Hop A USD-Denominated Interest Bearing Cryptocurrency

Cunicula Version 19 November 2013

Outline
I. Inspiration and Ideals
II. How Hop adapts an ideal to the real world III. Pitfalls and Challenges IV. Conclusion

I. Inspiration and Ideals

Hops Inspiration: Milton Friedman

Algorithmic Monetary Policy I'm in favor of abolishing the Fed I would rather substitute a computer for it
http://goo.gl/qJtCoJ

Friedman rule for monetary policy central bank should target deflation equal to the real interest rate on safe assets
http://en.wikipedia.org/wiki/Friedman_rule

Hops Inspiration: Milton Friedman

Can Bitcoin achieve Friedmans ideal?

Algorithmic Monetary Policy I'm in favor of abolishing the Fed I would rather substitute a computer for it
http://goo.gl/qJtCoJ

Friedman rule for monetary policy central bank should target deflation equal to the real interest rate on safe assets
http://en.wikipedia.org/wiki/Friedman_rule

Hops Inspiration: Milton Friedman

Can Bitcoin achieve Friedmans ideal?

Algorithmic Monetary Policy I'm in favor of abolishing the Fed I would rather substitute a computer for it
http://goo.gl/qJtCoJ

Friedman rule for monetary policy central bank should target deflation equal to the real interest rate on safe assets
http://en.wikipedia.org/wiki/Friedman_rule

Hops Inspiration: Milton Friedman

Can Bitcoin achieve Friedmans ideal?

Algorithmic Monetary Policy I'm in favor of abolishing the Fed I would rather substitute a computer for it
http://goo.gl/qJtCoJ

Friedman Rule Policy 1) Deflation 2) Stable Prices

Friedman rule for monetary policy central bank should target deflation equal to the real interest rate on safe assets
http://en.wikipedia.org/wiki/Friedman_rule

Hops Inspiration: Milton Friedman

Can Bitcoin achieve Friedmans ideal?

Algorithmic Monetary Policy I'm in favor of abolishing the Fed I would rather substitute a computer for it
http://goo.gl/qJtCoJ

Friedman Rule Policy

Like Bitcoin!

1) Deflation 2) Stable Prices

Friedman rule for monetary policy central bank should target deflation equal to the real interest rate on safe assets
http://en.wikipedia.org/wiki/Friedman_rule

Hops Inspiration: Milton Friedman

Can Bitcoin achieve Friedmans ideal?

Algorithmic Monetary Policy I'm in favor of abolishing the Fed I would rather substitute a computer for it
http://goo.gl/qJtCoJ

Friedman Rule Policy

Like Bitcoin!

1) Deflation 2) Stable Prices

Friedman rule for monetary policy central bank should target deflation equal to the real interest rate on safe assets
http://en.wikipedia.org/wiki/Friedman_rule

Hops Inspiration: Milton Friedman

Can Bitcoin achieve Friedmans ideal?

Algorithmic Monetary Policy I'm in favor of abolishing the Fed I would rather substitute a computer for it
http://goo.gl/qJtCoJ

Friedman Rule Policy

Like Bitcoin!
Like the USD!

1) Deflation 2) Stable Prices

Friedman rule for monetary policy central bank should target deflation equal to the real interest rate on safe assets
http://en.wikipedia.org/wiki/Friedman_rule

1 out of 2 isn't bad, but can we do better???

Hops Inspiration: Milton Friedman

Can Bitcoin achieve Friedmans ideal?

Algorithmic Monetary Policy I'm in favor of abolishing the Fed I would rather substitute a computer for it
http://goo.gl/qJtCoJ

Friedman Rule Policy

Like Bitcoin!
Like the USD!

1) Deflation 2) Stable Prices

Friedman rule for monetary policy central bank should target deflation equal to the real interest rate on safe assets
http://en.wikipedia.org/wiki/Friedman_rule

Pros and Cons: Gold vs. USD vs. Friedman Ideal

Index of Real Purchasing Power of Gold, USD, and Friedman Ideal Currency (Jan 2003 = 1)
5

Gold
Long-term appreciation Near-term value is unpredictable

USD
Long-term depreciation Near-term value is stable

0 4/19/2001 9/1/2002 1/14/2004 5/28/200510/10/20062/22/2008 7/6/2009 11/18/2010 4/1/2012 8/14/201312/27/2014 USD Gold Freidman Ideal Currency

Friedman Ideal Currency

Long-term appreciation Near-term value is stable

The Friedman ideal currency offers the same stability as the USD, but without the inflation tax.

II. How Hop adapts an ideal to the real world

Real-world Realities
Bitcoins price will always be volatile (see gold).
Prices and contracts will always be denominated in USD, EUR, etc.
Government like to generate revenue via inflation. Firms and households require a currency with a stable price.

Intermediaries will always be necessary for most bitcoin payments.

Middlemen (e.g. bitpay) threaten bitcoins key goals (decentralized, low fees)

Are these realities compatible with Friedmans ideal?

Hops like a P2P Paypal Hops are Paypal shares. HopUSD are PaypalUSD
Hops are equities. Their price floats and will be volatile.
HopUSD are bonds. They pay interest.
Just like bitcoins (or gold or shares in paypal) They will offer a high expected return as compensation for risk. HopUSD are joint liabilities of all of hops equity holders. Interest rates on HopUSD float. They depend on the markets risk perceptions.
Yields would tend to decline as HopUSD gained wider acceptance.

HopUSD serve as a stable medium of exchange.

Like paypalUSD, the face value of 1 HopUSD = 1 USD Unlike paypalUSD
They can be used to make USD payments to anyone who accepts them.
HopUSD are decentralized and can be exchanged without intermediaries HopUSD txn fees depend on competition for blockchain space, not monopoly price gouging HopUSD pay out interest directly to their owner (not to a corporation).

HopUSD aims to be Friedmans Ideal Currency But theres a long road ahead.
HopUSD targets Friedmans vision.
Prices are stable since they are pegged to the USD. Real Yield on HopUSD bonds = Real Interest Rate + Risk Premium
If HopUSD were perceived to be just as safe as US treasuries
risk premium = 0 and hopUSD = Friedmans ideal currency

The risk premium on hopUSD starts extremely high (like a junk bond)
As HopUSD gains acceptance, yields would decline to those of a regular corporate bond. If acceptance was broad enough, yields could fall to a similar level as developed country government debt.
Cross your fingers, thats hops ambition.

Balance Sheets: Equity and Debt

Value of Company Assets = Value of Equity + Value of Liabilities
Paypal Assets Liabilities Value of Equity (i.e. paypal market cap) Assets Bitcoin Liabilities Value of Equity (i.e. bitcoin market cap) None Value of Bitcoin network Assets Hop Liabilities Value of Equity (i.e. hop market cap)

Value of Paypal network

Outstanding Value of PaypalUSD (+ misc. debt)

Value of Paypal network Outstanding Value of PaypalUSD (+ misc. debt)

Value of Bitcoin network

Value of Hop network

Outstanding Value of Hop Value of network HopUSD Outstanding Value of HopUSD

Hops Value Proposition: Bitcoin vs. Paypal vs. Hop

Bitcoin Paypal Hop

Fixed money supply

Can do equity txns w/o central counterparty risk?

Nominal fees for equity txns?

Issues USD denominated debt?

Can do USD debt txns w/o central counterparty risk?

Nominal fees for USD debt txns?

Pays interest on holdings of USD denominated debt?

X X X X

X X X X X X

III. Pitfalls and Challenges

Simple idea
Users convert their hops into hopUSD and their hopUSD into hops.
These are unilateral conversions at the blockchains exchange rate. Conversions change the total number of hops and hopUSD in circulation.

The blockchains exchange rate targets parity of the hopUSD

Target outcome: 1 hopUSD 1 USD (as observed on external markets like Mt.Gox) Exchange rate adjusts based on binary votes from PoS miners
1 for a very small movement upwards (i.e. offer more hops for each hopUSD) 0 for a very small movement downwards (i.e. offer fewer hops for each hopUSD)

Parity of hopUSD and USD gives the hop network value.

Hop equity holders do the PoS mining and benefit from hop networks value. Hop equity holders have some financial incentive to vote honestly.

Design Challenge #1: Blockchains Time Lag

Time t Time t+1 Time t+2 Real world price change fully incorporated in blockchain Time t+3 Past Conversion txn executed at current price.

Conversion txn included In block. (commitment)

Real world price change occurs.

Blockchain must see a vote in a PoS block to adjust conversion prices.

Blockchain price adjustment inherently slower than real time markets. Design makes it much, much slower to limit power of individual miners.

Conversions could arbitrage this lag at a profit, wasting blockchain space. Solution: Require advance commitment to conversion txns.
Delaying conversions gives the blockchain time to adjust prices. (see the time line.)

Design Challenge #1: Blockchains Time Lag

Time t Time t+1 Time t+2 Real world price change fully incorporated in blockchain Time t+3 Past Conversion txn executed at current price.

Conversion txn included In block. (commitment)

Real world price change occurs.

Blockchain must see a vote in a PoS block to adjust conversion prices.

Blockchain price adjustment inherently slower than real time markets. Design makes it much, much slower to limit power of individual miners.

Conversions could arbitrage this lag at a profit, wasting blockchain space. Solution: Advance commitment to conversion txns -> no arbitrage opportunity
Delaying conversions gives the blockchain time to adjust prices. (see the time line.)

Design Challenge #2: Dishonest Voting

PoS miners can expropriate equity by manipulating the blockchains exchange rate.
But due to their equity stake, PoS miners incur a cost if this disrupts the hop system.

Design minimizes private benefit of manipulation and maximizes systemic cost of disruption.
I minimize the price influence of a single PoS voter.
Need very large stake to achieve large price benefit

I maximize effects of price manipulation on other users of the Hop system.

Profits from manipulation require long-term deviations from HopUSD parity. (maximal cost of disruption) Observed long-term deviations allow third parties to enjoy benefits too. (forced to share benefits with speculators)

2) Some Tangible Design Goals:

1) Honest PoS voting is more frequent than dishonest PoS voting. 2) Trading profits from dishonest voting are small.

This ensures that the blockchain price follows the real world price. Trading profits redistributes equity from honest to dishonest stakeholders. A bit is okay, too much and honest people exit.
To game the Hop system you must destroy the Hop system

Design Challenge #2: Dishonest Voting

To limit influence of an individual PoS miner.
Each vote can adjust price by only a very small amount. A dishonest vote subsequent honest vote in the opposite direction.
Price effect is fleeting.

Need large share of stake to achieve a substantial or sustained impact.

To ensure that private gains = big disruption for all users.

Recall, conversion txn face a delay before execution. (see challenge #1) In addition, conversion txn execution is extended across many blocks.
Current target is 6 months worth. The final exchange rate for conversion is an average of the exchange rate for the entire 6 month period.

To affect price substantially, you need to disrupt the exchange rate for the entire period.
A day of disruption yields extremely little reward
Price effect achievable in one day is small. Txn price is averaged over 180 days. One day with a bit disruption has a negligible impact.

Design Challenge #3: Managing Risks of HopUSD Issuance

People demand foreign currencies for two reasons:
Use 1: To purchase investment assets priced in these currencies. This includes the currency itself. Use 2: To purchase goods and services sold using these currencies.

Like bitcoin, HopUSD will be sought after for use 1 long before use 2 becomes a reality.
Growth of Use 1 lowers txn costs.
Examples of txn cost effects: market depth, bid/ask spread, number/quality of exchanges, info about currency Forget about merchants first task is always attracting speculators.

Growth of Use 2 requires low txn costs to be viable.

Issuance must balance the benefits of liquidity against the risks of excessive leverage.
Speculators must create, trade, and willingly hold HopUSD before it sees any real use Speculators must not create too many HopUSD or the system will collapse as a Ponzi.
Condition for Solvency:
Value of Hop network > value of outstanding HopUSD

The Danger of excess issuance:

Excess HopUSD + Drop in USD Price of Hop Equity Insolvency HopUSD trades for less than 1 USD Whole system fails

Design Challenge #3: Managing Risks of HopUSD Issuance

Where does investment demand come from?
1 HopUSD wait wait 1 year has passed 1+ HopUSD

HopUSD are interest bearing bonds. They pay out at a variable interest rate, call it . determines demand.
If seems high people convert Hop equity to HopUSD debt If seems low people convert HopUSD debt to Hop equity

The Hop system adjusts to target a constant debt to equity ratio.

Design Challenge #3: Risk management = arbitrary design decision

Hop targets a debt to equity ratio of 0.05. (I explain how next)
This fully insures HopUSD holders against up to a 21-fold drop in the price of hop equity. The graph considers a busts effects on debt and equity holders
Hops target ratio of 0.05 implies 1) HopUSD very safe (bitcoins price drops have never been large enough to hit HopUSD) 2) Hop Equity just slightly more risky/volatile than bitcoin.
Risk of Holding Debt Depends on Debt to Equity Ratio
0% -20% -40% -60% -80% -100% 0 0.05 0.1 0.15 0.2 0.25 0.3 0.35 0.4 0.45 0.5 0.55 0.6 0.65 0.7 0.75 0.8 0.85 0.9 0.95 1 1.05 1.1 1.15 1.2 1.25 1.3 1.35 1.4 1.45 1.5 1.55 1.6 1.65 1.7 1.75 1.8 1.85 1.9 1.95 2

Starting Ratio of Debt to Equity

% Loss on Equity Investment (50% Decline in Network Value) % Loss on Equity Investment (90% Decline in Network Value) % Loss on Debt Investment (50% Decline in Network Value) % Loss on Debt Investment (90% Decline in Network Value)

Design Challenge #3: Interest Rate Determined by Debt Equity Ratio

Investors will demand more HopUSD if it offers an above market expected return after adjustment for risk (condition shown below) > And will want to sell HopUSD if < I allow to vary as a function of leverage, between a lower bound of -100% and an upper bound of +100% per annum.
The higher the debt equity ratio, the lower the interest rate on hopUSD. This encourages investors to
Convert their HopUSD debt to Hop equity when leverage is too high. Convert their Hop equity to HopUSD debt when leverage is too low. (implying no supply of HopUSD)

HopUSD Interest Rate vs. HopUSD Debt as % of Total Network Value

Annual Interest Rate on HopUSD as a Function of Leverage
100% 95% 90% 85% 80% 75% 70% 65% 60% 55% 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% -5% -10% 0% -15% -20% -25% -30% -35% -40% -45% -50% -55% -60% -65% -70% -75% -80% -85% -90% -95% -100%

Debt Offers Very High Return

1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% 21% 22% 23% 24% 25% 26% 27% 28% 29%

Target Range of Debt Issuance

Failing to Convert Debt To Equity Imposes Large Losses

Value of Debt as a Percentage of Total Network Value

How are the debt ratio and interest calculated?

There are four types of assets.
Mature Hop equity and Hop equity committed to conversion to HopUSD Mature HopUSD and HopUSD committed to conversion to Hop equity.

Only Mature HopUSD earn interest (or pay out negative interest). The total USD value of the network is calculated as
+ HopUSD committed to conversion to Hop equity + (Mature Hop equity + )

The ratio of debt to total value is calculated as

Rapid neutralization of interest rate changes caused by price movements

Price of equity increases Debt ratio falls interest rate increases equity converted to debt interest rate falls Price of equity falls Debt ratio rises interest rate falls debt converted to equity interest rate rises

Forward-looking interest rate adjustment interest rate does not change b/c of random price fluctuations
Essential feature to maintain parity of HopUSD in the face of price fluctuations

Pitfalls of a Pegged Cryptocurrency

There are lots of poorly understood design challenges.
Maintaining a peg to the USD Creating sustained investment demand and thus adequate liquidity Preventing excessive investment demand and consequent instability Preventing gaming of the system for profit

Average user will say: The aim is to sustain a USD peg. Like #$#$@#.
So is hop like #$#$@#?
No!

Success requires overcoming all design challenges simultaneously.

Hop anticipates and tries to address all the challenges listed above. #$#$@# stops at maintaining a peg to the USD and ignores the rest.

IV. Conclusion

Hop is an ambitious work in progress. You can help with the progress part!
If Hop achieves its design goals, it could mean the death of bitcoin.
But thats a good thing! Hop is more decentralized and more useful than bitcoin!

Your input is needed!

Does Hop make sense to you? If not, whats confusing about Hop?

Do you see problems with Hops design?

What are they? Suggestions for fixing them?

Conclusion
I hope you learned
Why I want to create Hop. The basic design features of Hop. Why design of a USD peg is challenging and finicky.

I know that
Many details are missing. You still have questions.

In the future
Ill fill in all the details (mostly achieved already in the whitepaper) Answer all your questions (just ask!)