Authors: Cody Born & Isaac Wooden
<aside> 🗺️ Abstract Both fiat currency and cryptocurrency systems today are non-ideal forms of money. Cryptocurrencies like BTC and ETH act as long-term stores of value, however their volatility and illiquidity prevent them from being used as reliable alternatives to cash. USD is a great proxy for near-term future value, however its buying power can be unpredictable due to rapid changes in monetary policy. This paper proposes an alternative global currency to fiat that more tightly tracks the buying power needs of people around the world using the price of energy. Because energy is strongly correlated to cost-of-living, is a globally supplied resource and is resilient to positive supply shocks, an energy-pegged asset is an ideal short-term store of value. We can achieve a liquid and decentralized energy currency protocol on Ethereum that leverages the hashrate difficulty and price of Bitcoin to derive a decentralized price peg for this new synthetic asset.
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Today, stablecoins are still stuck in the skeuomorphic design phase. Despite the expressiveness of Ethereum and ability to reinvent money from the ground up, the best stablecoins that we’ve built are variations of fiat currencies that we already use today like DAI and USDC. Holding a US dollar-pegged asset is great for everyday use since the US dollar is the global reserve currency, providing holders a decent hedge against asset volatility; however, as we’ve seen in recent years, USD has had periods of pronounced inflation and illiquidity. With much of the global energy supply denominated in USD and the war in Ukraine leading to a global energy crisis, many countries have legitimate concerns over their ability to provide energy for their citizens. Similarly, people around the world have watched years of fiat-denominated savings inflated away, disrupting their ability to plan for the future. If we were to rethink a global currency from the ground-up, we would require one that is both liquid when people need it and one that retains its buying power over time.
To build a sound money system, we need to first identify a better asset that we can peg our currency to. We require a resource that operates globally; one whos supply cannot be controlled by any single entity. To retain its buying power, the resource this currency uses as its foundation must also be strongly correlated to the changes in cost of living. The solution is energy.
Energy is not only used to heat our homes, but acts as the primary constituent in everything we consume. When the price of energy rises, it directly impacts the costs of almost every segment of every supply chain. Resource extraction, processing, manufacturing, transportation, and labor all require energy.
CPI vs Energy vs Gold prices (log scale - United States)
In this time-series chart, we can see that US energy prices are a better approximation for US cost of living (CPI) compared to gold (r² of .911 for energy vs .689 for gold). We use gold as a comparison since gold has historically been used as an inflation hedge. Note that all three variables are denominated in USD and therefore the US dollar would be a flat line if it appeared on this graph.
Correlation between Energy and CPI MoM changes
No correlation between Gold and CPI MoM changes
These next two charts look at the month-over-month percentage changes of energy and gold compared to the CPI as the baseline. Again, this shows that energy has a much stronger correlation to CPI than compared to gold (r² of .467 vs .028). Since the price of energy is correlated with the general cost of living, using energy can act as an ideal store of value as it doesn’t lose purchasing power over time.
Unlike most resources, energy isn’t tied to any one source or nation. We can generate energy from oil, nuclear, and renewables allowing us to upgrade and adapt its sourcing over time. Additionally, energy benefits from induced-demand. Cheaper energy leads to new uses of energy, shifting the supply-demand relationship and dampening the downward price impact of a potential positive supply-shock due to technology improvements.
To create a synthetic energy token with high liquidity, we follow the proven model of MakerDAO, the decentralized issuer and governor of DAI, a USD-pegged stablecoin with $5.7B in circulating liquidity. MakerDAO is a collateralized debt protocol that achieves a USD-pegged asset by leveraging volatile assets like ETH as collateral and using a ETH/USD price oracle to determine the issuance rate and liquidation ratios. As long as the locked-collateral (eg ETH) is worth more than the outstanding debt (DAI), debt holders can be certain that their asset is redeemable for collateral worth the current USD value of their DAI. Although ETH is not great money due to its volatility and illiquidity, ETH acts as great collateral. Because ETH is deflationary, if demand remains constant over time it can generally outperform most borrowed assets. Under normal operating conditions, the liquidity of the collateral asset doesn’t impact the liquidity of the debt asset; however liquidity is important for managing liquidations during rapid drawdowns of the collateral asset. This is generally handled in MakerDAO by having a lender-of-last-resort willing to step-in and provide liquidity during periods of extreme volatility. In this case, the lender-of-last-resort is the DAO itself.
If we have a price oracle for energy in terms of assets like ETH we can create a synthetic energy asset that tracks the value of energy, similar to how MakerDAO uses a USD price feed to create DAI. For the sake of security, it’s important that this energy price oracle is decentralized and cannot be manipulated to deviate the peg.