price calculation method to determine the price of a coin, and HBD only uses data from two exchanges where HBD is listed. The volume on these exchanges is very low, and therefore, it can create distortions in the price that do not reflect the real condition of the markets.
Keep that in mind and make sure to check the internal market before drawing any conclusions related to HBD or Hive.