There is an underlying assumption I see often that BTS market cap must always expand with bitUSD market cap, because demand for bitUSD forces up demand for BTS, the collateral. And further for the pool of all bitAssets. But is this logically true? I found this complex to think through, so would genuinely not be surprised if I were wrong. But my conclusion is that the statement is not necessarily true - one does not necessarily
drive the other.
First we need to recognise that at least from a valuation perspective, there is no reason why BTS should by necessity demand a higher valuation as a direct consequence of bitUSD growth. If all BTS ever earned as income from providing the platform were some small transaction fee for bitUSD usage (which in theory could be close to zero), its fair valuation should relate to that income, not the market cap of bitUSD.
Now let's think about the market dynamic.
1) Imagine somebody demands a huge amount of bitUSD today, but that overall market expectations for BTS valuation are unchanged
. This party goes to an exchange and buys bitUSD with their fiat USD, driving the price above 1 fiat USD.
2) Seeing this favourable price, some arbitragers buy bitUSD with their BTS, sell it at the exchange for the higher fiat USD price, buy back their original BTS with fiat USD, and pocket a profit. This leads to an equalisation of the bitUSD premium on the exchanges and on the BTS/bitUSD exchange, but has had no net effect on BTS demand
3) Now seeing this favourable BTS/bitUSD price another set of arbitragers that are current holders of BTS are able to come in and create new supply in bitUSD through shorts. The arbitrage is to short bitUSD (making them longer BTS), and to sell BTS on the exchanges, which maintains their overall exposure to BTS. Again there has been no net effect on BTS demand.
But importantly BTS has moved from the hands of the arbitragers into the collateral pool to support the larger supply of bitUSD.
The end result of this sequence is that there has been no change in the net demand for BTS, but that there has been a movement of BTS into the collateral pool.
If demand were ongoing, and BTS value were unchanged, this sequence could be repeated until all the BTS sat in the collateral pool. The only condition is that the market cap of BTS needs to remain more than 3x the market cap of bitUSD, otherwise its likely that forced covering of the shorts due to under-collateralisation would begin to unwind the supply and so release BTS collateral from the pool again (which incidentally, on its own still has no net effect on BTS demand).
The logical conclusion I draw, if this is correct (
), is that the market cap of BTS bears no direct relation to the market cap of bitUSD, except
that the market cap of bitUSD bumps against a ceiling as it approaches 1/3 the market cap of BTS. The only economic relationship that can drive growth for BTS is whether BTS derives greater value of transaction and other platform fees from the larger supply of bitUSD.
Can anybody see the flaw if there is one?
[Edit 12 Nov 2014: After having reviewed the discussion and thought some more on it, I now interpret the result like this. For the market cap of bitAssets to grow up to the ceiling, it does not require BTS market cap to rise at all. The growth can be facilitated completely by arbitragers without increasing their net demand for BTS, if the market is stubborn in the valuation it places upon BTS. However, the result still allows the potential for the market to increase its evaluation of BTS if bitAsset markets grow, which in all likelihood it will do if enough people follow the meme that "bitAsset growth justifies higher valuations of BTS". But this is not a given, and if BTS valuation were constrained by other issues, even strong demand for bitUSD could not be fulfilled beyond the ceiling.
As a minor technical point, I also now believe that in step 3 of the sequence above, these players are not strictly implementing a risk-free arbitrage (in actual fact, there is no risk-free arbitrage for shorts). Instead they are speculating that the premium of the bitUSD price over the peg will fall, which is not guaranteed if demand remains consistently strong. This does not alter the argument or conclusions above, it only affects their incentive to participate in meeting the demand.]