Graphene market pegged assets are a new type of freely traded digital asset whose value is meant to track the value of a conventional asset such as the U.S. dollar or gold. What makes market pegged assets unique is that they are free from counter party risk. Graphene uses an advanced decentralized consensus ledger that takes some cues from Bitcoin. While Bitcoin has demonstrated many useful properties as a currency, its price volatility makes it risky to hold and difficult to use for everyday pricing and payments. A currency with the properties and advantages of Bitcoin that maintains price parity with a globally adopted currency such as the US dollar has high utility for convenient and censorship resistant commerce. This paper will explain how market pegged assets including “gpUSD” (intended to track the value of the US dollar) achieve price parity while minimizing risk to holders.
Bitcoin and similar crypto-currencies track transferrable digital tokens secured by private cryptographic keys over a decentralized computer network. A consensus mechanism ensures tokens are not duplicated and all participants agree on the state of the system without need for a central validating authority. This consensus is recorded on a decentralized shared ledger called a “block chain”. These systems have been found to enable value storage and exchange over the internet beyond the control or censorship of a centralized party. Demand for this utility has driven up the price of crypto-currencies. Graphene uses an analogous core token simply called Graphene that is traded with the abbreviation “GPH” on exchanges. Like Bitcoin, the exchange rate between GPH and major currencies remains volatile.
A Graphene market pegged asset can be viewed as a contract between an asset buyer seeking price stability and a “short seller” seeking greater exposure to GPH price movement. The open source Graphene software program implements a decentralized marketplace for market pegged assets where all transactions are recorded on the shared block chain ledger and the software enforces the market rules. This block chain based marketplace is referred to as the “internal market” to distinguish from “external markets” such as websites that facilitate the exchange of government issued currencies with crypto-currency. A GPH holder may use her GPH to place a buy order on this internal market for her asset of choice.
The rules considered thus far do not specifically restrict the internal exchange rate between gpUSD and GPH in a way that ensures it will track the external exchange rate between USD and GPH. A first step toward this goal is to get reliable information about the external exchange rate into the internal market algorithm. It is not immediately obvious how this is accomplished in a way that is resistant to control and manipulation by a central party. Thankfully, the consensus mechanism used for Graphene utilizes a carefully considered real-time stake-weighted approval voting system to elect “delegates” who are motivated to act in the best interest of the system and its stakeholders. These delegates run computers on the Graphene network that check and commit broadcasted transactions to the block chain ledger. The trusted delegates can also be used to input external exchange rates into the block chain so that the software algorithm can incorporate this information into the market rules. This external exchange rate information is called a “price feed.” Delegates typically combine price information from multiple sources, such as external exchanges, to generate a price feed and update it regularly. The system takes a median of all price feeds so that manipulation of the price information would be very difficult by any single delegate or party without considerable collusion. The price feed and other delegate behavior is publically auditable and delegates may be voted out by GPH holders at any time.
It is important to consider how the price feed can be used to regulate the internal market. Both GPH and market pegged assets are freely transferrable tokens. If the internal market restricted trading to occur only at the specific exchange rate determined by the median price feed, it would simply encourage anyone willing to trade at a different price to do so outside the system, such as on an external exchange.
The motivation to participate in the system is different for short sellers and market pegged asset buyers. Market pegged asset holders are typically looking for predictable value coupled with the properties of a crypto-currency. Short sellers are typically bullish on the price of GPH and wish to capitalize on increased exposure to market movement relative to the market pegged asset. If the market value of GPH rises with respect to the asset, the short seller can buy back the asset for significantly less GPH and profit accordingly. If GPH value falls in relation to the market pegged asset, the short seller faces a greater loss than if they were to have simply held GPH. Ultimately a short seller may face a “margin call” where his collateral is automatically used repay the obligation. A margin call is triggered in the current Graphene system whenever collateral contains less than 2 times the amount of GPH required to cover the obligation.
Thе "collateral" is only returned to the short seller when assets are purchased back from the market and effectively destroyed to fulfill the contract. This is referred to as “covering a short.” If the value of the collateral relative to the current price of the market pegged asset falls below a certain margin of safety the assets can be automatically repurchased from the market before collateral becomes insufficient. These rules create systemic demand for market pegged assets while allowing them to remain fungible.
Market orders and other signed transactions on the Graphene block chain are grouped into 3 second blocks by delegates. When buy and sell orders on the internal Graphene’ market are matched, the highest buy orders are matched with the lowest sell orders.
Control over the price feed is distributed among separately elected delegates who compile information from exchange sources. Despite such precautions, it is important to carefully explore risks of using the system. Risks can be broadly categorized as value risk, counterparty risk, or systemic risk.
Market pegged assets maintain their price parity due to being backed by collateral that has an established real world value. When the value of the collateral falls, the system is designed to react by driving the internal asset exchange to match the new real world exchange rate and trigger margin calls as necessary. However, there exists a possibility that the underlying collateral (GPH) drops in value so quickly the market pegged assets become under-collateralized. Often termed a “black swan event,” a sudden crash of GPH value could prevent the system from adjusting in time. In this event, the full amount of collateral is no longer sufficient to purchase the market pegged asset back at the new real exchange rate. In such an event, assets may trade below their face value. It is possible the market could recover if GPH regained value. It is also possible the market would need to be “reset” and asset holders forced to settle for GPH collateral worth less than the intended face value of their assets. Under normal conditions, short term market movements, spreads, and fees charged by exchanges may also affect the potential cost of conversion into and out of market pegged assets
Unlike many attempts to create a digital asset that tracks the dollar, market pegged asset are not an “I owe you” issued by any entity. For this reason, it does not rely on a specific counterparty to honor its value. Although manipulation risk occurs in any market, it is minimized by the open source and auditable nature of the Graphene system and carefully considered market rules. gpAssets stored on an exchange become IOUs and are subject to counter party risk just like storing bitcoin on an exchange. This risk is not a property of the gpAssets themselves. We recomend that users never deposit gpAssets on an exchange and instead only use gateways that issue their IOUs onto the Graphene network. This way you can trade your gpUSD against gateway IOUs without exposing your gpUSD to counter party risk while in the order book.
Systemic risk is a catch-all for other risks required to utilize the system. The primary risk is individuals are responsible for protecting the cryptographic private keys that sign transactions proving ownership of assets. These keys must be protected from theft or loss. This risk can be greatly reduced and virtually eliminated by following best practices. Systemic risk also includes the possibility of an overlooked fatal flaw in the open source software or the possibility of large scale failure of global network infrastructure.
Graphene market pegged assets are a viable open source alternative to the incumbent banking system. Achieving price parity with a commonly used currency facilitates pricing and acceptance by merchants. Additionally it reduces the need to calculate capital gains and losses on volatile assets to determine tax liability. While certain risks of the system have been outlined, no system is without risk. The current banking system allows private funds to be frozen or confiscated without consent, such as by court order or administrative actions. Banks and financial institutions are susceptible to insolvency. The availability and quality of banking service varies greatly throughout the world. Graphene brings publically auditable open source banking to anyone with access to the internet. Market pegged assets allow savers and spenders to choose preferred asset types. This brings flexibility and ease of use to the open source banking experience.