Decentralized Liquidity System
In order to prevent a single point of failure and be highly adaptive to changing market conditions, the Element Zero Liquidity System acts in a completely decentralized manner, using machine learning to manage all decisions. This includes the amount that should be held in the Liquidity and Holding Reserves, how many coins/tokens to hold of each cryptocurrency, how to invest the funds in the Holding Reserve and when to liquidate, as well as when to allow redemption and initiate circuit breakers.
Element Zero’s liquidity system has two reserves, a Liquidity Reserve and a Holding Reserve. These are both managed by an Artificial Intelligence (AI) system. The Liquidity Reserve is a pool to support the on-going liquidity, and it allows users to contribute and redeem funds using widely accepted cryptocurrencies. The Holding Reserve consists of asset investments for steady, long-term growth and acts as a backup reserve, holding a large number of assets tokens. These asset tokens are based on conservative class assets, such as commercial real estate. The Liquidity Reserve and the Holding Reserve maintain a relationship based on lending and borrowing funds from each other to balance events due to high redemption or contribution demand.
Many years ago, banks used a collateral system based on gold. Clients would deposit gold into bank vaults and would receive “paper money” or a “note” in return. The notes stated the bank was holding the gold on behalf of the owner of the note. When the owner of the note wanted to redeem their gold, instead of physically obtaining the gold, they would simply sell their note to someone else and so on. The system worked because of people’s trust in the note. It was based on a physical commodity, therefore honored by banks.
Over the years, banks have changed their system and stopped using gold as collateral. Today, banks function on a hybrid of collateralized and non-collateralized systems. When a bank receives a deposit from a customer, the deposit is leveraged multiple times and offered to other customers through banknotes (such as a loans). The main concern with the hybrid approach is what happens if all the clients want to liquidate their deposits at the same time (this scenario is called a “run on the bank”). Banks have identified three ways to mitigate this:
- Maintain a liquid reserve to cover ongoing requests.
- Reduce any liquidity pressure by selling loan notes to other banks. And,
- In the case whereby the bank has to pay out on more notes than the available liquid funds allow, the bank can leverage their non-liquid assets and future income to borrow funds from the backup reserve at the central bank.
A hybrid of a collateralized/non-collateralized system is essentially a system (similar to the banking system referenced above) that can effectively manage its liquidity when it does not have enough funds in the reserve to cover redemptions when notes are all the requested at the same time. The key to a successful liquidity system based on this hybrid system is creating a reserve large enough to support ongoing redemption requests, even if the cryptocurrency market crashes. This kind of reserve supports a strong level of trust amongst users and promotes the development of a significant secondary market where users can trade stablecoins between themselves, knowing there is always liquidity available.
Additionally, this method eliminates the potential for rumors to negatively impact the stablecoin’s reputation. Even if there are Circuit Breakers with a daily redemption limit. As long as users are able to redeem coins in exchange for the current value of the stablecoin from the reserve, the liquidity of the coin itself is proof it will overcome any negative rumors.
