Bitcoin (BTC/USD), Ethereum (ETH/USD) – Money Mechanisms: Cryptocurrencies Might Need To Have Robust Systems In Place To Maintain Balance Or Risk Imploding

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Cryptocurrencies like Bitcoin BTC/USD and Ethereum ETH/USD have given a freedom to many investors. These new forms of money have expanded what is possible and whom it is possible for. 

But, still in their relative infancy, the economies of crypto remain volatile. Many projects rise to dizzying heights only to implode soon thereafter.

Traditional economies, for all their faults, have mechanisms in place to help them function and remain relatively stable. This is playing out as Americans feel the weight of inflation as the cost of gas, food and other goods rapidly rises. 

The U.S. has a central banking system in which the Federal Reserve can adjust interest rates to combat inflation. Adjusting rates is like putting a finger on the scale, influencing how lenders and borrowers behave and therefore, the flow of money. By slowing borrowing and lending, inflation tends to be curbed, but at a price.

Many cryptocurrencies, by design or by omission, lack these systems. And still others lack robust systems that function in the way they were designed. Take for example the recent collapse of the popular Terra Classic LUNC/USD.

The crypto had a mechanism in place that helped it maintain the value of its stablecoin UST. If the value of UST fell below $1, LUNC of equal value was minted, theoretically bringing the price of UST back up to $1. However, when this system was overstressed, the value of LUNC fell too rapidly and too much LUNC was minted, leading to hyperinflation that created a death spiral negative feedback loop from which the system could not recover.

It is clear that redundancies must be in place. That is why projects like Seasonal Tokens — consisting of four tokens Summer SUMMER/USD, Autumn AUTUMN/USD, Winter WINTER/USD and Spring SPRING/USD — exist, the project has built-in four mechanisms that are meant to maintain the health of the ecosystem.

The first is the inherent balance of proof of work. As the mining output of any one coin increases, the difficulty increases to compensate and visa-versa. This keeps the rates of production constant at one reward every 10 minutes.

The second is the theoretically rational behavior of miners. If the price of one token plummets, many miners will likely choose to start mining another of the seasons, increasing the rewards for those who remain mining and compensating for the decrease in price.

The third is the reverse of the second. Miners will want to switch to mining the most profitable season, but when some of them do, that token will become harder to produce, possibly equalizing the mining profitability.

And finally, the fourth is from the behavior of investors. Because the tokens rise and fall in price cyclically, traders will want to trade their overvalued tokens for undervalued ones, increasing the number of tokens they hold and balancing the price actions of the four seasons.

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Featured photo by Christophe Hautier on Unsplash

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