Thanks for all the hard work! I can understand the amount of thought and effort that went into this. Out of respect I did spend some time and thought on this post. I only offer critique in hopes that it will help you achieve the success you are seeking.
Let me start off by saying flat out: MasterCoins wont work.
Here are a few reasons why.
Will fix the two biggest barriers to widespread bitcoin adoption: instability and insecurity.
I fail to see those as being the primary barriers to widespread adoption. This is subjective unless there is evidence to this effect. This flaw also results in a greater error: Solving instability by manipulating markets, and solving insecurity by centralizing control (see below) as this will only increase instability and insecurity in the long run.
The concept of a “trusted entity” is needed for initial distribution of MasterCoins and initial protocol
software development. This entity:
• Should have a publicly known identity and location.
• Should devote the funds received to protocol software development, marketing, and business
expenses. Funds could also be used for legal costs if necessary.
...
All of the above stipulations (there are seven) also rule out any privately owned company. No company is going to let you into their operations and into their books. Is the bitcoin community going to ask them to move to a different county? That leaves only volunteer type organizations, like charities or non-profits. These organizes could serve this purpose but if you think things aren't progressing as you want now, wait till NGO or NP politics and bureaucrats get a hold of it.
The value of bitcoins and MasterCoins must be manipulated to support two goals:
1. In order to ensure sufficient hashing power, Bitcoins must gain value at the same time that
MasterCoins gain value.
2. In order to reward early MasterCoin adopters, Bitcoin values must not be forced up as quickly as
MasterCoin values are rising.
To accomplish these two goals, a minimum bitcoin value and maximum MasterCoin value will be set ...
If the entire system depends on market manipulation, I would say from the very start this system is unsustainable. Manipulated markets always eventually "buck" the manipulators.
Surely it will succeed in some instances but ultimately it will fail. There is no guarantee that destroying the bitcoins would increase their value, the best you can hope for is that the signal you send in saying "we are destryong bitcoins now to support the bitcoin market" actually effects the market. In fact in the example of destroying bitcoin in the manipulation of Mastercoin prices, actually destroying the bitcoins is impossible . Sending them to some address that apparently isnt accessible doesnt destroy them.
Similarily the stability mechanism (page 10) is also flawed as it explicitly relies on market manipulation. Take the goldshares example. You cannot increase the value of shares by destroying them. Destroying them means you have them to destroy them. If you have them in the first place that means they arent in the market which means destroying them will do nothing to the market. The only thing you can hope to achieve again is that the signal that you are destroying shares will affect the market. Are the shares going to be bought then destroyed? If so, bought with what? And who suffers the losses from the destruction?
As I see it, what MasterCoins essentially does is, using the existing bitcoin network, buy up bitcoins using a centrally-controlled, non-democratic, closed and non-transparent currency. Then attempts to manimupate and regulate the bitcoin market, the Mastercoin market, and all user currency markets. Wow, thats gonna take a lot of money.
Who would ever trade their bitcoin for MasterCoin given this?
Now admittedly I may be wrong, it's happened a couple of time before. So let me offer some suggestions.
First the idea of adding additional data into the blockchain is probably good and as far as I know, very easy to do.
Therefore I think you should drop the idea of a trusted entity, drop the idea of price manipulations, and promote the concept of useing mastercoin as a way to add more data to transactions to give the features you mentioned to bitcoin itself.
Other features require third parties. If there is profit to be made in offering these services then people will provide them.
Dont take this critique personally, it is better to be proven wrong then to waste your efforts in vain. I appreciate anyone who proves me wrong for that begins the process of enlightenment.