Why premines are not not ideal for a currency

This post is part of the "stuff we thought was dead obvious" series.  The series includes "How racists are dumb", and "How rapists are despicable morons" and "Shooting yourself can be dangerous" along with the classics "water is wet" and "the Earth is an oblate spheroid".

Five or ten years ago I would not have thought to write this post.  The phrase "premine" was considered somewhat insulting already, because it was assumed that people understood that this practice was suspicious, scammy, and thus unlikely to provide a stable currency.

So what is a premine?  The idea is that some currency is created before the ledger is operational; that some privileged people can get ahold of a substantial amount of coin before the mining even begins.

The practice became more common amongst the lower quality altcoins.  The authors wished to reward themselves monetarily for their work (being amateurs they were just in it for the money) and adding a premine to the code seemed one way to do this.

Then came the arrival of the 100% premine.

The 100% premine. 

If you thought adding a hard-coded premine to the codebase of a coin was scammy, you would be rather shocked at the blatancy of a 100% premine.  In this scheme, not only some but in fact the entire supply of a coin (that's all the coin that ever will be produced) is created in advance and given to the devs or early investor groups.

The first coins I came across that did this were NXT and XRP.  Both simply created the entire supply out of nothing, with no monetary policy afterwards, and then started selling the supply.  Who would buy such a thing?  This was my thought, that nobody would consider it.  However I was wrong.  Hence returning to this post to see where I went wrong.

In fact the 100% premine coins have grown.  33 out of 50 of the top digital currencies listed on coinmarketcap.com are 100% premines.  They are marked with an asterisk for easy identification.  Here are some of the big 100% premine coins:

1-- Ripple [XRP]
2-- EOS [EOS]
3-- Stellar [XLM]
4-- Cardano [ADA]
5-- IOTA [MIOTA]
6-- (etc)

So let's explore why this kind of monetary policy is a bad idea first, and then we can come back and look at some of the justifications people use for such a practice.

Centralized  

One problem with the 100% premine is it forces a centralization of ledger control.  Who secures the ledger in a public coin?  Why, the miners do of course.  And who are the miners?  Well in a 100% premine coin, there are no miners.  This means that there is no financial incentive for any new players to secure the coin, and that it will be secured solely by the bagholders or premine recipients trying to popularize the network.  "The company" secures the network, because these coins are company coins, and here "The company" refers loosely to whoever holds most of the premine, enough to give them incentives to run the software.  These players also have a role to play in exchange markets, but we will return to that.

One possible way for a 100% premine coin to not be ledger-centralized is for miners to be given transaction fees.  This would mean however that transaction fees would need to be substantial, and there aren't a lot of teams trying to push their high-fee coin.  Instead the purveyors of 100% premine coins tend to claim that the transactions will be cheap or free.  The idea here is to get more people to buy into the system, so their premine will be worth more.

Centralization alone is not necessarily a problem, but it is a risk factor to consider.  It means that the operation could be shut down, could go bankrupt, go under, get bulldozed, be attacked.  It is a point of weakness where corruption or legal troubles could cause problems in use of the currency.  It's not ideal for a currency to be thusly centralized wouldn't you agree?

Manipulated Markets

Another problem with the 100% premine is the effect it has on the exchange value of the commodity, namely preventing a natural supply-demand market price discovery system from working.  A mineable asset has a newly issued supply continuously appearing.  This supply forms a counterpart to the demand, enabling a fair price to be discovered.  This is the theory, but in practice markets of all kinds of assets are controlled by large players known as market makers.  You might think that allowing any kind of downward pressure on the price to be a bad thing.  Mining provides such a downward pressure by giving people new coins they could dump on the market.  So you might think mining will drive the value of the coin down.  Isn't this bad?  Well not really; in fact a coin is more usable if it can find a natural price point and this requires a balance of upward and downward pressures.

The 100% premine is basically a carte blanche for the early recipients of the premine to manipulate the market as they see fit.  There are no natural market forces so any participants are completely at the mercy of these market makers.  The point here isn't that mineable assets have natural, clean, uncorrupted markets..  of course they don't!  The point is that there are no market pressures at all to combat such pump-and-dump bubble blowing with a 100% premine coin.

Corrupt Devs

It's pretty clear that the 100% premine is about the designers of the coin grabbing some money.  It's also clear that doing so isn't part of a coin being able to improve on human interactions or to increase our chance of making it to stars or even surviving as life-on-earth.  However lets assume for a second that the consensus algorithm simply wouldn't allow for anything but a 100% premine (hah) and that the developers really are trying to make a product for the good of mankind.

The trouble here is that once there's a ton of money in the bags, even after this assumption of good intention, there's a lot of incentive for certain elements of society to try to get some of the money in the bags.  This leads to an element of "we're just in it for the money" in the people working with the coin, regardless of any initial incentive.

Rationalizing the Premine

Some assets in fact do need to be 100% premined.  Bus tickets.  Stock certificates.  These things aren't intended to be pure exchange commodities (currencies), in fact they come with promises from a central authority of future returns or redemptions.  If your token comes with promises of receiving some dividends, goods, or services, the premine might be just what you are looking for.  However this doesn't appear to be the case for most of the premined assets people are calling cryptocurrencies.

Another justification for a premined scam is that mining is energy intensive.  Well yeah, shared consensus is energy intensive.  Shouldn't we just let the king decide?

A final justification I have seen is that the 100% premine was "fairly distributed", in some auction or token-issuance-period.  While it may be possible for some to be more fairly distributed than others, the notion that a premine is a fair distribution for a currency is very misguided.

Conclusion

If you're a speculator or currency user, stay away from the 100% premine coins.  The price will be unpredictably manipulated and eventually the company controlling the ledger will run into problems effectively killing the coin eventuallly.  It will be very hard to move forward after the initial hype of the premine-holders marketing their way to monetization.

If you're a currency or blockchain developer, pick a monetary policy that doesn't suck right out of the box.  I like logarithmically growing supplies, but hey there are a lot of options.  All of them are better than the 100% premine.