ELI5 Reddit - Why will bitUSD work when they aren't backed by USD?

[xeroc]

Rules:
-------------------------------------------------------------------------------
- The volume of the bucket is given by the demand for a bitAsset (bitUSD)
- The goal is to keep the water level constant at the consensus level (say 1
  meter)
- When people want to have bitUSD .. the volume of the bucket increases
  As an example, they add an extra bucket via a pipe to the main bucket.
  Water starts to flow from the main bucket (the market) to the users bucket
  (pocket ). The price he has to pay for his water (in liters) depends on
  how much water is in the main bucket. As the water level decreases .. the
  price per liter/gallon increases. Obviously, the water gets rarer and rarer.
  The more the water level moves below the consensus level the more expensive
  it gets.

- When people want to get rid of their bitUSD  .. the volume of the bucket is
  decreased .. The seller wants to put their water back into the main bucket and
  pump it through the pipelines. The water level in the main main bucket rises
  and moves above the consensus level. Hence, the price decreases because of the
  surplus. Other participants no start increasing their buckets because the water
  (bitAsset) is cheap now in contrast to if they had to buy earlier.

- The total amount of bitUSD is the volume of the bucket .. and thus the demand
  for bitUSD

The Market Peg
-------------------------------------------------------------------------------
The Market Peg is a device (look previous post) that works as follow:

http://en.wikipedia.org/wiki/File:Ballcock.svg


- In the main bucket there is an extra devise with a ventile that can control
  the water level.

- when the swimmer goes below a certain threshold (i.e. the height/depth of the
  water, and thus (indeirectly) the price of the bitUSD) .. the ventile opens
  and new bitUSD are created to fill up the bucket and the demand.

- In order for the ventil to produce water ... someone has to go buy water ...
  the price for the new water depends on the water level in the bucket.
  Obviously the water level is lower than the consensus level and as such the
  water is expensive if you want to get some. However, he cannot create water
  out of thin air. But he can borrow it from the local water supply with the
  promise to give it back and sell it for the higher-than-consensus price at
  the market (the main bucket). As a security the local water supply offers the
  water at TWICE the market price. The buys accepts the deal and fills up the
  main bucket.

- when the swimmer is at a certain level (ie. height/depth of water) above the
  consensus level (150% afaik)the swimmer makes the ventile to close again and
  call for margin (unless someone buys water/bitAsset).
  A margin call is performed such that the guy who bought water from the local
  water supply and sold it to the market at a high price has to buy his water
  back again at a cheaper price to pay his loan at the local water supply. Thus
  he makes a loss.



I am not so sure about the last paragraph describing the margin call ... could s.o. check?

[xeroc]

you have a bucket full of water ... (with that market peg machine)

you want to buy half of the water .. by adding an extra bucket (with a pipe) that has the same volume ..
then both buckets are half full ..

if you now also want to add an extra bucket .. with the same volume ... you will get less water .. because the water level is not refilled yet ..



ok .. maybe I write sth down offline .. so that I dont' screw up that much publicly

[xeroc]

wait ...

let me think ... if the demand increases .. the volume increases .. but the price of the bitUSD should rise!!! (at least short term)
so of you have 1m of water ... you need to pay 1USD for 1bitUSD ...
if the water level decreases to .. say 80 cm .. then you need to pay .. say 1.20USD for one bitUSD ..

sure .. the less water there is .. the more expensive it gets!! .. so remove that water level stuff

[Riverhead]

Very nice Xeroc. I bet someone could put together one of those animated videos explaining the market peg using the water control system graphic animations.

If such a video could be made so that a non finance guy like myself would have a light bulb go off then this thread will have accomplished its mission.

[Empirical1]

I'm starting to see how BitUSD could maintain it's expected market peg to USD within the BitShares system but I'm also starting to think about how one would spend either BitUSD or USD as one still needs to these days until people and organization directly accept BitUSD in place of fiat USD.  So, it seems to me that for me to pay my mortage if I am holding in BitUSD it would be:

BitUSD->BTSX->Bter Exchange->BTC->Coinbase->Bank Account->Mortgage Company

which is still too unnecessarily convoluted.  What is the Ideal?  BitUSD->Mortgage Company ?? 
Yes
What is realistic?  BitUSD-> CoinBase ->Bank Account->Mortgage Company ?
Yes, as in CoinBase or somebody else.

I like it!! 

The cost in fees and time of having to transition via a coinbase initially is why I feel a BitUSD may have a practical value that is 1/2% off a $. (You highlighted earlier in this thread an advantage that may push it the other way though.)

Either way if a BitUSD value is within 1.5% for most they'll be directly interchangeable.
If not I'm still not worried because a BitUSD will still have crushed volatility compared to crypto-currency, so retailers/savers will be a happy to use BitUSD even if it involved a small conversion.
I actually believe a BitUSD will have a practical value of more than 1 USD in the medium term+

[xeroc]

Most people won't understand market science,
but they will soon believe a bitAsset will hit its target too.

I like that ...
As a controls guy ... can you fix the description above?

[xeroc]

I thought a little more about my previous explanation ... it is not 100% accurate .. but easy to get ..

the more accurate explanation would look like this

- The volume of the bucket is given by the demand for bitAsset (bitUSD) ..
- When people want to have bitUSD .. the volume of the bucket increases
- When people want to get rid of their bitUSD  .. the volume of the bucket is decreased ..
- The price of the bitUSD is the height (or depth) of the water in the bucket
- The total amount of bitUSD is the volume of the bucket .. and thus the demand for bitUSD

the Market Peg is a device (look previous post) that works as follow:
- when the swiming thing (no idea of the name, lets call it the swimmer) .. goes below a certain threashold (i.e. the height/depth of the water, and thus the price of the bitUSD) .. the ventile opens and new bitUSD are created to fill up the buckte
- when the swimmer is at a certain level (ie. height/depth of water) that represents the bitUSD (here comes the consensus over the depth of the water) the swimmer makes the ventile to close again ..
- if the water is too hight .. because someone wanted to get rid of bitUSD and the volume of the bucket decreases (and thus the water level rises) .. the ventile closes completele ...
- If a certain threshold (150% afaik) of the intended(ie. consensus) water level is reached (unless someone buys bitUSD) ... a margin call is performed ... calling for someone that HAS to take water out of the bucket .. and as such .. the water level decreases until consensus is reached again ...

// EDIT:
Advanced:
- in order for the ventil to produce water ... someone has to go buy water ... the price for the new water depends on how low the level is in the bucket (ie, how much he needs to fill up) ... to get the water .. he needs to pay TWICE the price ;-) ...now its getting akward ... can s.o. fix this example

// edit2:
cant make my mind up ... is the water level the price of the bitUSD in btsx ..
we can fix this .. I just cant .... maybe I should get sth. to eat

[Stan]

Why it works... because humans can sometimes be very irrational. 

Ther market peg is actually VERY rational .. it is a so called "negative feedback" loop that forces the price towards the consensus the more it moves a way from it ..

I can probably find some very nice examples from control theroy .. let me search

EDIT:
on wikipedia there are some quite technical examples
http://en.wikipedia.org/wiki/Negative_feedback#Examples

Maybe someone can write sth up with this:
http://en.wikipedia.org/wiki/File:Ballcock.svg



My english is not sooo good .. but I think of

whenever the water level is to low .. the market makers start 'creating' USD such that the levels rise ..
on the other hand theirs a leakage .. such that the need to find the balance between .. so that their is not too much water (increases the leakage) and too few water (opens up the refiller) (I got that wrong)
When the water level rises too much, the ventil closes the ventil such that the level is maintained ...
now if you want to have some of those you need to take water out of the bucket ... consequence ... the level drops .. new water comes in

when you want to get rid of your water you put it un the bucket .. the level rises .. and someone else can get water out of it without the the need for the market makers to open the venitl ..

Does that sound valid? Can someone with native english experience rewrite that to an easy understandable text?

This is a fantastic way to describe this (although developing control systems for unmanned systems is how I spent my first career so perhaps it is just me.  )

Yes, we have designed a system with closed loop feedback where the measured error between the commanded (pegged) value and the output (redeemed) value is used to generate a compensating signal that drives the output in the direction of the commanded input.  This is how a camera on the nose of a missile steers it towards its target.  This is also how a thousand buy/sell decisions drive bitUSD to $1.

Most people don't understand rocket science,
but they still believe a missile can hit its target.

Most people won't understand market science,
but they will soon believe a bitAsset will hit its target too.

[xeroc]

Why it works... because humans can sometimes be very irrational. 

Ther market peg is actually VERY rational .. it is a so called "negative feedback" loop that forces the price towards the consensus the more it moves a way from it ..

I can probably find some very nice examples from control theroy .. let me search

EDIT:
on wikipedia there are some quite technical examples
http://en.wikipedia.org/wiki/Negative_feedback#Examples

Maybe someone can write sth up with this:
http://en.wikipedia.org/wiki/File:Ballcock.svg



My english is not sooo good .. but I think of

whenever the water level is to low .. the market makers start 'creating' USD such that the levels rise ..
on the other hand theirs a leakage .. such that the need to find the balance between .. so that their is not too much water (increases the leakage) and too few water (opens up the refiller) (I got that wrong)
When the water level rises too much, the ventil closes the ventil such that the level is maintained ...
now if you want to have some of those you need to take water out of the bucket ... consequence ... the level drops .. new water comes in

when you want to get rid of your water you put it un the bucket .. the level rises .. and someone else can get water out of it without the the need for the market makers to open the venitl ..

Does that sound valid? Can someone with native english experience rewrite that to an easy understandable text?[/s]

[jae208]

None of these explain why it actually tracks...

Sent from my SCH-I535 using Tapatalk

Explain it like you're talking to a FIVE year old.

It works because everyone else thinks it works. If you don't think it will work, you will lose money by trading the wrong way, because you disagree with the majority. So the only people that stay in and make money are those that agree.

The other explanations are more complex *and* fail to explain *why* it works, they just say *how*.

Why it works... because humans can sometimes be very irrational. 

[Riverhead]

It works because everyone else thinks it works. If you don't think it will work, you will lose money by trading the wrong way, because you disagree with the majority. So the only people that stay in and make money are those that agree.

Sounds like the Fine Art market. The intrinsic value of the Mona Lisa is $0 however it sells for millions because of a collection of people that are willing to buy/sell it from/to each other. Like a successful night club that everyone goes to because everyone goes there.

[GaltReport]

I'm starting to see how BitUSD could maintain it's expected market peg to USD within the BitShares system but I'm also starting to think about how one would spend either BitUSD or USD as one still needs to these days until people and organization directly accept BitUSD in place of fiat USD.  So, it seems to me that for me to pay my mortage if I am holding in BitUSD it would be:

BitUSD->BTSX->Bter Exchange->BTC->Coinbase->Bank Account->Mortgage Company

which is still too unnecessarily convoluted.  What is the Ideal?  BitUSD->Mortgage Company ?? 
Yes
What is realistic?  BitUSD-> CoinBase ->Bank Account->Mortgage Company ?
Yes, as in CoinBase or somebody else.

I like it!! 

[tonyk]

I'm starting to see how BitUSD could maintain it's expected market peg to USD within the BitShares system but I'm also starting to think about how one would spend either BitUSD or USD as one still needs to these days until people and organization directly accept BitUSD in place of fiat USD.  So, it seems to me that for me to pay my mortage if I am holding in BitUSD it would be:

BitUSD->BTSX->Bter Exchange->BTC->Coinbase->Bank Account->Mortgage Company

which is still too unnecessarily convoluted.  What is the Ideal?  BitUSD->Mortgage Company ?? 
Yes
What is realistic?  BitUSD-> CoinBase ->Bank Account->Mortgage Company ?
Yes, as in CoinBase or somebody else.

[GaltReport]

I'm starting to see how BitUSD could maintain it's expected market peg to USD within the BitShares system but I'm also starting to think about how one would spend either BitUSD or USD as one still needs to these days until people and organization directly accept BitUSD in place of fiat USD.  So, it seems to me that for me to pay my mortage if I am holding in BitUSD it would be:

BitUSD->BTSX->Bter Exchange->BTC->Coinbase->Bank Account->Mortgage Company

which is still too unnecessarily convoluted.  What is the Ideal?  BitUSD->Mortgage Company ?? 

What is realistic?  BitUSD->CoinBase->Bank Account->Mortgage Company ?

[Riverhead]

It's possible this planned article is for not as the explanation cannot be made simple. There are a few different answers in this thread of varying complexity. Each could be right but non of which fits into the eli5 bucket.

A good example of one, and what gave me the idea is this:

http://www.reddit.com/r/explainlikeimfive/comments/1jvduu/eli5_how_does_publicprivate_key_encryption_work/