Anyone in legacy finance who hears the term "negative interest rates" is likely going to think of Europe and how doomed their economy is at the moment. When we think of the concept a loan, it's hard to wrap our brain around the possibility of actually giving someone a discount when they borrow value, rather than expecting them to pay it all back with interest.
In the context of central banking, low interest rates, 0% interest rates, and even negative interest rates, are a terrible sign that signals the economy is on life-support and barely hanging in there. After all, how else can a bank make money if not by charging interest on the loans they give out? That's practically the definition of a bank. It's not hard to imagine how negative interest rates are a completely unsustainable solution for an economy that is bleeding out value in every direction, but might help it slightly in the short-term. We live on borrowed time.
"In the context of central banking"
In crypto however, negative interest rates make perfect sense and, in my opinion, are going to be a big part of DEFI in the future even though no one considers them a viable option today.
I did a lot of research on MAKERDAO back in the day, and I've done a lot of research on HBD as well. Algorithmic stable coins are a very powerful addition to the crypto multiverse. Hive does not yet allow users to take loans from the network, but MAKERDAO does. MakerDAO charges positive interest rates on the loans they give, and I've since concluded that this is absolutely ridiculous.
Imagine scraping together $3000 and throwing into a CDP, then printing $1000 "out of thin air" based on the value position of that collateral. Now, the network is telling you: "You need to pay 9% interest on that loan." What? Basically what MakerDAO is telling their users is that they need to pay interest rates on their own money, which is obviously ridiculous. MakerDAO should be paying their users to create these loans because this is the attention economy and that's how it works.
The platforms that offer the best deals are the ones that are going to get the most users, that much is pretty obvious. MakerDAO and associated stable-coin DAI have gotten away with this garbage business model for years because they were the only game in town, but already we see other algorithmic coins like TerraUSD surpass it in market cap. I have my doubts about UST as well, and it's very clear that there is a lot of room for improvement with these protocols.
I've done a lot of theory-crafting on DEFI because I'm looking to make my own token right here on the Hive blockchain. I want AMM pools with high yield. I want to burn millions of dollars worth of Hive and HBD to create liquidity on this new platform. I also want a full futures market that allows users to long/short the market as they see fit. That means CDP smart contracts will be a necessity.
At first I concluded that 0% interest rates were the way to go. I'm a big fan of eliminating variables and complexity that doesn't need to exist. I assumed that if I needed to create supply for the stable coin (price breaks to the upside) I could simply decrease yield to the associated single-staking pool. In the context of MAGITEK, that would mean decreasing the yield on the ICE token within the CACHE. This would push ICE out of the CACHE and into the LPs (which I'm calling POTIONS). I could also decrease yield to the MANA/ICE potion itself, which would also reduce demand for ICE and get more tokens into the ecosystem. Unfortunately this would lower liquidity in that LP as well which could cause a conflict of interest.
The ecosystem I want to build is weirdly interconnected, and doing things like raising/lowering yield to a cache or potion could conflict with one of the other economic goals. For example, what if my fear/greed pendulum was telling us that it was a good idea to start shorting FIRE (derivative of HIVE) or MANA (governance token)? In order to do that there needs to be a good amount of ICE/LIGHTNING collateral used to mint the FIRE/MANA tokens in order for them to be dumped onto the market.
The point of all of this is that economies are impossibly complex, which is why when something goes wrong out in the real world, the cure can often be worse than the disease, leading to a chain-reaction of other unintended consequences down the line. Thus, removing a perfectly good tool like interest rates from the ecosystem entirely could be a huge mistake assuming we encounter some problem that would best be solved by manipulating interest rates.
What I have since come to realize is that when a cryptocurrency offers negative interest rates on CDP contracts, not only does it make perfect sense because all the tokens minted from those contracts are grossly-overcollateralized, but also negative interest rates are the perfect way to inject free-flowing capital into the ecosystem without locking them in place. longest, sentence, ever
FREE-FLOWING CAPITAL
This is actually a super big deal, because while we can manipulate supply and demand by allocating yields to LPs and single staking pools, there is really no good way to incentivize money just floating out there randomly in the ecosystem. Creating this incentive is super important because it can exponentially increase velocity of money and create a very healthy economy.
That is exactly where negative interest rates come into play.
If we decide we need more people to lock up their Hive (FIRE) and create more stable-coins, we could easily increase yield to the single staking pool for Hive (FIRE), but in addition to that also give users yield (negative interest rates) just for minting ICE (the stable coin). The implications of this development have far-reaching effects.
Imagine being able to not only go long on Hive, but instead of having to pay an interest rate on the loan you take out you're instead getting paid to do it. Imagine how easy that would be to market and what a crazy user experience that would be. Not a single platform in crypto has even considered offering this functionality.
Well of course no crypto platform would offer a deal like that: because it's totally unsustainable and the entire platform would inevitably crash to zero!
Yeah okay, sure bud.
We have to consider why negative interest rates were being offered in the first place. In the scenario above the demand for stable-coins was too high or the supply was too low. We needed to increase the supply by offering negative interest rates on the futures market. The network NEEDED those coins to be dumped on the market to maintain stability, so discounting the solution as an unsustainable one without actually thinking about it is a bit premature.
For example what happens if the market pumps x10 and MAGITEK wants to hedge up and conserve that value for the entire community? That means we need deep deep liquidity in the most stable pools we have. MANA/ICE is the most stable pool we have, but if we greatly increase yield to this pool that could create overwhelming demand for ICE, pumping the value of the stable coin... can't have that. How do we bring down the value?
We need more users to print ICE, but if they use FIRE collateral to do it they are going long, which again was exactly the opposite of what we were going for. LIGHTNING might be useful because it's minted by destroying HBD and should be stablish, but what if it isn't enough and the price of ICE keeps going up? Wouldn't it be nice if we could use LIGHTNING collateral to mint ICE?
Well, if we allocate yield to the LIT CACHE that gets LIGHTNING in the CACHE... but what if users decide to use that collateral to mint FIRE and short the market by dumping the FIRE or extracting HIVE out of the FIREWALL? That's actually a good move because we are worried about a dump after the 10x, but it doesn't solve the problem that we wanted to solve, which was incentivizing users to mint ICE with the LIGHTNING collateral. Negative interest rates are an "obvious" solution to the problem of incentivizing the creation free-flow of capital in short supply.
We can see that the game-theory here is... insane... and MAGITEK only has 4 interconnected assets (MANA/FIRE/LIGHTNING/ICE). Just like the Traveling Salesman Problem, for each interconnected asset we add, the complexity of the system increases more than exponentially (Factorial N! complexity).
Again, think about it.
How crazy would it be if you could go onto a DEFI platform, give yourself a loan, dumping the loan for whatever asset you wanted (be it going long or depositing actual USD into your bank account) and then getting paid yield... on money that you don't even control anymore. That money is just out there free floating in the economy; creating massive velocity and trading hands in ways that were not thought to be possible. That's powerful. Looking at the current "competition" in crypto, that is the easiest sell ever to users that want their money to have more utility. Welcome to the attention economy.
Non-fractional reserve banking
The only way any of this can be sustainable is that CDP loans are the exact opposite of fractional reserve banking. The legacy banking sector allows banks to loan out money that isn't even theirs to begin with. This creates the unsustainable and inevitable bank run, where the bank goes insolvent because too many people ask for their money back thinking it should be there, when in reality the bank leveraged that money into an interest rate for themselves by loaning out value that didn't even belong to them in the first place. So OF COURSE in a system like THAT negative interest rates make negative sense.
Compare that system to CDP loans.
Not only are CDP loan non-fractional, they are so overcollateralized that often times $1 will be collateralized with $3's worth of value or more. So of course in a system like this, where the stable-coins are massively over-collateralized and basically impossible for there to be a bank run, does it make sense for negative interest rates to exist. If you had to lock $3000 to mint $1000, why wouldn't you be getting paid interest on the rock solid $1000 that just got created? This is a concept that currently no one in crypto seems to understand, and I believe that Hive can capitalize on that on the layer 2 testnets and create real innovation and disruption to the legacy financial sector (as cliché as it is to say so).
And of course if the platform uses negative interest rates to inflate supply during periods of rapid expansion, then perhaps positive interest rates would be used to reduce supply during periods of contraction. It's all about creating elasticity and flexibility in a dynamic economy that requires stability to flourish. The crazy thought here is that different network will deploy completely opposite strategies given certain situations. Just like 10 different economists would give us a different answer or 10 different doctors would diagnose a different illness. It's going to take quite a bit of trial, error, and pain before we find our what works and what doesn't.
Conclusion
In an ecosystem of exponential overcollateralization, it only makes sense that networks would pay users to lock up their funds in order to create a much lesser fraction of derivative assets that are completely invulnerable to bank runs. What has more value? A dollar that the bank may or may not have when you cash out? Or a dollar that the bank never controlled in the first place? Financial incentives dictate that we should be paying communities directly to create such resistant algorithmic stable coins.
I say a lot of crazy stuff about DEFI and how I think it should work. Things like: lowering inflation (yield) will lower price, and vice versa increasing yield creates incentive for a capital injection. Allocating inflation to the correct places creates more value than it dilutes. And now I'm saying that negative interest rates are "clearly" the way to go. Am I talking crazy here, or am I onto something real?