Steem - Part 1 - An Analytical Look

I felt since this website is powered by Steem, it would make sense to post about it first. This is part 1 of a two part series on Steem. In this part, I will discuss Steem's overall model, what it aims to accomplish, and I will examine the Steem token as well as its derivatives.

Background:

Steem positions itself as the token of the Steemit community, allowing for the elimination of fee based micro-transactions that plague other for profit communities while providing a Reddit like forum. The entire concept of the token is that it represents value, even at a minimal level, of the curation, creation, and interaction with information on its site that is not captured on other platforms.

"There are some key principles that have been used to guide the design of Steem. The most important principle is that everyone who contributes to a venture should receive pro-rata ownership, payment or debt from the venture."
Steemit white paper page 5

The idea is that the "venture" here is the social network, and all of us interacting with it (even me typing this now) are contributing value which should be represented in some sort of returned value. This is in contrast to platforms like Reddit who do not reward users in any monetary way. The Steem token, and its derivatives that I will cover later, represent this value to be distributed to community members.

The Model

Steemit and its token are attempting to handle a very real problem in internet information sharing that is not currently handled by existing models.

Per Steemit itself:

Steem is designed around a relatively simple concept: everyone’s meaningful contribution to the community should be recognized for the value it adds. When people are recognized for their meaningful contributions, they continue contributing and the community grows. Any imbalance in the give and take within a community is unsustainable. Eventually the givers grow tired of supporting the takers and disengage from the community.
Steemit white paper page 6

This can be seen on other failed models, the two most applicable here are YouTube and Reddit.

Reddit
Reddit fails its model because all value generated by users is collected by the company itself rather than the users themselves. It is effectively feeding off of the free information given to it through its user base and really only providing a central platform to post on. Reddit does track "value" added through karma points, however as Reddit users will tell you themselves, they only represent "worthless internet points". Although, interestingly enough, users on Reddit tend to compete and take pride in their "worthless internet point" totals. More on this later.

YouTube
While not a blogging or posting site, YouTube falls into the same category as Reddit by leeching off of free content provided by its users. YouTube does a better job of managing this than Reddit because it does compensate its users through actual real money rather than "worthless internet points". The failure of YouTube has been its mass "censorship" campaign, effectively silencing creators that advertisers do not "like". This shows its preference to please advertisers rather than its community, and it also shows the authoritarian control YouTube wields over its community.

Steemit's model is to use the Steem token and its derivatives to allow compensation to remain within the community while still allowing the community to self regulate. The goal here is to provide real world value to users like YouTube does but without the conflict of interest that advertiser generated revenue brings.

This is accomplished through a voting system that is reminiscent of Reddit karma but also by combining payments of the Steem token to be given through generation of points based on upvotes or downvotes. Effectively, Steem is paid to users through how much the community approves and consumes their content.

Steem Token

Without getting into the specifics of the technology here, Steem is a token hosted on its own blockchain that represents contributions made through members. It is effectively power that a user holds in the Steemit community, garnered through time spent contributing or through purchasing of the token in the open markets.

The Steem founders clearly have a background in corporate finance as they have broken their token down into two separate instruments that represent the two types of funding that a company can receive, debt and equity.

There are two items a community can offer to attract capital: debt and ownership. Those who buy ownership profit when the community grows but lose if the community shrinks. Those who buy debt are guaranteed a certain amount of interest but do not get to participate in any profits realized by the growth of the community. Both types of capital contributions are valuable to the growth of the community and value of its currency.
Steem white paper page 7

The breakdown here matters because the founders clearly saw how volatile crypto currencies like bitcoin can move, so they decided to introduce a "lockup period" or as they call it "vesting schedule" to the token by means of breaking Steem down into Steem Power (SP) and Steem Dollars (SBD) to represent equity and debt respectively.

Why would they do this? They do this because when you introduce a vesting schedule into any sort of investment instrument, you are forcing owners of these instruments, especially equity owners, to make decisions that will be in the best interest of their instrument over the period of the vesting schedule. Effectively, holders of these instruments are "long term investors" that will be less likely to attempt to manipulate the short term value of their instruments like many other crypto currency holders do.

Steem Power

Per Steem itself:

Start up companies require long-term capital commitment. Those who invest their money in a startup expect to wait years before they can sell their shares and realize their profits. Without long-term commitment, a startup seeking to raise additional capital through the sale of additional shares would be competing with existing shareholders looking to exit. Savvy investors want their capital contributions to grow the company, but growth cannot happen if the new capital is given away to those looking to exit.
Steem white paper page 8

Steem Power effectively is locked up equity or ownership that you cannot easily sell. It represents your overall stake in the Steemit community while disallowing you from easily selling out of that stake on a whim, an attempt to create a long term vision for owners. It is similar to owning a stock in a company that you are only able to sell over a 13 week period broken into 13 equal payments of your stock's value.

Steem power gives you more influence in the Steemit community because it "powers you up". This allows your votes to count for more, which in effect gives you more power over the project to shape its future.

Steem attempts to manage its own price internally for its conversion of Steem Power into Steem by managing "witnesses" who act similar to miners that vouch for the price. The idea is to use the median 3.5 day trailing price as verified by these witnesses to fight against both market manipulators as well as short term price volatility.

Steem Dollars (SBD)

Steem Based Dollars, which is what SBD stands for despite Steem itself referring to them as "Steem Dollars" repeatedly, are compared to convertable notes by Steem:

Steem Dollars are created by a mechanism similar to convertible notes, which are often used to fund startups. In the startup world, convertible notes are short-term debt instruments that can be converted to ownership at a rate determined in the future, typically during a future funding round.
Steem white paper page 9

A convertible note to those that do not know financial lingo is a type of debt instrument issued by companies, usually smaller companies or startups, that allow the owner of it to enjoy a kind of hybrid instrument. Convertibles pay an interest rate like a loan or a savings account (although they are not guaranteed like savings accounts), but they allow the owners an option to "convert" the debt instrument into equity at some point in time.

SBD attempts to mimic this by disallowing you to sell your SBD and only allows you to convert SBD back into Steem based on a waiting period as defined by Steem. This effectively acts like the vesting schedule for Steem Power, but is much shorter. It still dissuades users from "day trading" these instruments however.

SBD pays interest much like any debt instrument, and this is where things get really interesting. Steem is attempting to manage their own interest rates through the same mechanism that they use to derive conversion prices of Steem Power into Steem itself. The mechanism described is similar to how central banks manage their own currencies.

SBD pays holders interest. The interest rate is set by the same people who publish the price feed so that it can adapt to changing market conditions. All debt carries risk to the lender. Someone who holds SBD without redeeming it is effectively lending the community the value of a dollar. They are trusting that at some point in the future someone will be willing to buy the SBD from them for a dollar or that there will be speculators and investors willing to buy the STEEM they convert it into.
Steem white paper page 11

The white paper discusses the metrics for controlling the interest rate as well as pegging the value of SBD to $1. The creators astutely point out the fallacy of attempting to peg SBD to $1, control interest rates, and control the SBD supply at the same time, as can be seen through the "Impossible Trinity" in economics.

What is interesting here is the Steem creators are attempting to fill the role of the Federal Reserve in a cryptocurrency, which violates a lot of the value that people derive from decentralized cryptocurrencies. Instead, the owners want to control the value, quantity, and interest rate of SBD, similar to what the fed attempts to do with the USD.

Any time SBD is consistently trading above $1.00 USD interest payments must be stopped. In a market where 0% interest on debt still demands a premium, it is safe to say the market is willing to extend more credit than the debt the community is willing to take on. If this happens a SBD will be valued at more than $1.00 and there is little the community can do without charging negative interest rates.
Steem white paper page 11

If SBD trades for less than $1.00 USD and the debt-to-ownership ratio is high, then the feeds should be adjusted upward give more STEEM per SBD. This will increase demand for SBD while also reducing the debt-to-ownership ratio and returning SBD to parity with USD.
Steem white paper page 12

This brings up a point that white paper does not cover which is the fact that SBD owners can be given negative interest rates based on these mechanics. This is sort of a violation of the promise that the white paper makes earlier that debt holders should be given an interest payment for the money they lend the Steem community. For those that do not know, a negative interest rate means Steem will charge you money for your SBD rather than pay you interest. This is similar to variable interest rate notes, and this mechanism will very likely create the market for interest rate swaps on SBD.

I won't cover it here, but this brings up a whole discussion of monetary policy and the value of SBD, and by extension SP and Steem itself. I will cover this in part 2 of this post where valuation and monetary policy are discussed. Suffice to say, this type of monetary policy is exceptionally Keynesian in nature, and lends itself to abuse from those that control it. We will examine how Steem plans to manage this in part 2.

Conclusion

In part 1, we took a look at Steemit, its model, and its currency. We examined the value that it proposes through this new model and also took a brief look at the derivatives of Steem, Steem Power, and Steem Based Dollars. In part 2, I will discuss the economic model that this idea proposes, comparisons of it to the real world, and how to value Steem based on these comparisons.