Hive Haircut Rule: Will It Ever Need To Be Changed?

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The Hive Haircut Rule is a measure that was put in place to safeguard the ecosystem. This was recently changed in Hard Fork 26, moving up to 30%.

What is the haircut rule?

Basically, it is a mechanism that continually looks at the relationship between $HIVE and HBD. Since the former is backing the latter, the blockchain needs to be sure it can fulfill the request. What this means is there needs to be at least $1 worth of $HIVE available for each HBD that is outstanding.

Here is where HBD is actually a debt instrument.

The haircut rule helps to ensure this and remove the counterparty risk. At the present moment, if the market capitalization of HBD reaches 30% that of $HIVE, the blockchain stops producing HBD until the ratio gets below the threshold.

As stated, this is a defense mechanism to maintain the peg. Remember, the peg is on the conversion, not necessarily the open market. There the price of HBD for $HIVE can fluctuate. However, when converting, the rate is hard coded into the blockchain.

Each HBD can be converted into $1 worth of $HIVE.

Of course, the coin has a free floating exchange rate. That means the conversion is always the same in USD terms yet can changes based upon market price. If $HIVE is $1, then it is a 1:1 swap; if 50 cents, then each HBD is worth 2 $HIVE.

The question is whether this will ever need to be changed?

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Producing More HBD

It is the haircut rule that makes HBD different from UST. With Luna, there was no limit to the amount of UST that could be created. The potential for a ratio of 125% existed. How could a backing coin hold if the market cap of what it was supporting was worth more? The answer is obvious as we found out.

One of the reasons the haircut limit was raised is so that more HBD could be produced. Certainly I am in the camp that we need a lot more of it on the market. We know, with the existing HBD supply, there is not a lot out there for commercial and financial applications.

That said, we are far below the limit. At the present market cap of roughly $151 million, we could have 45 million HBD in circulation (HBD in the DHF is not counted as it is effectively locked away, posing no threat to the ecosystem).

According to Hiveblocks, there are 31 million HBD total in existence. The DHF is sitting on 20 million, meaning there are 11 million in circulation. That is a long way from 45 million.

Of course, that is at the present market cap. The key to remember is the relationship between HBD and $HIVE is in USD. That is the unit of account both use.

Here is where things get interesting.

If we need to produce more HBD, the only requirement is for the market cap of $HIVE to increase. In fact, this is an fantastic way for the ecosystem to expand.

As more HBD is needed, the community (market) can produce it. By converting $HIVE, that decreases the supply. This, in theory, should drive the price up if demand is the same. Naturally, demand for the access token can come from the need for resource credits, creating the circular economy we discuss so often.

Therefore, if we the market required 300 million HBD, that is possible of the market cap of $HIVE is $1 billion.

It is a process that just keeps moving up the ladder.

Is 30% The Right Ratio?

This is something that is in place only for the last few months. In theory, it was a sensible move but we have to see it operating in practice. So far, there isn't even a hint of a problem.

The ratio is there primarily to prevent a money attack. UST was vulnerable because the expansion of both coins was without limit. That is not the case on Hive.

So what is the proper ratio and will we have to increase this in the future?

A better question might be why we would need to? Under what circumstance could a higher ratio be required?

The only thing I can think of is because we needed more HBD. However, if we were bumping into the ceiling, is that wise? As we can see, since there is no limit to the market cap of $HIVE, more HBD can always be produced.

If we need 30 billion HBD, still a rather small amount, the market capitalization of $HIVE would have to be $100 billion.

Seems fairly reasonable.

Could the ecosystem weather a 50% ratio? That could be possible. However, is it something that is wise to do? At this point, we are just speculating. If we find the haircut rule is regularly being hit, perhaps we can take a look at that. However, if the expansion of the ecosystem keeps driving the demand for $HIVE, we should not encounter any problems.

$HIVE is a value capture token. Whatever is created in value on Hive, in theory, should be captured in the price of the coin. Of course, we know markets do their own thing so it is not exact. Nevertheless, in the long run, as Hive's value grows, so should the market cap.

This allows for even more HBD to potentially be created.

In Conclusion

It is impossible to know exactly what level is proper for the ratio. We do know that 30% appears to be very manageable. There might be times where the rule is implemented and HBD production ceases until things get back in alignment. This is what the mechanism is designed to do.

Will there come a point where we want to raise it again? It is possible. However, the Hive ecosystem provides monetary elasticity as the market (community) sees fit. The haircut rule is in place to prevent the manipulation of this by nefarious actors who seek to duplicate what happened with UST.

In the end, if we are building value on HBD, through utility, we likely will never have to alter the haircut rule. $HIVE should capture the value of the entire ecosystem, of which HBD is a part of.

Of course, it is worthy to mention that even though Hive is feeless, to make payments in HBD does require some Hive Power. Once again, we see the circular. As HBD transactions increase, more HP is required to be able to transact.

This action would push the demand for $HIVE higher.

That said, we could see a time when volatility skyrockets. With a fair bit of $HIVE on Upbit and more being fed into Hive Power, the amount free floating could diminish. This tends to create volatile conditions that could see large moves in price.

Having the haircut rule in place helps the ecosystem weather these moves. While temporary, they could be points o vulnerability without it.

If you found this article informative, please give an upvote and rehive.

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