Here is an updated and slightly more polished version. Even though some things are not fully delved into like the formula for distributing yield, I think you could end up just confusing people and turning them off by adding every detail or scenario and I also don't want it to seem too "salesy".
BitShares Market Pegged Assets
BitShares market pegged assets are a new type of freely traded digital asset whose value is meant to track the value of a common asset such as the U.S. dollar or gold. BitShares uses an advanced decentralized consensus ledger that takes some cues from Bitcoin. While Bitcoin has demonstrated many useful properties as a currency, its price volatility makes it risky to hold and difficult to use for everyday pricing and payments. A currency with the properties and advantages of Bitcoin that maintains price parity with a globally adopted currency such as the US dollar has high utility for convenient and censorship resistant commerce. The purpose of this introduction to market pegged assets is to explain how this price parity is achieved.
Bitcoin and similar crypto-currencies enable value storage and exchange over the internet that is beyond the control or censorship of a centralized party. Demand for this utility has driven up the price of crypto-currencies. Bitshares uses an analogous blockchain based core token simply called BitShares that is traded with the abbreviation "BTS" on well-known crypto-currency exchanges.
Market MechanismMarket pegged assets are created on the BitShares blockchain using a similar method to a contract for difference. The open source BitShares software program implements a decentralized internal marketplace for these assets and enforces the market rules. A BTS holder may use her BTS to place a buy order on the internal market for her asset of choice. Market pegged assets are created when a buyer is matched with a "short seller" of the asset. The short seller takes on the obligation of buying back the asset in the future and must maintain collateral sufficient to repurchase the asset at current market rates. This creates systemic demand for the asset.
"BitUSD" is the name of the BitShares market pegged asset that tracks the US dollar and we will use this as an example. In order to ensure that the internal market participants trading bitUSD for BTS have the opportunity to settle at the real USD to BTS exchange rate, the external exchange rate is fed into the system by a network of independent "delegates." Delegates are elected by BTS holders to run the network, process transactions, and provide exchange rate information. This external exchange rate information is often called a "price feed." The delegate election process is covered in detail in documentation on the BitShares' "DPOS" consensus algorithm. Delegates typically combine price information from multiple sources such as exchanges to generate a price feed and update it regularly. The system takes a median of all price feeds so that manipulation of the price information would be very difficult by any single delegate or party without massive collusion.
It is important to understand how the price feed is used to regulate the internal market. It does not directly control the market or the sale price between buyers and sellers of market pegged assets. It functions to regulate creation and destruction of market pegged assets in a way that pushes the market price toward the long term expected exchange rate (parity with the dollar). While the internal exchange rate of bitUSD to BTS has no restriction, new "short sales" are prevented from executing below the median price feed. Short selling is the process by which new bitUSD is brought into existence and the rule that short sales are not executed below the real exchange rate prevents new bitUSD creation when price is below parity with the dollar. New bitUSD is created only when demand for bitUSD is at parity with the dollar or above.
When a short seller buys back bitUSD and covers their position they repay their obligation and can recover their collateral BTS. At this time they are taking bitUSD out of circulation and reducing the total supply. The current BitShares market rules force short sellers to cover their position within 30 days of opening the short position. This means that the full amount of outstanding bitUSD must be purchased off the market every 30 days. BitUSD holders are not required to sell; therefore short sellers covering their positions are eventually forced to purchase from newly opened short sales at or above the exchange rate. This is effectively a guarantee to any bitUSD holder that they can sell bitUSD for the dollar equivalent of BTS within any 30 day period.
Short sellers are typically bullish on the direction of BTS vs. the market pegged asset. If the market value of BTS rises with respect to the asset the short seller can buy back the asset for significantly less BTS than they originally sold it for and profit from the transaction. If BTS value falls in relation to the market pegged asset, the short seller must buy back the asset at a loss. If the price of the asset rises a lot, a short may face a "margin call" where the rules of the program use the posted collateral to automatically buy back the asset from the market to repay the obligation. A margin call is triggered in the current BitShares system whenever the value of the collateral falls to less than two times what is required to cover the obligation.
Order MatchingMarket orders and other signed transactions on the BitShares blockchain are grouped into 10 second blocks by delegates. When buy and sell orders on the internal BitShares' market are matched, the highest buy orders are matched with the lowest sell orders and any BTS contained in the overlap are destroyed so that each party gets exactly what they paid for. The reason for this is twofold. Firstly, it prevents high frequency trading that attempts to insert an order between two placed orders to profit from the overlap, this is sometimes called "front running". It also makes it very costly for a large buyer or seller to quickly move the market by placing a large order far from the current market rate. Doing so would require the buyer or seller to pay the more expensive rate and lose any overlap with all orders their order is matched with. The destruction of BTS from the overlap of orders creates value for BTS holders as a whole by making the token more scarce. When there is significant demand to short sell assets at the price feed rate, the current BitShares system allows short sellers to offer interest to asset holders in exchange for priority in order matching. In this way, holders of market pegged assets can also collect an additional yield on their savings.
RiskThe implementation of market pegged assets in the BitShares system is designed to minimize risk of loss to asset holders. Short positions are opened with collateral valued at three times the face value of the asset. The initial collateral is comprised of the BTS paid by the buyer for the asset and twice this amount of BTS contributed by the short seller. The collateral requirements and margin triggers were chosen conservatively to protect the holders of market pegged assets from volatility of the underlying collateral. Forcing short positions to cover every 30 days provides additional assurance of short term liquidity. Control over the price feed is distributed among over 50 separately elected delegates who compile information from multiple exchange sources. Despite such precautions, it is important to carefully explore risks of using the system. Risks can be broadly categorized as value risk, counterparty risk, or systemic risk.
Value Risk:
Market pegged assets maintain their price parity due to being backed by collateral that has an established real world value. When the value of the collateral falls, the system is designed to react by driving the internal asset exchange to match the new real world exchange rate and trigger margin calls as necessary. However, there exists a possibility that the underlying asset used for collateral (BTS) drops in value so quickly the market pegged assets become under-collateralized. Often termed a "black swan event," this sudden and dramatic crash of BTS value could prevent the system from adjusting in time. In this event, the full amount of collateral is no longer sufficient to purchase the market pegged asset back at the new real exchange rate. In such an event, assets may trade below their face value. It is possible the market could recover if BTS regained value. It is also possible the market would need to be "reset" and asset holders forced to settle for BTS collateral worth less than the intended face value of their assets.
Counterparty risk:
Unlike many attempts to create a digital asset that tracks the dollar, market pegged asset are not an "I owe you" issued by any entity. For this reason, it does not rely on a specific counterparty to honor its value. Although manipulation risk occurs in any market, it is minimized by the open source and auditable nature of the BitShares system and carefully considered market rules. Some counterparty risk exists when buying market pegged assets on an external public exchange. The exchange must be trusted with customer funds for the time period they are deposited. It is not recommended that digital assets are stored on an exchange long term.
Systemic risk:
Systemic risk is a catch-all for other risks required to utilize the system. The primary risk is individuals are responsible for protecting the cryptographic private keys that sign transactions proving ownership of assets. These keys must be protected from theft or loss. This risk can be greatly reduced and virtually eliminated by following best practices. Systemic risk also includes the possibility of an overlooked fatal flaw in the open source software or the possibility of large scale failure of global network infrastructure.
OutlookBitShares market pegged assets are a viable open source alternative to the incumbent banking system. While certain risks have been outlined, no system is without risk. The current banking system allows private funds to be frozen or confiscated without consent, such as by court order. Banks and financial institutions are susceptible to insolvency. The availability and quality of banking service varies greatly throughout the world. BitShares brings publically auditable open source banking to anyone with access to the internet. Market pegged assets allow savers and spenders to choose preferred asset types. This brings flexibility and ease of use to the open source banking experience.