Alright I think I have figured this all out.
In order for the actual BTSX price to change, BTSX must be bought or sold on an exchange.
So how does trade in bitUSD influence that?
Imagine that someone wants to buy a LOT of bitUSD. Enough that they move the price up to $1.02, lets say.
Now there is an economic incentive to do the following:
* Buy BTSX on an exchange.
* Use the BTSX as collateral to short bitUSD, selling it to the person willing to pay $1.01.
You profit from this provided that you are later able to exit the short at a fair value.
Therefore: Buy bitUSD => BTSX increases in price
On the flip side, lets say someone wants to sell a lot of bitUSD. They are willing to sell it at .99.
This creates an incentive for shorts to cover. The short, who previously had tied up their BTSX as collateral, now is free to do whatever they want with it, including sell it on an exchange.
Therefore: Sell bitUSD => BTSX decreases in price.
These effects are muted relative to simply buying or selling on an exchange, of course.
Any time that longs are panicking and wanting to hedge, they can buy bitUSD. This not only effectively hedges their position, it also SUPPORTS the price of BTSX, instead of hurting it (as would occur if they hedged by selling BTSX on the exchange).
Therefore, hedging in bitUSD acts as a stabilizing force, reducing volatility to both the upside and downside.
The more that people use bitUSD, the more than the BTSX price will move more smoothly, going up or down in value in relatively smooth lines over time, not in bubbles/spikes!
That is an awesome feature! It reduces the chance of black swan events!