1.5 Thinking Fast & Slow

The Ampleforth protocol establishes a set of initial conditions and incentives for the network. And although the protocol propagates price information into supply, it’s the actors that propagate supply information back into price.

Recall that the Ampleforth protocol programmatically sets supply targets, which is important because the promise of elastic supply needs to be strictly enforced. However, changing supply does not mean that traders will correspondingly adjust their bids.

In practice, traders will respond to supply changes based on how quickly or slowly they think others will respond, ultimately seeking to buy low and sell high.

Inductive Explanation

To illustrate, it helps to separate fast traders, FT, who operate on short trading windows from slow traders, ST, who operate on long trading windows. The total set of traders,T, is the combined set of fast and slow traders, T = FT ∪ ST.

To a slow trader who typically holds for long periods and only occasionally buys and sells, whether demand-information is reflected in price or count makes no difference with respect to net balance.

But for a fast trader who benefits from near term trades, expansion and contraction events present gain opportunities. Consider the following example:

Slow Trader: Let’s imagine Alice is a slow trader who buys and sells infrequently. She checks in at time, t0, and sees that she has 1 Ample worth $1.2. Later she checks in at t1, and sees that she now has 1.2 Amples each worth $1.
  • Alice at t0:
    1 coin, worth $1.2/coin
  • Alice at t1:
    1.2 coins, worth $1/coin

Since Alice′s net balance at t0 and t1 are equivalent, there isn’t any compelling reason for her to buy or sell before or after the state change. But for a fast trader, there is an additional state to consider:

Fast Trader (Expansion): Let’s imagine Bob is a fast trader who buys and sells frequently. He checks in before expansion at state t0, again while the system is expanding at state t1, and finally after expansion at state t2.
  • Bob at t0:
    1 coin, worth $1.2/coin
  • Bob at t1:
    1.2 coins, worth $1.2/coin (sell opportunity)
  • Bob at t2:
    1.2 coins, worth $1/coin

At t1, there’s a limited opportunity for Bob to sell more units than he could have at t0 for the same price before other fast traders take advantage of the opportunity and drive the price back down. And the opposite is true in the event of contraction:

Fast Trader (Contraction): Let’s imagine Charlie is a fast trader who buys and sells frequently. He checks in before contraction at state t0, again while the system is contracting at state t1, and finally after contraction at state t2.
  • Charlie at t0:
    1 coin, worth 0.8/coin
  • Charlie at t1:
    0.8 coins, worth 0.8/coin (buy opportunity)
  • Charlie at t2:
    0.8 coins, worth 1/coin

Similarly, at t1 there’s a limited opportunity for fast traders to purchase a greater percentage of the network from Charlie (should he be willing to sell) for the same price they could have at t0, before other fast traders take advantage of the opportunity and restore the price to its equilibrium value.

Next: How to Trade Amples