Elastic Supply and Crypto Loans

 

Elasticity is a complex, yet deeply significant principle in economics. In its simplest terms, something is elastic if its demand dramatically changes when something else (such as its price) changes. If demand does not change, or is not dependent on other factors, then it is inelastic. An example of an elastic good is a phone, as the demand for a brand or model of phone is tightly linked to the price of that phone. An example of an inelastic good is insulin, as the price of insulin does not affect the demand for it, as people need insulin and will pay any price (unless they truly cannot afford it at all, which then becomes more of a humanitarian issue than an economic principle). Perhaps the most inelastic thing in existence is a human life, as humans are (arguably) intrinsic, meaning all their value is in-and-of themselves, and not reliant on any other factors.

 

An elastic supply is where the price of an asset changes depending how many of that asset is in circulation. In recent years, blockchain developers and FinTech economists have been experimenting with this, creating cryptocurrencies that have a value that is directly tied to the amount of coins in circulation. In many cases, elasticity is favoured in the world of loans, as it can bring about a level of stability that suits both the borrower and the lender. But how exactly does elasticity do this, and how does a loan collateralized with an elastic cryptocurrency work?

 

Understanding elasticity

 

As mentioned above, an asset is elastic if its value is tied to another factor. Luxuries such as designer clothes and expensive foods are elastic because if they go on sale, then more people will buy them, and if they rise in value then less people will buy them. Essential medication like insulin is mostly inelastic because the same people will still buy it even if its price decreases, and the same people will buy it even if its prices shoot upwards (so long as they can). This is an example of elasticity that is affected directly by price: if the price of the goods change, then the demand changes.

 

Let’s look at how circulating supply can affect elasticity. For some assets, its circulating supply will affect its demand. Scarcity can have a huge effect on an asset’s elasticity. The gaming world is a fantastic example of this: some trading cards become elastic when they are rare, especially if they are particularly useful in gameplay or tournaments. In September 2002, the trading card game, YuGiOh, released a selection of cards that could only be purchased from a limited number of stores. Within the cards released during this time, there was one (named “Mechanicalchaser”) that was both extremely rare, as well as extremely useful in gameplay. People would buy this card at marketplaces individually for $200+, however, its price was only this high because of its immensely low circulating supply. If this card was commonly found in widely available packs, then its price would have dropped tremendously. This makes it elastic, with its demand being tightly bound to its supply.

 

In cryptocurrency, we are currently seeing some coins playing around with this idea by having circulating supply directly affect price, regulated by algorithms and smart contracts. Coins such as Ampleforth and Yam are trying this out. Looking at Ampleforth’s AMPL coin, it is designed to be pegged to 1 USD (frozen at 2019 prices) by regulating its circulating supply. The coin maintains its price at $1.00 by increasing the number of coins in people’s wallets whenever demand increases. In cryptocurrency, demand is determined by market cap, so when the coin’s market cap increases, AMPL’s circulating supply increases. Usually when market cap increases, the value of a coin increases, too. But by increasing supply at the same time, the price deliberately stagnates. If the market cap/demand falls, then the circulating supply falls too, and people have some of their coins burned to increase scarcity so that the status of $1.00 can be maintained.

 

When the market cap expands, the circulating supply expands. When the market cap contracts, the circulating supply contracts. This means that the price always relegates itself and returns back to $1.00.

 

Elastic supply coins and collateral

 

What is fascinating about these elastic supply coins is that the amount in your wallet changes regularly so that circulating supply can match market cap. This means that if you were to use them as collateral for a loan, the amount you hand over to the lender can be different than the amount you get back. At first this can be alarming to both parties, but it is less worrying than it sounds. The amount of coins may change, but the overall value of the amount used for collateral never does. A borrower may use $10,000 worth of an elastic supply coin for collateral, and at the time of the loan that could equate to 10,000 coins. If by the end of the loan, the market cap and circulating supply decreases, then the borrower may receive 5000 coins back as half would have been deducted via the algorithm, but despite this, those 5000 coins will still be worth $10,000. Additionally, as elastic supply coins are meant to always return to one specific price, those 5000 coins would double to 10,000 in due time.

 

The positive of this is that both the lender and borrower can rest assured that the amount used for collateral will always stay at the same value, even if the amount of coins fluctuates. Elastic supply coins are a new form of economic technology that has only been possible because of smart contracts, and so it will be interesting to see how they function and grow in the long run.