Basics of blockchain economics (and how it should guide protocol changes)

General
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“Should a ZEC whale dump their ZEC for BTC?”

That is the question I’ve come to in the last few weeks, after years of researching “User-Defined Assets” (or “ZRC-20 tokens”) and thinking about them and consulting with others who know a lot more than me.

Should a ZEC whale dump their ZEC for BTC, and if they do, is that good or bad for the future of economic freedom for all?

Suppose there is a ZEC Whale who owns $10,000,000 worth of ZEC (i.e., about 100,000 ZEC). And suppose that as the Zcash community, we collectively deploy a “UDA”/“ZRC-20” upgrade which allows anyone to issue any tokens that they want on top of the Zcash network.

In that case, someone will issue “ZBTC” tokens, which are redeemable for BTC coins.

At that point, the ZEC Whale will wonder to themselves. They’ll ask themselves if they should sell their ZEC and buy ZBTC instead. What are the remaining differences between the two assets? Well, if our hypothetical ZEC Whale is one of those people who believes that inflation influence price, then that would be a major factor in their decision:

ZEC is currently experiencing 12.17% inflation. BTC is currently experiencing 1.81% inflation:

Screenshot 2021-01-26 at 11.19.18
Screenshot 2021-01-26 at 11.19.182372×1269 415 KB

(source: https://messari.io/screener/cybercoinology-2021-01-04-24bc1135-24BC1135)

So if they are someone who (like me) believes that inflation influences price, then they may say “Well, if I hold ZEC, I am going to pay $1,217,000 dollars over the course of the coming year, in inflation. If I dump all my ZEC and buy ZBTC, I’ll pay $18,100 instead. So I will save $1,198,900 this year!".

Now, is this a problem if our hypothetical ZEC Whale does that? Is it compatible with the mission of Zcash?

The mission of Zcash is a decentralized thing. There isn’t just one mission of Zcash — every Zcasher gets to bring their own mission and make it part of Zcash. But our mission over at the Electric Coin Co is to “Empower people with economic freedom”.

Does this hypothetical ZEC Whale dumping all their ZEC for ZBTC help or hurt with the mission of empowering everyone with economic freedom? After all, more people would be empowered, at least in the short term, with economic freedom if they could bring their BTC over onto the Zcash platform and benefit from the unique benefits of the Zcash platform, such as the shielded pool, encrypted memos, and the future Halo-powered scalability improvements.

So, if this hypothetical ZEC Whale selling all their ZEC to buy ZBTC to save $1,198,900 in a year would further the mission of empowering everyone with economic freedom, then we should support it and make it possible!

But hold on. Where does that $1,198,900 go?

The answer is what I started with at the top of this thread:

That hypothetical ZEC Whale’s inflation is what supports the Zcash network and the Zcash platform, and what funds new initiatives that advance the mission. If all such ZEC Whales sold their ZEC to buy ZBTC instead, that would be fine for their personal economic freedom, but it defund the greater, shared mission that supports everyone else’s freedom. It would mean that the underlying Zcash platform, and ongoing initiatives to support the mission, such as the invention of new technologies like Halo, would no longer be sustainable.

So that’s why I’ve currently concluded that the right question to ask is “Should a ZEC whale dump their ZEC for ZBTC?”. Because the answer to that question determines the long-term sustainability of the Zcash mission.

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Should a ZEC whale dump their ZEC for USD?

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I’m thinking about what could be some of the potential benefits or additional outcomes/incentives/theory if a whale/whales sell ZEC for ZBTC…gonna brain fart some initial thoughts below

  1. let’s assume that whale has their holdings in a t-address, & if ZBTC is a shielded UDA then would selling for ZBTC in turn increase the shielded pool & thus increase the privacy benefits of all z-address shielded pool swimmers?

Let’s awesome that whale is a Zcash Zealot/long term holder, that would mean that most likely that would like to get their ZEC exposure back at some point? Is it after the next inflation halving? 2 more? & if the incentive to swap to ZBTC from ZEC is to save $1,198,900 in a year what happens if the ZEC/BTC makes a large price movement? Or ZEC/USD outperforms BTC/USD?

a ZEC price move of 12% would be $1,200,000, which covers the loss due to inflation, but you now are not exposed on the upside of a larger price movement of ZEC? The whale would have to believe that ZEC will not outperform a 12% move…

Not sure if any of this makes sense, sorry for the ramble…

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24

I think a better whale question would be “should I transfer my BTC to ZBTC so I can gain some privacy?” How about my ETH to ZETH?

As a whale :whale: I can take a dip in the Zcash private pools to gain privacy for my coins and take advantage of Zcashs much lower fee structure to transact with my new ZBTC before I convert it back to BTC sometime in the future.

Is there a need for UDAs to somehow use real ZEC to pay transaction fees? Thereby the more transactions using Zcash UDAs the more Zcash would be utilized?

The big value proposition I see in UDAs is not necessarily the current ZEC holders using the assets to convert ZEC to a UDA, they already have the privacy benefits. It’s attracting other coins holders to use Zcash assets.

And the additional benefit, as @decentralistdan points out is stronger privacy for all Zcash users because of more transactions moving in the shielded pool.

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Assuming that one believes Zcash the protocol & ZEC the asset are objectively good for economic freedom then decentralization of the supply from whales to new or smaller holders could be considered good…

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Hi Shawn! Thanks for the reply. So, I’m not sure if I see how your comment applies to my question:

Yes, in this hypothetical scenario where there is ZBTC, then ZBTC is definitely way better than BTC, because it has all the functionality of the Zcash platform and all of the token economics of BTC. But where does ZEC fit in?

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not sure how viable this would be but what if in order to mint any UDA(ZBTC included) one would have to collateralize the “minting” with ZEC in the shielded pool? Somewhat similar to the keep tBTC in a way…

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Hope you aren’t talking about any of the founders. A position that big would take a long time to build, and a long time to exit. We would be able to see it on the chart. Right now the chart is mostly buyers. Look at the volume. The word inflation is scary to people because they think it means they are losing money. Currently the price is outpacing the rate of inflation. So any money ‘lost’ is gained back in the form of price appreciation. I don’t think there is any incentive for a whale to dump zec for btc. I’m not an expert but wouldnt the Zcash just be wrapped to prevent the need to actually sell? You would also be taxed on that trade, whereas wrapping isn’t a taxable event.

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Lets be very clear, this is a straw-man argument against UDAs.

The straw-man is of the form “this thing that everyone says would be good for Zcash is actually bad in a way that no one else can see.” It’s like the opposite of “this is good for Bitcoin.” And actually its a common pattern we see in arguments about Zcash’s future. But there’s usually at least one logical flaw in these “this is actually bad” straw-men.

The straw-man suggests that if there existed a shielded version of Bitcoin on Zcash called ZBTC (think of this like wrapped Bitcoin on eth, but on Zcash and private), then a hypothetical Zcash whale would dump zcash to switch to ZBTC because it offered privacy without the inflation cost. And this would tank Zcash long term, even if it’s good for Zcash short term.

Problem is, this ignores the existence of competitors the whale would switch to regardless of what Zcash does. If that whale exists and the incentives are what Zooko said (more on why thats dubious later), then the instant any blockchain offers private wrapped BTC, the Zcash whale will dump ZEC and switch to that chain. Because all the whale wanted was a private medium of exchange. So if, for example Tezos launches there multi asset shielded pool or Ethereum supports privacy for wrapped BTC, that whale is gone in this straw-man And when the whale moves to another chain, he doesn’t even buy Zcash to pay transaction fees. But wait, it’s worse than that in this hypothetical straw man: If you believe such whales exist or will exist, even if you don’t care about ZBTC yourself, then you too should get out of Zcash in anticipation of them leaving for another chain when they add private assets. And you should demand UDAs for Zcash because at least then when the whale switches from ZEC to ZBTC, they will still need ZEC to pay fees.

Luckily, this straw-man probably is not true. Its hard to say conclusively, because crypto-economics is in its infancy and none of these theories are even coming from economists, but we have some empirical evidence. Ethereum didn’t tank with all the Eth whales selling Eth to buy tokens. In fact, Eth got better and stronger because tokens let other people build on eth just like UDAs will let people build on Zcash.
And remember, as I said up thread, UDAs bring more traffic to Zcash, which gives zec holders better privay, so its a value add privacy wise too and zcash users should value that.

Maybe the economics that helped Ethereum do not hold for zcash for some reason. Maybe there is a reason why this thing that nearly everyone thinks would be good for zcash is actually bad: but extraordinary claims require extraordinary evidence. And this straw-man isn’t that, its just a piece of this is bad for zcash contrarianism.

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I’m not talking about any of the founders, I’m using a hypothetical whale as an example of the decision that all zodlers would be faced with in that scenario.

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No, it is not. It is an important question that we could answer, and that I believe should be answered. I hope, and think, that we can find good answers to this question. That would show us how to build a UDA/ZRC-20 architecture that is compatible with sustainability of the Zcash mission.

(But in order for us to be able to find good answers together, the first step would be to refrain from accusing one another of arguing in bad faith.)

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33

I think the first direct benefit of (private) UDAs on Zcash would be more transactions in the shielded pool. Since Zcashs core value proposition is privacy then the stronger the privacy Zcash provides, the more valuable Zcash is to all users.

The second part, which is what I think you are getting at, is how do we make sure “ZEC the coin” itself is part of the value proposition of Zcashs UDAs?

A couple ideas:

What about mint/spend/transaction fees that must be paid in Zcash? Similar to how ETH uses gas fees?

I’m not an engineer, but is there a way to ensure users “stake” ZEC in a liquidity pool (privately) to start/use those UDAs?

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34

Zooko’s question is a good one, not in bad faith at all, and quantitatively framed. Here are some other factors to consider.

  1. ZRC-20 would add more use cases to ZEC, increasing value for ZEC, as we have seen with how ETH is needed to pay ETH fees for ERC-20s.

  2. The redemption risk of ZBTC offsets the lower inflation cost, so it’s not a lossless trade of ZEC for ZBTC. Even if trustless, you are involving two chains vs one - complexity is there.

  3. That said, the “life raft” property of ZEC as a backup chain for BTC — in the event there is some major issue with respect to privacy, eg say a chain analysis database being leaked — would increase the value of ZEC. That is, being able to import some/all of the BTC ledger to ZEC is a very valuable property.

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Thanks, Balaji, and welcome to the Zcash forum! (If you don’t know, Balaji is kind of a legend, and I’m really glad to see him engaging with the Zcash community.)

Let me try to put my question more positively:

“Why should a ZEC whale keep their ZEC instead of trading it for ZBTC?”. Because the answer to that question determines the long-term sustainability of the Zcash mission.

ZEC is coming from behind against ZBTC because of inflation (12.17% vs 1.81%), but I agree with Balaji’s and Shawn’s comments, that the answer could be built out of some combination of increasing the value of the economic activity on the Zcash blockchain, and capturing some of that value for ZEC with some kinds of fees.

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Again, if such a zec whale exists — a whale who would dump ZEC to switch to ZBTC in an instant if we built it and in doing so tank zcash— what happens when several other chains build zbtc analogs? We know they are planning to do this? Assume they do it well, what happens?

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Is ZBTC’s privacy dependent upon the ZEC blockchain?

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Literal ZBTC would need zcash, but you can build a version on Tezo or Ethereum that offers the same privacy and functionality. And people will. Tezos is planning on doing it using a modified version of sapling.

I think @balajis hit the nail on the head. Wrapped BTC isn’t risk free and never will be. So the whale Zooko has in mind who only wants wrapped private BTC (if they exist) will jump ship either to ZBTC or eth-z-btc. But there is a compelling reason for holding a native fixed supply asset that is private and those people will hold ZEC as BTC with privacy. And whatever that demand is, it certainly isn’t decreased by the existence of other assets on chain. Just look at what happened to ethereum.

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The wrong economic idea gives rise to the wrong questions, there are too many gaps in this theory, so there is no answer to this question in the form you asked, but if you add variables (the price of zcash falls for several years before this moment or rises), then the decision will change from these variables. We also add liquidity, the volume of capitalization here and we get another result, and all because there is no inflation in the sense in which you write (the more coins, the lower the price, because there are no more than 21 million coins), and there is no value transfer, there are simple market rules.
For zec, there is the concept of inflation only in the classical representation, when for 1 unit you can buy 1 unit of goods (in this case, the price in dollars or in pairs with bitcoins or altcoins may have different inflation), for zec inflation does not depend on output, there is no connection to these two charts with any other commodity, in bitcoins and ethereum, inflation is far ahead of release. So the question should be: Does high inflation jeopardize Zcash’s mission? I think definitely YES! And what you wrote is not in any case, because it is only a tool, and it depends on the circumstances.

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If ZBTC is dependent on ZEC blockchain, I don’t see the problem here. If Zcash’s privacy is so valuable that ZBTC becomes highly desired, ZEC’s price will have to increase to reduce the risk of 51% attack on the blockchain that enables ZBTC.

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or do one-off Zcash inflation rate adj while keeping max supply unchanged? (unpopular idea).