Opening a short transaction as I know is as follows:
If I short bitUSD, I am collecting BTSX and putting up collateral BTSX. The person buying it is selling his/her BTSX to get the bitUSD.
Closing the transaction from the short side:
He would use BTSX to buy back bitUSD.(hopefully less BTSX than he received to profit)
Closing from the long bitUSD side:
He would sell the bitUSD and receive BTSX. (hopefully get more BTSX back than originally sent to profit)
So here is where I don't follow. If the shorter can't cover, meaning he doesn't have the BTSX to buy the bitUSD back, then where will the seller of the bitUSD get the BTSX for giving up the bitUSD?
If you are going to confiscate the bitUSD, you have to simultaneously create BTSX to pay for that bitUSD (since the shorter couldn't cover his portion of BTSX owed to the transaction).
So now you created more BTSX and you are keeping the "unbacked" bitUSD "alive". It would seem if that bitUSD was just sitting there waiting for castrophe that eventually the free market will tend to move to that point just because everyone knows the fail safe is in place. At some point the system will get purged because it's an option.
If you are okay with the BTSX creation and hoarding of bitUSD, then I'll ask:
How will the platform determine who's bitUSD to buy back? Not all bitUSD will be on the table at once. So the new bitUSD insurance fund is going to act as an active market maker setting "untrue" bids on bitUSD. This is not a good idea. You are guaranteeing liquidity through default.