TechFlow Insights
The point of a stablecoin is not necessarily to be pegged to the dollar, but to provide an asset with low volatility. RAI is somewhat like a new currency, one that has lower volatility than its underlying collateral, Ethereum. Second, current market structure suggests that if users want a decentralized stablecoin, the cost of stability is a slow decline in the price of RAI (relative to the dollar). This is because demand for stablecoins is high, while leveraged demand for decentralized assets like Ethereum is limited.
To balance supply and demand, a fully decentralized stablecoin needs a way to incentivize both long positions (users of the stablecoin) and short positions (providers of the stablecoin). One way to do this is by adding a mechanism rate—charging interest on debt (the stablecoin suppliers) and crediting it to holders (the stablecoin users). However, when holdings exceed debt, the rate may become negative. RAI mostly uses negative interest rates; when the rate is negative, RAI does not change user balances, but instead keeps balances constant while adjusting the actual price of the stablecoin.
RAI adjusts its redemption price to reflect the interest rate, where the redemption price is the target value of 1 RAI. For example, if the redemption rate is -3%, and the current redemption price is $1.00, then the redemption price one year later would be $0.97 (in practice, RAI started with a redemption price of $3.14). The redemption rate is automatically calculated by the protocol, which detects supply-demand imbalances by tracking deviations between the market price and the redemption price. A simple hypothetical mechanism: if the current redemption price is 4% below the market price, the redemption rate is -4%. If it's more than 10% above, the redemption rate is +10%.
Dankrad Feist, researcher at the Ethereum Foundation, believes that a decentralized stablecoin based on supply-demand equilibrium will have negative interest rates, meaning it will have a higher inflation rate than fiat currencies.
