Professor and Computer Scientist Aggelos Kiayias Explains how Cardano May add “Stablefees” and Support Decentralized Reserve System

Professor Aggelos Kiayias, a Greek computer scientist, currently a professor at the University of Edinburgh, has published a blog post titled “Stablefees and the Decentralized Reserve System.”

Kiayias notes in a blog posted by IOHK, the company supporting Cardano development, that  facilitating transactions via crypto platforms “stumbles on the dual utility of the platform’s underlying asset.”

Users are able to hold and trade them as part of their investment portfolios, Kiayias adds, while noting that they supply the necessary “fuel” for handling transactions. According to the Professor, this duality suggests that the system “should have a mechanism for adjusting transaction costs, so they remain competitive and reasonable.”

He also mentions that the “bounded throughput of decentralized platforms per unit of time introduces another hurdle: the system should also allow the users to discover the correct price for timely transaction processing,” which may depend on their individual requirements.

He further notes:

“Why not drop transaction fees altogether? Three reasons: One, transaction processing incurs costs on the system’s side (in terms of computation and storage). It is reasonable to allow transaction processors (stake pool operators, in the case of Cardano) to offset their costs. Two, even with a theoretically infinite capacity, it is important to prevent transaction issuers from saturating the network with worthless transactions. Three, it is appropriate to incentivize transaction processors to provide quality of service. A surge in demand should influence their payoffs accordingly.”

Kiayias also notes that adding a fee to each transaction should be able to address the considerations noted above.

He adds that Bitcoin (BTC), the flagship cryptocurrency, set out the first mechanism for pricing transactions via distributed ledger technology (DLT)-enabled platforms. As explained by the Professor, this mechanism is somewhat like a first-price auction: transactions are able to places bids for a place in a block while “naming a specific reward, and block producers select the transactions that they prefer to include.”

Kiayias further notes that block producers also get rewarded with “the right to mint new coins, i.e., their operation is subsidized by the whole community via inflation of the total coin supply.” He also mentions that inflation drops “geometrically over time, and transaction fees become increasingly dominant in the rewards.” According to Kiayias, this mechanism, “while enabling Bitcoin to run for well over a decade, has been criticized for its inefficiency.” He points out that transaction costs have also increased considerably over time.

Kiayias has shared a new mechanism that “builds on Cardano’s approach to ledger rules and system assets, and complements the Babel fees concept.” The goal is making fees “fair, stable, and predictable over time.” Kiayias and his team describe the mechanism “in the context of Cardano.”

But they clarify that it may be adapted to any other cryptocurrency with “similar characteristics.”

The main idea behind Stablefees is to have “a base price for transactions through pegging to a basket of commodities or currencies,” Kiayias explains while noting that stablefees includes a native “decentralized reserve” contract that “issues and manages a stablecoin pegged to the basket.”

He also notes that a comparison in the fiat world “might be the International Monetary Fund’s SDR, (established in 1969) and valued based on a basket of five currencies—the U.S. dollar, the euro, the Chinese renminbi, the Japanese yen, and the British pound sterling.”

He adds that the stablecoin — let’s call it “Basket Equivalent Coin” (BEC) — is the currency used for “paying transaction fees (and all other real world pricing needs of the platform, e.g., SPO costs).”

In this system, the ADA cryptocurrency will be playing “a dual role: Reserve asset of the decentralized reserve, and reward currency for staking.” It will also be the “fall-back currency in extreme scenarios where the reserve contract is in a liquidity crunch.”

Kiayias continued:

“Before a transaction, the issuer will have to obtain BECs, either via other third parties or directly by sending ADA to the decentralized reserve contract. On what basis will the reserve issue BECs? The reserve contract will also issue equity shares -we will call them decentralized equity coins (DECs)-, in exchange of ADA.”

He further explains that by leveraging the value of DECs, the decentralized reserve will often be able to adjust the value of BEC so “it is pegged on the underlying basket of commodities.” He adds that DECs will be able to “absorb the fluctuations of ada vs. the basket to ensure that the real-world value of BECs remains stable (cf. the AgeUSD stablecoin design that has been already deployed and used on Ergo).”

He added that this trinity of coinage, “issued natively by the system, will attract different cohorts. BECs’ stability and liquidity might be attractive to risk-averse, transaction-intensive holders.” According to Kiayias and his team, DECs will provide the greatest rewards if ADA rises, but also take the “most significant hit when ada goes down. Long-term holders may find DECs more attractive.”

He further noted that since decentralized reserve prices these coins in ADA, both BECs and DECs are able to facilitate participation in both the staking and governance process, Kiayias adds while noting that returns may be issued “at different rates, reflecting the different nature of each coin.” He also mentions that ultimately, rewards will always be “denominated and payable in ada, which will remain the most versatile of all three coins.”

He continues to note:

“The centerpiece of this mechanism is an on-chain oracle that determines the price of the basket in ada. SPOs can implement this oracle in a decentralized manner. The reserve can offer extra rewards to all oracle contributors from the fees collected during BEC/DEC issuances. This will ensure two things: thousands of geographically-diverse contributors, and ledger rules calculating a synthesized exchange rate in some canonical way (through a weighted median across all price submissions in an epoch, for example).”

He adds that if Oracle contributors can manipulate their contributions, they can be “held accountable by tracking their reputation and performance on-chain.”

He also mentions:

“How would one price transactions and reward block producers? Using the current approach in Cardano, each transaction will be deterministically mapped to a precise value denominated in BECs, using a formula determined by the ledger rules. The formula will take into account both transaction size and its computational requirements, and may also incorporate runtime metrics (such as the average system load).”

He points out that the resulting value will be “the base fee guaranteeing that the transaction will be processed by the system.” Given the base fee, end users will be able “to apply a multiplier if they wish (which will be a value at least 1, e.g., 1.5x, 3x, etc.) to increase the fee and accelerate processing,” the Professor noted while adding that this will “become relevant at times of surging demand.”

According to Kiayias, this approach has one key advantage when compared with the first-price auction model: “the pricing mechanism is continuously stabilized to a reasonable default value.” He adds that users may carry out price discovery in one direction “only to accelerate processing, if required.” Also, transaction issuers can store BECs “to secure their future transaction-issuing ability without being affected by ada price volatility.”

He further notes that the Stablefees mechanism may be considered “a natural extension of Babel fees —spot conversion of BECs into ada by the decentralized reserve.” He also mentions that both mechanisms “complement (and are compatible with) each other.”

He points out that Babel fees may be deployed “together with Stablefees with just one change: Using BECs to cover Babel fee liabilities, instead of ADA.” This also means that fees will “always be payable in ada (via a Babel fee liability convertible in ada on the spot).” Hence, the whole mechanism “is backwards compatible: it won’t affect occasional users who just hold ada and do not wish to obtain BECs,” Kiayias explains.

He further notes:

“While the above narrative identifies a unique and global BEC, the same mechanism can be used to issue regional BECs pegged to different baskets of commodities, which could possibly be weighted differently. Such “regional” BECs will be able to increase system inclusivity, while enabling SPOs to have more fine-grained policies in terms of transaction inclusion.”

He explains that the mechanism describe above needs a decentralized reserve contract and the issuance of BECs and DECs “by the contract to buyers.” A “lite” version “avoids the reserve contract and directly adjusts the fee formula by pegging it onto the agreed basket of commodities through the price oracle,” Kiayias adds.

He also mentions that the resulting system “denominates transaction fees nominally in BECs and immediately converts them into ADA.” The payable amount fluctuates, “depending on the value of BEC,” the Professor notes while adding that the mechanism is otherwise identical, “also facilitating unidirectional price discovery through the multiplier.”

He clarifies:

“The only disadvantage is that a prospective transaction issuer has no access to a native token that enables transaction processing predictably; transaction issuers must pay fees in ada. Still, the fees will continuously adjust and remain stable via the pegging mechanism with respect to the basket. As a result, a transaction issuer will be able to organize their off-chain asset portfolio to meet their transaction needs effectively.”

Kiayias confirms that his team is looking into the fine details of the Stablefees mechanism. After this research has been completed, Stablefees may be integrated into Cardano to provide fair and predictable transaction pricing, the Professor added while noting that the price oracle and the global BEC (and regional variants, if included) will “undoubtedly find uses beyond paying transaction fees.

This should help with expanding the capabilities of decentralized applications (dApps) in the Cardano ecosystem, Kiayias wrote.

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