Economic Background of Feed Price Discount

Economically, the feed price discount is a market intervention. In the free Steem Dollar market, the demand is much smaller than the supply mainly due to negligible usage of Steem Dollars (e.g. no market place using Steem Dollar yet). As a result, since late July, Steem Dollar price went down below $1.00 or even $0.90 combined with downtrending STEEM market (when STEEM price is rising, demands for Steem Dollar increase since SBD conversion is more likely to provide profits). In this context, Dan suggested feed price discount 2 months ago.
Basically, feed price discount is like a subsidy that moves the demand curve uptoward, and hence increase the market price. In the opposite side, witnesses can add premium to feed price (which can be compared to a tax), which move down the demand curve especially when Steem Dollar(SBD) price is greater than $1.00. But if you took Economics 101, you heard that market interventions can generate deadweight loss, and hence they are not desirable unless market failures, such as externalities, exist. Then, what are we gaining and what are we losing with the feed price discount?

The Two-edged Sword

The main benefit of feed discount is having a stronger peg in the bearish market. Helping the peg can be justified if we have a consensus that it supports the expansion of Steem ecosystem (e.g. attracting merchants). Imagine that SBD price is only $0.50. Rewarded authors will be dissatisfied, merchants will complaining, and it is not a pegged cryptocurrency anymore. The pegged Steem Dollar is a key part of our ecosystem as a real currency that can be used in real worlds.

But there is nothing free. The feed price discount also has negative sides. It will attract more SBD conversions, which usually generate additional sell pressures on STEEM, and consequently pull down STEEM price and every STEEM holders will be worse off. It is a quite surprising that about 15% total STEEM sells were generated from SBD conversion in October (477/2874k) and 8% in November (204/2440k). Surely, this numbers are not deterministic, but they are enough big to influence the market.

Reducing Debt Is Not Equal to Reducing Debt Ratio

One more thing that should be considered is a debt problem. Since SBD is a STEEM derivative, excessively high market cap of SBD compared to STEEM market cap can potentially destruct the system. So one would argue that we have to reduce the SBD(debt) more actively by incentivizing SBD converters more with high discount rates. It sounds reasonable, but has some blind points. First, since SBD conversion is linked to STEEM price decrease, it has unclear outcome in terms of the debt ratio, while it obviously decreases the total debt amount(SBD supply). Actually, the debt ratio is negatively and highly correlated with debt amount(-0.95) that shows decreases in debt amount rather increase debt ratio.

As a Converter, I Am Enjoying High Discount, But...

I personally much benefit from the discount. I earned over 10% in a month only by SBD conversion despite that I am buying SBD at around the peg. However, I am now against high discount rates, which give me more money because I believe it is less necessary in recent stabled or rising STEEM market. If the market is not downtrending, excessively high feed price discount will result in one of the two. 1) If SBD buyers do not compete each other and they make a tacit agreement not to buy SBD over $1.00 (so a kind of oligopoly situation), there will be more free money for them caused by the discount. For instance, if STEEM price remains the same and 10% discount, every SBD conversion will gain at least 10% profit if they do not buy above $1.00. 2) If there is severe competition among SBD buyers, SBD price will increase above $1.00 at where the marginal revenue becomes zero. Either of them is not intended in our system, and we should remind that feed price discount produces additional sell pressures on STEEM.

Be Reactive

Ideally, the discount level should be no more and no less than future STEEM price changes, if we have a time machine. It is impossible, so practically, the discount rate has to be very responsive to SBD price and STEEM market condition. If the market is expected to be bullish or is bullish, or at least stabled, the discount rate should be decreased even below zero. When the market is bearish or SBD price is significantly smaller than $1.00, the discount rate should be increased quickly. We do not have to be too much proactive worrying potential incoming downtrends, rather we have to reactive. Furthermore, the shorter conversion period after next hardfork (3.5 days) makes SBD conversion less risky so that the discount also reduced.