Steem dollar SBD is a way for blockchain-based social network Steem to get investment. By form, this way of investment on the Steem platform is similar to conventional convertible notes.
In business world, convertible notes are a way to fund startup ventures and small business acquisitions. Because stability is important to any business project, including Steemit, it created Steem Dollars as a way to bring more stability to the Steem network.
The mechanism that creates SBDs on the network is also similar to the way businesses and individuals create convertible notes. A convertible note is pegged in value to some currency or commodity. The terms of a convertible note specify how its owner can convert the note to the currency or a commodity. Usually, this can be done with a short notice, hence the word “convertible” in the name.
For these reasons, together with the creation of Steem Dollars, the Steem network also created a reliable price feed and rules to prevent abuse of the feed.
On the Steem network, holders of Steem Power (SP), a vested version of the Steem currency STEEM that exists on the network together with Steem Dollars SBD, elect witnesses. Witnesses can then publish price feeds. To do so, they get paid by the Steem network.
The idea behind the process is that SP holders both have a vested interest in the future of the network because of their vested investment and trust the witnesses they elect. Because witnesses get paid, there is free market competition among those who want to become witnesses. If a witness publishes false information in a feed, others will notice, demote the witness and the witness will stop getting paid. This is why witnesses are interested in publishing true information and preventing fraud from happening on the network.
The price for conversion of Steem Dollars then becomes a median of the witness feeds.
A median of a set of odd number of elements is the middle element. For example, if there is a set of 7 prices and these prices are 2, 2, 7, 4, 6, 5, 1, then to find a median you would first arrange these numbers in order and get 1, 2, 2, 4, 5, 6, 7. The median is doing to be the number in the middle, 4. In a set with an even number of elements, the median is an average of two middle numbers. To find the average, you will need to add the numbers and then divide them by two. For example, if the range of prices contains eight elements and they are 2, 2, 7, 4, 6, 5, 1, 8, then to find the median for the set you would first arrange the elements in order and get 1, 2, 2, 4, 5, 6, 7, 8. The two elements in the middle are 4 and 5. The average of 4 and 5 is (4+5)/2= 4.5, which is the median for the set.
Looking at the median instead of the whole range when it comes to price feeds on the Steem network is important because this way the network doesn’t take into consideration the outliers. If a malicious witness increases or decreases the price of his or her feed in a way that is very different from what is happening with other witnesses on the network (which is the only way to manipulate the prices in a way that could have an impact), the price won’t change significantly (because the network looks at the median of all the value and not individual values), yet network members will still notice the behavior. This means that witnesses don’t have much to gain if they try to manipulate a price, yet they still have a lot to lose.
The network samples price feeds every hour. It then takes a median price of the samples over 3.5 days. This is done to prevent short-term market manipulation that may occur even if all witnesses are honest, yet the network has to deal with events or circumstances that are beyond its control.
In the event of a feed corruption, the members of the network can vote corrupt members out before the actions of corrupt members have an impact on the price.
Another issue the Steem network had to solve with Steem Dollars SBD was a possibility of a timing attack. The timing attack is an attack in which hackers try to compromise a system by tweaking its ways to obtain timely measurements of certain parameters of the system. With Steem network and Steem Dollars SBD, market participants have access to the information that the network uses to create 3.5 day averages before the system actually creates the averages. At the same time, there’s an automatic delay of 3.5 days for all conversion requests of SBD. This means that while traders have access to the information and can use the information to help the network prevent attacks, they can’t use the information for personal gain, such as observing the trends and then selling at a high and quickly buying again at a low. Also, the network only allows members to exchange Steem Dollars SBD to STEEM. Converting STEEM to SBD is impossible.
The Steem blockchain decides when to create SBD and who the recipient is going to be. This allows the network to add SBD to the circulation in a controlled predictable way and to prevent potential abuses of the system.