Is burning tokens in exchange for bonds deflationary
The below is in reference to basis-style algo stables, which issue bonds as a way to temporarily reduce the stablecoin supply to counteract de-peggings below one dollar.
Of course there are even more fundamental flaws in this design, but I do not recall seeing the below discussed, so decided to write it up:
- Bonds may inadvertently act as a substitute for the asset which they promise future payment of
- therefore reducing the “supply” of said asset less than expected
- due to also creating a competitive asset with similar, if somewhat riskier and less liquid, characteristics.
- therefore reducing the “supply” of said asset less than expected
- This potential substitution could undermine the intended role of bonds in the basis algorithmic stabilisation mechanism
- possibly resulting in bond issuance actually increasing the supply of basis-like assets
- rather than withdrawing basis from circulation.
- possibly resulting in bond issuance actually increasing the supply of basis-like assets
- The magnitude of this effect depends on the extent to which marginal currency holders are able to use bonds as a replacement to currency
- which depends on factors such as liquidity, legal frictions, default risks, financial system integration etc.
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