Author Topic: Idea: Settlement forced from the external market rather than the internal market  (Read 887 times)

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Offline starspirit

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For consideration, this is a possible alternative to forced settlement in the internal bitUSD:BTS market that could offer the following benefits if it stacks up:

- no internal forced settlement and no opportunity for BTS market manipulation
- supply reduction is triggered directly by discounts in the primary bitUSD:USD market
- forced short covers get a demonstrably fair market price
- it could facilitate a natural buy wall in the bitUSD:USD market (and sell wall, if use yield)
- the voluntary act of self-creation could be the only action that requires a feed from the BTS market

I haven't thought long down this track, so it could fall down somewhere...please attack!

Basic concept

1. No forced settlement of longs, and no constraints on buyers, sellers or shorts in the internal bitUSD:BTS market

2. On any day the ask in the external bitUSD:USD market falls below 1:1, this instantly triggers a block of shorts to be selected for calling (this could be done on yield or collateral). The size of the block could conceivably depend on the level of discount, size of ask orders etc.

3. When such a block of shorts is selected, 24 hour notice is put to the market that a sale of collateral for bitUSD will occur. This gives ample notice for shorts, bargain-hunters, arbitragers etc to prepare for the sale, to get the most effective settlement terms for selected shorts. Shorts in the block could cover before that if desired.

4. At the 24 hour mark, any still uncovered shorts in the block have their collateral sold automatically for bitUSD to cancel their short

5. Each day, as long as the ask in the bitUSD:USD market is below parity, further short blocks will be covered until the ask returns back to or over parity. This guarantees "settlement" and a return to parity as long as there are some willing holders.

How settlement is enabled

I've been a big proponent of the need for longs to be able to force settlement in order to underpin valuation of bitUSD, and thereby minimise discounts to the peg. But maybe this doesn't need to happen in the internal market, where one needs to carefully design some rules so that BTS prices cannot be easily manipulated to force more favourable settlement terms.

The method here effectively achieves the same result, but bitUSD owners can effectively force settlement from the bitUSD:USD market rather than the bitUSD:BTS market, with other parties incentivised to take the bitUSD for USD and offset in the internal market. The way in which this would occur is as follows:

- if there were a lot of demand for BTS, some parties might buy the external bitUSD to sell for BTS in the internal market, especially if they could get a sizeable BTS stake at a lower premium than buying in external markets. Competition among stake-buyers puts an upper bound on the settlement price at which they are willing to buy the BTS from the margined shorts

- if there is weak demand for the BTS, arbitragers will buy the external bitUSD to sell for a premium in the internal market. They need a premium to cover the spread in selling their BTS proceeds in the weak external market. Competition among arbitragers puts a lower bound on the settlement price at which BTS is bought from the called shorts

- market-makers in the bitUSD:USD market may buy the bitUSD at or below parity to sell at a premium later, given ongoing supply reduction is guaranteed to return to bitUSD to at least parity

The settlement price for called shorts, between these bounds, reflects all market and liquidity conditions and is therefore a "fair" free-market price. I don't think it can be easily manipulated, but interested if others can see ways it can.

Some extra ideas

Introducing a yield between longs and shorts

A yield mechanism would allow for situations where the market consensus is that a bitUSD is worth more or less than parity with the USD. As a result, it would allow more moderate swings in supply to balance the demand. It would also limit premiums to the peg. I've discussed this elsewhere, though it should be noted this is not in line with BM's current proposals. I have a process to incorporate yield into the above approach but won't detail it here unless interested.

Creating and cancelling shorts

Given that pegging is enforced in the bitUSD:USD market, especially with a yield mechanism to limit premiums, market-making becomes a more profitable endeavour in that market. BTS owners can easily earn an income from this as follows:
- self-create bitUSD
- use the bitUSD to sell at a premium for USD, and buy at a discount with USD, in the bitUSD:USD market, earning the spread
- when user wishes to stop this activity, buy the bitUSD and self-cancel

It's also possible for shorts to always be self-created and self-cancelled, and never be created in the internal bitUSD:BTS market. This could vastly simplify the internal market. But it would require shorts to self-create with $2 of BTS, then sell their $1 bitUSD for BTS in order to get exposed to $3 of BTS. This is 3:2 leverage, and would not be as much leverage as the 2:1 provided if they can short directly in the internal bitUSD:BTS market.
« Last Edit: May 15, 2015, 03:16:01 am by starspirit »