Solution to High Volatility potentially breaking the BitUSD Peg

[theoretical]

What about decreasing the margin to 2x and using fees to recapitalize losses from blown shorts gradually over time?  That way, XTS holders who don't touch BitUSD don't risk a sudden dilution of their capital from an adverse event.  Rather, dividends are reduced or eliminated.

You could also "buffer" the fees in a reserve balance, which would simplify bookkeeping enormously.  E.g., whenever a blown short happens, you just add the negative BitUSD balance and positive collateral XTS balance to the reserve balance, and zero out the position attached to the account like a normal margin call.  Then the total negative BitUSD in the reserve balance is how many BitUSD you want to purchase on the market to get rid of the excess uncollateralized BitUSD, and the positive XTS balance is how much capital you have to make that happen.  The actual open market operations to be performed with the reserve balance would be specified by some fixed algorithm.

The reserve BTS balance should decay exponentially over time (I'd suggest a half-life of ~120 days).  This means that reserve balance will eventually be paid as dividends to XTS holders (by destroying XTS) if no blown shorts occur.  Also, the fraction of the reserve available for open market purchases in a single block, and the market depth to which it can go, should probably be limited.

In an event with lots of blown shorts, the reserve funds might be inadequate to make good on them right away, but BitUSD holders will know that eventually the extra money will be destroyed.

Of course there are lots of flourishes you could add.  For example, the reserve BTS balance shouldn't decay when the reserve is in danger of insolvency.  (I.e., XTS assets of reserve balance divided by XTS liabilities of reserve balance gets lower than some threshold K, e.g. K ~ 2, as determined by valuing BitAsset balances at the current market price).  Or maybe we could temporarily increase fees when the reserve balance is hurting.

[bytemaster]

Would making the minimum trading unit bigger also decrease the volatility?

I.e Lets say 1 Bitcoin was trading at $1000

If the minimum trading unit was $0.10 then manipulating the price a few $ might start a small short squeeze.
If the minimum trading unit was $1 then manipulating the price tens of dollars might have the same effect.
" " " was $10 then they would have to move it a few hundred $.

Obv. $10 would be extreme, but as the blocks will be processing slower than real time trading, Bitshares hopefully won't be practical for HFT bots or people trying to make 0.X% gains so you should be able to make the trading unit bigger than most other platforms which should also suit the slightly longer-term trading mindset of the users and reduce volatility?

Minimum trading unit will be driven by transaction fees and I don't see small purchases having any effect at all on short squeezes because anyone that close to the edge risks a 5% penalty for having a margin call executed on them.

[Empirical1]

Would making the minimum trading unit bigger also decrease the volatility?

I.e Lets say 1 Bitcoin was trading at $1000

If the minimum trading unit was $0.10 then manipulating the price a few $ might start a small short squeeze.
If the minimum trading unit was $1 then manipulating the price tens of dollars might have the same effect.
" " " was $10 then they would have to move it a few hundred $.

Obv. $10 would be extreme, but as the blocks will be processing slower than real time trading, Bitshares hopefully won't be practical for HFT bots or people trying to make 0.X% gains so you should be able to make the trading unit bigger than most other platforms which should also suit the slightly longer-term trading mindset of the users and reduce volatility?

[bytemaster]

Yes, you have just quoted two phases of our design and we would like to experiment with interest as an alternative iteration.

[theoretical]

there is no interest charged for holding a short position

I swear there's at least one official I3 video which stated that dividends generated by BitUSD held as collateral would be paid to BitUSD long positions.  And it was stated that this would be equivalent to charging interest on short positions.

The top post of the top sticky in this forum states:

short positions will pay a 5% borrowing cost.

This sticky makes it sound more like a one-time fee than an ongoing interest charge.

Also, If there is a 5% fee / interest on short positions, doesn't greatly increasing the margin requirement (from 2x to 10x) also greatly increase the amount the price has to move to overcome the fee enough to break even (let alone make a profit)?

If there is no 5% fee / interest on short positions, doesn't that reduce pressure on short holders to take profits?  If there's less pressure on short holders to take profits, doesn't that hurt market liquidity and make the price less stable?

[bytemaster]

How is my description not accurate?

My main objection is this:  What Bad Things would happen if you increased the margin requirement to 1000000x from 2x?

How do you know that 10x margin requirement isn't enough to make those Bad Things happen?

If nothing else, with 10x margin requirement, I'm thinking many investors will be scared away by the small upside and large downside.  The remaining capital will be stretched quite thinly, and most of it will be inefficiently deployed insuring extreme events.

In other words, I think 10x margin is so favorable to BitUSD holders that there won't be enough BitUSD short sellers to make the system work at any price.

Because there is no interest charged for holding a short position, taking a short position is a way for long-time-holders (like most of us in BTC) to earn a return betting on the growth of the system.   Remember, the 10x margin increase does not actually change the risk profile for the short position except in extreme events, it just changes the amount of leverage they can apply.   The extreme events are less likely to occur with a 10x margin than a 2x margin.

This will simply make BitUSD more scarce and the demand for it will drive the value of BTS up.

You do make a good question regarding why not use 1000000x vs 2x vs 1.0000001x.   My answer to you is that increasing the margin requirement gives non-linear reduction in risk.  The benefits of going from 1.000001x to 1.1x are greater than the benefits of going from 1.1 to 1.2.... Thus the higher the margin the less benefit you get per increase.  There is a bell curve an the margin requirement determines how many standard deviations away from normal market conditions a price change of a given magnitude is likely to occur.   Going from 1.000001 to 1.000002 almost doubles the area under the risk curve, but only handles an insignificant fraction of the risk.   Going from 2x to 10x goes from covering 90% of the risk to 99.99% of the risk.  Going from 10x to 10000000x only covers you for events that are unlikely in our lifetime. 

The numbers used are merely an example of the mathematical relationship between increasing margin and reducing risk. 

[dv]

How is my description not accurate?

My main objection is this:  What Bad Things would happen if you increased the margin requirement to 1000000x from 2x?

How do you know that 10x margin requirement isn't enough to make those Bad Things happen?

If nothing else, with 10x margin requirement, I'm thinking many investors will be scared away by the small upside and large downside.  The remaining capital will be stretched quite thinly, and most of it will be inefficiently deployed insuring extreme events.

In other words, I think 10x margin is so favorable to BitUSD holders that there won't be enough BitUSD short sellers to make the system work at any price.

Agreed. Especially when combining with the enforcement of 1% minimal market depth, perhaps it's very hard to make the system start working.

[theoretical]

How is my description not accurate?

My main objection is this:  What Bad Things would happen if you increased the margin requirement to 1000000x from 2x?

How do you know that 10x margin requirement isn't enough to make those Bad Things happen?

If nothing else, with 10x margin requirement, I'm thinking many investors will be scared away by the small upside and large downside.  The remaining capital will be stretched quite thinly, and most of it will be inefficiently deployed insuring extreme events.

In other words, I think 10x margin is so favorable to BitUSD holders that there won't be enough BitUSD short sellers to make the system work at any price.

[bytemaster]

Your description is not quite accurate, but we have ultimately addressed this issue by simply increasing the collateral requirements to 10x from 2x.  The probability of a blowout when down by more than 5x because it is non-linear.

[theoretical]

Let me see if I understand the problem you're trying to solve in this thread.

Let's say Alice shorts 1000 BitUSD at a price of 0.1 BTS / BitUSD.  Bob has a pre-existing bid order which is matched to Alice's short sale.  Alice and Bob are each required to have 100 BTS in their account for this match to occur.  (For simplicity, I'm neglecting fees.)

The 200 BTS (100 each from Alice and Bob) is set aside into a "pie" that Alice initially "owns" 50% of.  Alice's equity -- her piece of the pie -- as a function of the BTS / BitUSD price is given by f(x) = 200 - 1000*x.  Initially her equity as given by this formula is f(0.1) = 100 BTS, exactly equal to the capital she contributed; it decreases as the price increases until Alice is "wiped out" (zero equity) when the price is 0.2 BTS.

My understanding is that Alice's position will be liquidated if the price rises above some liquidation threshold L.  (I think L is the average of the initial price and the wipeout price, 0.15 BTS, but I'm not sure about this.)  This means that, if the market price rises above L, a "liquidation" bid order will be placed on Alice's account automatically by the system.  If this order is matched, then the resulting purchase price is paid out of the 200 BTS "pie" set aside earlier, the negative dollars are wiped from Alice's account, and she receives the remaining BTS from the pie; the liquidation order is priced such that this remainder is exactly equal to her equity (again, I'm ignoring real-world complications like the 5% liquidation fee, or what happens if the liquidation order is only partially filled).

However, if the price rises above 0.2 BTS / BitUSD, then the liquidation bid order cannot be matched.

The fact that some BitUSD "escaped" being destroyed means that the total market capitalization (as determined by number of BitUSD in circulation times the market price) can potentially exceed its total collateral value (the sum of all the pies of all short accounts, minus the sum of all the short-holders' equity).

Is this a fair description of the problem?

[Liberty]

You can also glean ideas by searching for post-crash proposals to avoid flash crashes in markets.

Can you give a few starting points?

Here is a detailed analysis of the May 5, 2010 "flash crash":

http://www.sec.gov/news/studies/2010/marketevents-report.pdf

YouTube is a source for many congressional hearings. The video series "Federal Regulation of Financial Markets" is close. I don't have links for the testimonies that I'm familiar with. The ones you are interested in are the videos of exchange executives speaking about the systems already in place and in development to avoid problems (and thereby encouraging legislation that makes their solution a costly compliance requirement for competitors). To see the truly useful recommendations it helps to start with an understanding that everything seen there (especially from the politicians running the show) is posturing for increased theft from someone.

A Google search for "Interval Price Limits" and "Reasonability Limits" will get you to information about one solution that has spread to other exchanges. The basic idea is to impose artificial trade limits on price volatility. I'm not going to risk giving examples of how I think trade limits could be implemented by III. I doubt any technical solution will be immune to dedicated manipulators with resources, but there are ways to make it more difficult. Volatility diminishes as the number of participants increases. An incentive that creates high market participation is a better approach than price limits, but markets still evolve to have whale participants that can use their influence to direct price movements for their gain. I like how derivatives provide a reward for finding market consensus (and punish those that stray), but first you need markets with higher participation than the derivatives themselves can influence.

[toast]

You can also glean ideas by searching for post-crash proposals to avoid flash crashes in markets.

Can you give a few starting points?

[Liberty]

"Solution to High Volatility potentially breaking the BitUSD Peg"

Traditional derivatives exchanges use Interval Price Limits and Reasonability Limits. Anchor price can be set from that last (or recent) block prices. The limits also help traders avoid price error. You can also glean ideas by searching for post-crash proposals to avoid flash crashes in markets.

[bytemaster]

You don't seem to understand the mechanics or economics behind how BitShares X works.  You cannot resort to price fixing and the collective capitalization of BTS holders has nothing to do with begging BitAPPL to APPL.     You just need enough people willing to speculate on BitAPPL but the amount they each speculate is irrelevant.

As long as there are currently people who are essentially receiving early shares in these assets at extremely low prices, there is almost no way they don't sell far below real world market value. Essentially, for all of these assets, as long as there are large amounts of holders before the public gets full access to it, their values will NOT be pegged to real world values for a very long time, because no matter what, these early holders will be tempted to sell out early when they see such a large percentage on their gains.

No one gets early shares in these assets below the peg.

[zavtra]

You don't seem to understand the mechanics or economics behind how BitShares X works.  You cannot resort to price fixing and the collective capitalization of BTS holders has nothing to do with begging BitAPPL to APPL.     You just need enough people willing to speculate on BitAPPL but the amount they each speculate is irrelevant.

As long as there are currently people who are essentially receiving early shares in these assets at extremely low prices, there is almost no way they don't sell far below real world market value. Essentially, for all of these assets, as long as there are large amounts of holders before the public gets full access to it, their values will NOT be pegged to real world values for a very long time, because no matter what, these early holders will be tempted to sell out early when they see such a large percentage on their gains.