- The sidechain is created and a set number of sidechain coins are pre-mined in the genesis block. This is the total number of coins available for the sidechain.
- There is a federation of nodes which control the transfer of STRAT <-> sidechain coins.
- If someone wants to use the sidechain, they must send a number of STRAT to the federation and in return they will receive a number of the sidechain coins. This number is decided by a predetermined rate of exchange. For example, it could be that for every 1 STRAT you send in, you receive 10 of the sidechain coins.
- The STRAT remains locked up until someone sends a number of the sidechain coins to the federation and in return they receive STRAT according to the rate of exchange. For example, if they are finished with using the sidechain they can send back the 10 sidechain coins to the federation and they will receive the 1 STRAT they initially sent in.
This is, of course, a vast simplification of the process (a lower level article can be found in Stratis Academy: A breakdown of the Two-Way Federated Peg solution), but it hits the key points as far as we’re concerned:
A) STRAT is needed if you want to use a sidechain
Anyone wanting to release sidechain coins in order to use the sidechain will need to have STRAT to do so. This introduces demand to STRAT which in turn has an impact on scarcity. Scarcity is the key determining factor in the price of a cryptocurrency.
B) STRAT is locked up when you use a sidechain
If you are using the coins of a sidechain, they represent a certain amount of STRAT which is locked up. A popular sidechain could potentially lock up a significant amount of STRAT. Let’s consider a sidechain which uses its sidechain coin as the currency of some particular economy, let’s say it is the payment channel for some kind of decentralized auction platform built using smart contracts. If this economy is $1m in size, then it means that $1m worth of STRAT is locked up by its users. Since sidechains offer an endless variety of blockchains, this could result in a large number of sidechains locking up a large number of STRAT at any one time. This drop in effective supply will once again induce scarcity to STRAT.
C) The price of the sidechain coin is effectively pegged to the price of STRAT, determined by the rate of exchange accross the chains
STRAT can be exchanged for sidechain coins and sidechain coins can be exchanged for STRAT once a sidechain has been founded. The rate of exchange will always be the same, so you will always get the same number of STRAT for your sidechain coin and vice versa. This means that the sidechain coin will be pegged in price to the STRAT coin. Sidechain coins can of course be traded separately on an exchange with other currency trading pairs. This means that it is possible that the price can fluctuate locally for the sidechain coin. However, through a levelling process similar to arbitrage, fluctuations in the price of a sidechain coin which go against the STRAT price will be counteracted by people capitalising on the difference in price (either by exchanging STRAT for sidechain coins or sidechain coins for STRAT). This means that if the overall value of a sidechain goes up (perhaps due to the utility or nature of the application of the sidechain), then more STRAT will be locked up to account for the increase in price. In this way, the value generated by a sidechain will be reflected by an introduction of scarcity to STRAT. As we’ve talked about many times before, scarcity is what drives the price of a coin.