Why the Prices of the Tokens Won’t Permanently Collapse into Each Other
by Ruadhan
The four Seasonal Tokens were designed so that their prices would cycle around each other, allowing holders of the tokens to profit by trading along with the cycles. Whenever we say this, we always need to make the following true statement: Nobody can guarantee the future behavior of prices. How the prices behave depends on the actions of many market participants, and nobody can predict with certainty what they will do.
Anyone who wants to use Seasonal Tokens needs to understand that there is no guarantee that the prices will continue to cycle around each other. Nobody has made that promise, and there is nobody to sue if the prices behave differently.
What is guaranteed is that the rates of production will cycle around each other, because these rates are coded into the tokens’ smart contracts. This tends to make the prices cycle around each other, because of the effect of supply on the market price.
However, supply is not the only thing that affects the price. There’s also demand, which comes from the combined actions of many people, and isn’t controlled by the contracts. We can’t predict demand with any certainty, so we can’t say with absolute certainty how the prices will behave.
This sometimes leads to fear of a possible “doomsday scenario” for Seasonal Tokens, in which the tokens all have the same price permanently, leaving no opportunities to trade tokens for more tokens. If that were to happen, the Seasonal Tokens would become just like any other proof-of-work cryptocurrency, with increasing scarcity but with no additional source of profit.
Here, we’ll look at what would happen if the token prices were equal to each other for a prolonged period of time, and we’ll find that, far from being a disaster, such a market condition would provide a great opportunity for profit, and would be temporary.
Some Scenarios that Could Lead to Equal Prices
If the prices of the four tokens are equal to each other, then it means that someone is willing to trade tokens at a one-to-one rate. Who would do that?
One possibility is that someone is deliberately pegging the prices to each other, manipulating the market by artificially keeping the prices equal.
Another possibility is that many people are taking tiny profits as soon as a tiny price difference appears. If everyone rushes to trade 1 Spring token for 1.001 Summer tokens whenever the Spring/Summer price reaches 1.001, then they’ll make almost no profit and they’ll push the prices back together.
Let’s refer to whoever is willing to trade tokens at a one-to-one rate as “the entity”, which could be a single market participant or many people acting independently. The prices can only be kept equal to each other for as long as the entity can continue to trade tokens at a one-to-one rate.
If the entity runs out of one of the tokens, then it will no longer be able to provide that token to the market, and consequently, it will lose control of that token’s price.
What to Do if the Prices are All Equal to Each Other
If the four tokens all have the same price, then that means that you can trade tokens for the same number of tokens of a different type. If you have 100 Spring tokens, then you can trade them for 100 Summer, Autumn or Winter tokens.
If there’s an entity pegging the prices to each other, then that entity is effectively offering to swap any number of tokens for tokens of a different type. In that situation, it’s rational to trade other tokens for the token that’s produced at the slowest rate.
For example, right now, Autumn is produced at the slowest rate. If people can trade Spring, Summer and Winter tokens for Autumn at a one-to-one rate, it makes sense to do so, in large quantities. Collectively, Spring, Summer and Winter outnumber Autumn tokens by about 3 to 1. The entity can’t possibly have enough Autumn tokens to keep providing them in exchange for equal numbers of the other three tokens. Eventually, the entity will run out of Autumn.
When that happens, the peg will break. The supply from mining will take control of the price, and, since Autumn is produced at the slowest rate, its price will tend to rise, and the entity won’t be able to suppress it.
Educating the Entity
An Autumn token is mined every 10 seconds on average, so in terms of mining time, an Autumn token is worth 10 seconds, and a Winter token is worth 6 seconds. The natural Autumn/Winter price is therefore 10/6, or about 1.66 Winter tokens per Autumn token.
If the entity disagrees, and believes that 1 Autumn token is only worth 1 Winter token, and is consequently willing to trade at a one-to-one rate, then it is willing to give away all its Autumn tokens for an equal number of Winter tokens.
After that happens, the entity’s offer of one Autumn for one Winter will end. The miners will be the ones who provide Autumn tokens to the market, and the miners know very well that one Autumn token is worth 10 seconds of mining time. Without the entity providing cheap Autumn, the Autumn price will have to rise to reflect the mining time.
The entity won’t be able to get 1 Autumn token for 1 Winter token after this happens. It will learn that Autumn tokens are really worth more than Winter tokens, and it will have been an expensive lesson.
Someone who is willing to give one ounce of gold for one ounce of silver is making the same mistake. They’ll be able to keep doing that, effectively fixing the gold/silver exchange rate at 1, but only until they run out of gold.
The lesson is that the supply from mining sets the “real” or natural exchange rate between the tokens, and someone who tries to peg the exchange rates to a different value can be forced to accept reality, which they will have to do when they run out of one of the tokens. Before that happens, they can maintain the peg, but, just like someone who gives an ounce of gold for an ounce of silver, they’re effectively giving money away.
Tiny Price Differences
If the prices are exactly equal, then you can trade 100 Winter tokens for 100 Autumn tokens, and you still have 100 tokens in total. If there’s a tiny difference in price, you might only get 99 Autumn tokens for 100 Winter tokens. Making that trade would decrease the total number of tokens you own. You would lose the guarantee that the number of tokens you own will never decrease. You would be taking a risk.
However, not everyone in the market is so risk-averse that they won’t risk a loss to make a profit. There are plenty of market participants who will understand that an exchange rate of 99/100 also can’t be sustained forever. These people will, rationally, accept the small loss in the total number of tokens they own, anticipating a profit when the prices move apart, which they can cause to happen by making these trades.
So in the long term, the prices can’t be exactly equal to each other permanently, and they can’t be so close to each other that they’re effectively equal. There will be price differences which are large enough to have a significant economic impact.
How Large Will the Differences in Price Be?
The supply from mining tends to push the prices towards the ratio of the mining times. So miners push the Autumn/Winter exchange rate towards 1.66. However, when people trade tokens for more tokens, they push the prices together.
These two forces reach an equilibrium at an exchange rate in between 1 and 1.66, when the two forces cancel each out. Exactly where this balance occurs can’t be predicted, because it depends on the behavior of the market participants, and, specifically, it depends on how much profit they demand before they make a trade.
If everyone is willing to trade 1 token for 1.01 tokens but not fewer, then they’ll trade whenever the exchange rate goes above 1.01, and will push it back down to 1.01. This is only a 1% profit with each trade, and, once you’re holding the cheapest token, you need to wait until after the next halving before you can trade again. This is a very small profit, and it’s unlikely that cryptocurrency investors would accept such a low rate of return.
As explained above, the people who do trade 1 token for 1.01 tokens will eventually run out of the most expensive token, and then they won’t suppress its price any more. There are nine months between one halving and the next, which is plenty of time. If a lot of people rush to take a tiny 1% profit, they’re likely to stop doing that before the season changes, allowing other investors to take advantage of larger price differences.
For people who want larger gains, the right procedure is to watch the prices for good opportunities to trade, namely when there’s a large price difference. An exchange rate of 1.05 might be easily achievable on a typical day, while an exchange rate of 1.15 might occur rarely. If most people are willing to trade when the rate goes above 1.1 but not at lower rates, then, when they do, they’ll push the exchange rate back down to 1.1.
In short, there’s a market for profits, and the exchange rate achievable will be set by the aggregate behavior of the market participants. The profit that you can make won’t be so low that it’s an undesirable investment, because if it is, then people will leave and invest in something else. The market will find a balance where the profits achievable are competitive with other investments.
Disclaimer
This blog post is not intended to be financial advice, and does not make any guarantees about future prices. It is intended to allow the reader to understand the market forces that affect the relative prices of the four Seasonal Tokens. There are unpredictable elements that influence the prices, making it impossible to make guarantees. Markets can behave irrationally, even for long periods of time, and so it is possible that the future prices will not behave as expected.
