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Offline Markus

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Do BitShares need an interest rate?
« on: January 05, 2014, 10:35:16 AM »

2) BitAssets will now receive a predictable, hardcoded 5% interest return, and short positions will pay a 5% borrowing cost.

There has been some discussion in the BitShares Status Update thread but I think this topic deserves its own thread.
After thinking about this for some time I wanted to share some thoughts. My question is:

Why do BitShares need interest payed by the shorts to the longs? Without it the BitAsset would track the real-life asset much better.

Essentially, what you are creating with this interest/dividend is an bond with a 5 % coupon and infinite maturity. The price of this asset will be highly susceptible to market interest rates changes. In theory causing the price of the asset to change the same magnitude as the interest rate: for example a rise from 3 % p.a. fo 4 % p.a. (4/3 = a 33 % rise) should lead to a drop in asset value by 25 % (to 3/4). Compare this volatility to a 30 year (the longest maturity available) US treasury bond.
Chart: http://www.comdirect.de/inf/anleihen/detail/chart.html?timeSpan=5Y&ID_NOTATION=15793986#timeSpan=SE&e&

The price of the BitAsset will be (much) higher than the real-life asset where the coupon (5 % assumed) is much higher than the market interest rate. For BitUSD with a US treasury bond yield of 3.9 % p.a. this effect might be negligible (the NPV calculation quoted in the BitShares white paper states 114 %*, I arrive at 128 %). For assets which normally don't fetch an interest (Gold, JPY, etc.) this will be a huge difference: A 100 year 5 % coupon JPY bond in an environment where you normally get 0.8 % p.a. would trade near 400 %, a 30 year bond just above 200 %.

In BitShares there is no need to charge the shorts a penalty. In real life you have to pay for shorting because you need a counter-party. Being long in any asset is quite a natural thing and you can do that on your own. Being short requires somebody to lend you the asset first before you to then sell it. This loan is open as long as your short position is open. In Bitshares being long and being short seem to be equivalent as both need a counter-party, so why disincentivise shorts? Would this not choke the supply?

If you want to fix these issues then at least every BitAsset will need its own interest rate. But my gut feeling is, the lower the rate the better, zero best.

* Is that calculation available anywhere? The paper only states the result.

Offline toast

Re: Do BitShares need an interest rate?
« Reply #1 on: January 05, 2014, 04:59:24 PM »
I think returns ought to be floating and determined entirely from how much the network was able to collect from the various fees.

This leaves only how to determine fee for shorting. Like you said, it is not clear that a fee is strictly necessary (there are many other fees to pay dividends with). Perhaps allow short positions to choose their rate, competing for limited blockchain space?
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Offline bytemaster

Re: Do BitShares need an interest rate?
« Reply #2 on: January 05, 2014, 08:12:46 PM »
I think returns ought to be floating and determined entirely from how much the network was able to collect from the various fees.

This leaves only how to determine fee for shorting. Like you said, it is not clear that a fee is strictly necessary (there are many other fees to pay dividends with). Perhaps allow short positions to choose their rate, competing for limited blockchain space?

There needs to be a global rate or BitUSD would not be fungible.  If there are no borrowing costs then you eliminate a major market incentive to cover and make shorting vs simply selling equal.   We want to bias toward sellers first before shorts.

There is a problem with having a fixed rate, and the solution is to use a prediction market to assess what the rate should be at any given time.  But this is something that will be in future chains and not the first chain.  A predictable 5% is better than unpredictable / floating rates in many ways.  One less variable and component of risk.
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Offline bytemaster

Re: Do BitShares need an interest rate?
« Reply #3 on: January 05, 2014, 08:13:44 PM »
Another reason why you want to have an interest rate is because it drives incentive to hold BitUSD and drives demand for BitShares.  A bank with 0 interest rates is unlikely to receive many deposits and we want there to be a large number of BitUSD deposits.
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Offline Markus

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Re: Do BitShares need an interest rate?
« Reply #4 on: January 05, 2014, 10:06:33 PM »
There needs to be a global rate or BitUSD would not be fungible.
I agree, that at any one time any one BitAsset must have a global rate to make them fungible. This doesn't necessarily mean if has to be larger than zero.

If there are no borrowing costs then you eliminate a major market incentive to cover and make shorting vs simply selling equal.   We want to bias toward sellers first before shorts.
This one seems to be the gist of the matter. Can you explain why this bias is necessary?

Another reason why you want to have an interest rate is because it drives incentive to hold BitUSD and drives demand for BitShares.
This will not drive up demand for long. What it will do is drive up price of BitAssets to an equilibrium level where future interest payments will be priced in - the 114 %, 128 %, 200 % and 400 % figures mentioned in my post. I don't think it will drive demand for BitShares. Rather, promising people they will earn more on a BitAsset than on the corresponding real-life asset taints the whole thing and makes it look Ponziish.

A bank with 0 interest rates is unlikely to receive many deposits and we want there to be a large number of BitUSD deposits.
This is not true if the price of the deposit is floating. Otherwise zero-coupon bonds would not work.

Offline Pocket Sand

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Re: Do BitShares need an interest rate?
« Reply #5 on: January 28, 2014, 08:09:17 AM »
Would like to start this discussion again if possible, Markus raised some very good points that would be worth further discussion.

Offline Markus

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Re: Do BitShares need an interest rate?
« Reply #6 on: January 28, 2014, 12:08:44 PM »
If there are no borrowing costs then you eliminate a major market incentive to cover and make shorting vs simply selling equal.   We want to bias toward sellers first before shorts.
This one seems to be the gist of the matter. Can you explain why this bias is necessary?
I was wondering if somebody could go more into detail on this one. I haven't gotten any reply yet.

Offline bytemaster

Re: Do BitShares need an interest rate?
« Reply #7 on: January 28, 2014, 03:30:31 PM »
Interest rates have an interesting effect and I have been thinking a lot about it while traveling to/from Miami.  Here are some of the thoughts I have had.

1) Price Fixing of any form will result in problems, thus 5% price fixing will result in the price of BitAssets diverging proportional to the difference with real world interest rates on the same asset.

2) Price Fixing at 0% is no different than price fixing at 5% in this regard.  It would give you a perfect price *today* but without a proper yield there would be no demand to HOLD it thus create a lot of churn as people look to move to a higher yield on that asset outside the system.

3) BitUSD needs to be correlated to the price movement of USD, not pegged TO USD in a perfect 1:1 manner.  Remember, there is no such thing as USD, just JPMorgan USD, BitStampUSD, BOA USD, FRN USD and each of these has a floating value against one another based upon the current interest rates offered at the various banks and the credit worthiness of each institution.  So long as a 2x gain in FRN USD results in a 2x gain in BitUSD it doesn't matter if FRN to BitUSD have a slight premium or discount, this premium or discount will be a 'constant' and mostly stable offset driven by constant and mostly stable interest rate differences.   

4) The interest rate on Gold, Silver, EUR, USD, etc must all be independent and adjustable to market conditions in order to achieve a more accurate peg.  The way this can be achieved is by using one BitAsset as a prediction market on what the interest rate should be on another BitAsset.   


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clout

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Re: Do BitShares need an interest rate?
« Reply #8 on: January 28, 2014, 04:01:44 PM »
Interest rates have an interesting effect and I have been thinking a lot about it while traveling to/from Miami.  Here are some of the thoughts I have had.

1) Price Fixing of any form will result in problems, thus 5% price fixing will result in the price of BitAssets diverging proportional to the difference with real world interest rates on the same asset.

2) Price Fixing at 0% is no different than price fixing at 5% in this regard.  It would give you a perfect price *today* but without a proper yield there would be no demand to HOLD it thus create a lot of churn as people look to move to a higher yield on that asset outside the system.

3) BitUSD needs to be correlated to the price movement of USD, not pegged TO USD in a perfect 1:1 manner.  Remember, there is no such thing as USD, just JPMorgan USD, BitStampUSD, BOA USD, FRN USD and each of these has a floating value against one another based upon the current interest rates offered at the various banks and the credit worthiness of each institution.  So long as a 2x gain in FRN USD results in a 2x gain in BitUSD it doesn't matter if FRN to BitUSD have a slight premium or discount, this premium or discount will be a 'constant' and mostly stable offset driven by constant and mostly stable interest rate differences.   

4) The interest rate on Gold, Silver, EUR, USD, etc must all be independent and adjustable to market conditions in order to achieve a more accurate peg.  The way this can be achieved is by using one BitAsset as a prediction market on what the interest rate should be on another BitAsset.   




+1

Offline Markus

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Re: Do BitShares need an interest rate?
« Reply #9 on: January 28, 2014, 10:07:13 PM »

4) […] The way this can be achieved is by using one BitAsset as a prediction market on what the interest rate should be on another BitAsset.   

Wouldn't the interest prediction market have to be roughly the same size (in trading volume) as the market for the underlying BitAsset itself? This would bind a lot of capital just to set the interest rate. If it wasn't large enough the BitAsset holders (longs vs. shorts) would manipulate the interest rate to their advantage.

Offline bytemaster

Re: Do BitShares need an interest rate?
« Reply #10 on: January 28, 2014, 11:04:12 PM »

4) […] The way this can be achieved is by using one BitAsset as a prediction market on what the interest rate should be on another BitAsset.   

Wouldn't the interest prediction market have to be roughly the same size (in trading volume) as the market for the underlying BitAsset itself? This would bind a lot of capital just to set the interest rate. If it wasn't large enough the BitAsset holders (longs vs. shorts) would manipulate the interest rate to their advantage.

It would be a large market, but it would also allow people to hedge against changes in the interest rate and provide the market with VERY useful information as a side effect.   This is a very valuable side market that could eventually be used for doing interest rate swaps and the like.
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Offline Markus

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Re: Do BitShares need an interest rate?
« Reply #11 on: January 29, 2014, 04:05:01 AM »
It would be a large market, but it would also allow people to hedge against changes in the interest rate and provide the market with VERY useful information as a side effect.   This is a very valuable side market that could eventually be used for doing interest rate swaps and the like.

Yeah, and since I've been preaching that there's a correlation between interest rate and fair BitAsset price I guess cross trading might be an opportunity too.

Any plans to have this ready for the first BitShares X chain? With the new +5% campaign I assume this won't happen.

Keep up the good work Dan, you're doing a great job!

Offline bytemaster

Re: Do BitShares need an interest rate?
« Reply #12 on: January 29, 2014, 04:41:54 AM »
Not to get too 'meta' but how should the interest rate on the interest rate BitAsset be set?   I am thinking it could be fixed at 0% because it isn't actually trying to maintain a peg against anything else. 


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Offline vikram

Re: Do BitShares need an interest rate?
« Reply #13 on: January 29, 2014, 03:12:44 PM »
Not to get too 'meta' but how should the interest rate on the interest rate BitAsset be set?   I am thinking it could be fixed at 0% because it isn't actually trying to maintain a peg against anything else.

Even with a 0% interest rate, people should still have an incentive to go long or short depending on their predictions right?

Offline bytemaster

Re: Do BitShares need an interest rate?
« Reply #14 on: January 29, 2014, 03:18:04 PM »

Not to get too 'meta' but how should the interest rate on the interest rate BitAsset be set?   I am thinking it could be fixed at 0% because it isn't actually trying to maintain a peg against anything else.

Even with a 0% interest rate, people should still have an incentive to go long or short depending on their predictions right?

Correct


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