Freely transferable tokens create opportunities for fraud and cause regulatory problems. Money laundering has plagued many cryptocurrencies, allowing pariah organizations such as the government of North Korea to conduct illicit activities. Securities regulation clearly applies to freely traded tokens that are purchased just for the potential to earn a profit with minimal to no responsibilities on the part of the token holder. Market makers with outsized capital can manipulate real time markets, crushing small investors and creating price misinformation. While the benefits of freely transferable tokens may outweigh the costs under certain conditions, if all tokens should be freely transferable is not based in economic reality.
On the other hand, tokens that are not freely transferable create liquidity issues preventing buyers and sellers from cheaply transacting. BOMB was a cryptocurrency designed as a social experiment to study hyperdeflation. The Bomb Token Report covers most of the interesting details, but a now deleted reddit post called “14 Things We Learned Creating a Million Dollar Hyperdeflationary Currency” noted how the lack of liquidity created a huge bid/ask spread that punished traders.
“While I have heard the term ‘Liquidity Premium’ before, I didn’t quite know how this would impact a deflationary currency. In short, a liquidity premium occurs when something costs more/less because it has high/low liquidity.
“The best way for me to think of this is a house. Although houses are valuable, they many times take months to be sold or liquidated for cash. Because of this, prices can be up to 20–30% lower than it would be if it were liquid.
“In relation to BOMB, our goal from the beginning was to decrease token velocity as much as possible. The side effect of this was low liquidity.“
This liquidity premium caused an almost total collapse in the BOMB market. The market cap fell from its peak of $12m in Jun 2019 to just $1 million as of November 2019. For any token that is not freely transferable, the liquidity premium must be minimized.
For SwiftDaos, freely transferable tokens are simply not an option. Every token holder is a full member in their SwiftDao, meaning they must sign a contract with the dao stating their responsibilities and benefits. Furthermore, as the SEC noted in the “The Dao Report”, members must reveal their identity to be able to coordinate and manage the organization:
“[T]he pseudonymity and dispersion of the DAO Token holders made it difficult for them to join together to effect change or to exercise meaningful control. Investments in The DAO were made pseudonymously (such that the real-world identities of investors are not apparent), and there was great dispersion among those individuals and/or entities who were invested in The DAO and thousands of individuals and/or entities that traded DAO Tokens in the secondary market—an arrangement that bears little resemblance to that of a genuine general partnership.”
Without the ability to organize effectively, The Dao members were unable to manage the organization. Ultimately, The Dao hack showed how impotent pseudonymous members are as they were completely unable to respond without the help of Slock.it, the primary Active Participant.
The solution to a liquid market for tokens with limited transferability is a Multi-Unit Dutch Auction, also known as a Single Price Auction. No complicated math or research is required; this type of auction, developed by Milton Friedman, is regularly used by the US to sell treasuries. US Treasury issuance has a similar problem to SwiftDaos, as the US government must sell large quantities of bonds within a short time frame and thus cannot use the open market. The Multi-Unit Dutch Auction for the US treasury market has the following steps:
- The Treasury states how many dollars’ worth of bonds they wish to sell.
- All participants enter blind bids with the interest rate they are willing to pay and the number of tokens they wish to purchase.
- The Treasury checks all the bids and orders them from the lowest rate to the highest
- The Treasury picks the lowest interest rate that allows them to meet their issuance target.
- All purchasers who placed bids above the Treasury’s rate purchase bonds at that single lowest rate.
The result is an efficient market where all players are incentivized to place the highest bid they are willing to pay without being punished since they all pay the same lowest rate. Translated into a SwiftDao smart contract, the process works as follows:
- The SwiftDao contract publishes how many tokens to sell, both new tokens and tokens from current holders.
- All participants enter blind bids with:
- Max rate in Dai/token they are willing to pay and
- Some amount of Dai.
- All participants reveal their bids. Participants who fail to reveal their bids lose their Dai. Participants who placed invalid bids have their Dai returned.
- The smart contract calculates the lowest rate to fill the token sale. Winning participants redeem their tokens and Dai exchanged at the lowest rate. Losing participants redeem their Dai.
The entire process takes exactly 4 weeks, with each step taking 1 week: Sale announcement, Bid Placement, Bid Reveal, and Redeem Tokens. The result is an efficient sale where each member is incentivized exactly the maximum, they are willing to pay, keeping the price high. Meanwhile, none of the participants are punished for bidding high as they all pay the same lowest price. Furthermore, since the auction is at most every 4 weeks and is the only way to transact tokens, sellers can easily offload their tokens with little to no liquidity premium. Market makers with excess capital cannot manipulate the price. All participants have signed the SwiftDao’s contract and thus are known members who understand their managerial responsibilities to the organization.
On a meta level, single price auctions show how SwiftDao standards are developed in contract to other Daos. First, best practices from industry are taken into account as they apply to the particular situation. Single price auctions have a long history, are well understood by financial professionals, and are used by one of the largest organizations on earth. Second, fraud resistance is baked into the core of SwiftDaos instead of layered on top. Fraud resistance creates the potential to raise much larger sums of money than traditional ICOs. Sophisticated investors were hesitant to put large sums into extremely risky projects while the unsophisticated in general stayed away. While the ICO craze might have seemed huge, in comparison to the size of traditional financial markets whether private or public the entire cycle was minuscule. Fraud resistance, when built in from the beginning, also means financial regulations are either redundant or inapplicable. One of the biggest challenges facing the SwiftDao standard is to effectively communicate with regulatory institutions why they are not needed. Doing so requires demonstrating a robust standard that effectively protects investors whether it is through SwiftDao’s single price auction, its automated exit, its social media integration, and its automated financial disclosures. If you have any knowledge of US regulatory agencies, or otherwise would like to contribute to the development of SwiftDao standards, be sure to sign up at https://swiftdao.com and take the time to reach out to the community on Discord or Telegram.