Bitcoin (BTC/USD), Ethereum (ETH/USD) – Monetary Mechanisms: Cryptocurrencies might need robust systems in place to maintain equilibrium or risk imploding

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

But, still in their infancy, crypto economies remain volatile. Many projects reach dizzying heights only to implode soon after.

Traditional economies, for all their flaws, have mechanisms in place to help them function and stay relatively stable. It’s playing out as Americans feel the brunt of inflation as the cost of gas, food and other goods rise rapidly.

The United States has a central banking system in which the Federal Reserve can adjust interest rates to fight inflation. Adjusting rates is like putting your finger on the scales, influencing the behavior of lenders and borrowers and, therefore, the flow of money. By slowing borrowing and lending, inflation tends to be contained, but at a cost.

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

The crypto had a mechanism in place that helped it maintain the value of its UST stablecoin. If the value of the UST fell below $1, a LUNC of equal value was struck, theoretically bringing the price of the UST back to $1. However, when this system was overloaded, the value of LUNC dropped too quickly and too many LUNCs were hit, leading to hyperinflation which created a death spiral negative feedback loop that the system could not recover from. .

It is clear that redundancies must be put in place. This is why projects like Seasonal tokens — composed of four tokens Summer SUMMER/USD, Autumn AUTUMN/USD, Winter WINTER/USD and Spring SPRING/USD — exist, the project incorporated four mechanisms to maintain ecosystem health.

The first is the inherent balance of proof of work. As a coin’s mining output increases, the difficulty increases to compensate and vice versa. This keeps production rates constant at a reward every 10 minutes.

The second is the theoretically rational behavior of miners. If the price of a token drops, many miners will likely choose to start mining another of the seasons, increasing the rewards for those who continue mining and compensating for the drop in price.

The third is the inverse of the second. Miners will want to switch to mining in the most profitable season, but when some of them do, that token will become more difficult to produce, perhaps evening out the profitability of mining.

And finally, the fourth comes from the behavior of investors. Since token prices rise and fall cyclically, traders will want to swap their overvalued tokens for undervalued tokens, thereby 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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