OK, I will try to recreate my lost post from the other day. Unfortunately, I will probably not be able to be as articulate as I was in the post I lost, because I'm trying to rewrite this from memory. I'll just go down the list of questions.
Gamey and Tonyk2 ask why CFD are more susceptible to manipulation than options are. First of all, in the US, options and futures very much impact the price of the underlying assets. For example, in the gold market, the futures market tends to set the price for the physical market in a kind of tail-wags-the-dog kind of way. This is curious, especially because, in the US, most futures and options contracts are settled for cash. Nonetheless, many coin shops rely upon the contract markets to set their prices for gold.
Secondly, as one may exercise an option contract, or take delivery of the asset underlying a futures contract, there is a direct relationship between the derivative (the contract) and the asset. So, if many traders (or a few wealthy traders, such as in the case of the Hunt brothers) all of a sudden began to take delivery of the underlying assets of their futures contracts, the supply of the asset would have to come from somewhere. This is not the case with CFDs which are cash settlement only.
I can make a pained analogy to try to convey the relationship. Let's say a gas station owner has a station in the middle of nowhere, and that the nearest gas station is miles away. This owner may be inclined to charge a high price for his gas, and he may be inclined to offer poor service and poor quality products. He does this in the false assumption that he has no competition. However, if he does this long enough, and if a competing businessman finds that there is enough profit potential in the area, the competitor may decide to open a gas station across the street. If the competitor sells gas at a fair price and offers quality goods and services, he may put the original gas station owner out of business. In other words, there is always competition, whether seen or unseen. OK, that was an awkward analogy, but in the futures and options market, there is always a short squeeze looming around any corner, if the shorts decide to take on the risk of naked short selling.
Have I described naked short selling? I can't remember what I've written and what I've lost. Naked short selling in the futures and options market is when a trader sells contracts to an asset he has neither purchased nor borrowed, and therefore cannot deliver. The result is that, if someone should stand for delivery, the naked short seller must get that asset from somewhere at whatever price the market will offer. This is a bad situation for the seller to be in. If enough pressure of this sort occurs at the same time, the result is a short squeeze in which prices shoot upward as shorts scramble to obtain assets that they can deliver. The ability to squeeze shorts exists in the futures or options market, but it does not exist in the betting market. There is no short squeeze in the CFD market, as all contracts are settled in cash, rather than in the underlying asset.
Ander, you make a good point about gateways. I have not given much thought to gateways, but I would think they would help. Having said that, the gateways would not be directly related to the CFDs either. In other words, if Alice and Bob traded CFDs among themselves, and Charlie offered a gateway to the underlying asset, Bob would not be directly affected if Bob tried to manipulate the CFD market. Alice still could not short squeeze Bob, even if Charlie offered a gateway. That's just my first thought on the matter, though I do think that gateways would help.
Tonyk2, in your example about BitShares and BitUSD, I am treating BitUSD as a receipt or contract. That means that the two assets pertinent to the trade are BitShares and USD, not BitShares and BitUSD. Only BitShares are available for delivery in this contract. Compare that to a gold/USD futures contract in which both the gold and the USD are available for delivery, and you see the problem with the CFD. No one can stand for delivery of the USD in a BitUSD contract.
Merivercap, you've touched on many points, so I'll try to address the ones that I haven't addressed elsewhere.
3) I agree that it is good to explain both sides of the trade, but in some cases I'm leaving that out to try to cut down on my already voluminous posts.
5) My reference to financial regulation was just about the dirty business of government regulation. I am not a lawyer, but I know that CFDs are considered illegal in the US and some other countries. Also, betting in general is highly regulated in many countries, so I am recommending that anyone who wants to trade in BitAssets should maybe check with a lawyer to make sure that he may do so unmolested in his jurisdiction. We're all of good intention here, but there are many people out there of questionable intent who may come out of the woodwork and get nasty if these types of trading arrangements come onto their radar.
5.5) I have a copy of the Big Short which I've never gotten around to reading. It's on my list. I'm not suggesting that betting can't be profitable. I'm not suggesting that betting is bad. After all, my main example, Jesse Livermore, made enough money betting in bucket shops to enter the stock market as a big player. I am only pointing out that betting and CFDs are a relatively weak arrangement that are subject to relatively easy and low-risk manipulation.
6) Quote:
The reason the bucket shops could manipulate trade is that they had knowledge of an additional large order book and vulnerable margin positions, not because traders weren't able to call bluffs or request the delivery of an underlying asset.
End Quote.
These two reasons are not mutually exclusive. A bucket shop could manipulate markets because it had knowledge of a large order book and vulnerable margin positions and because traders weren't able to call bluffs by taking delivery of the underlying assets. Large institutions like JPMorganChase have knowledge of order books and vulnerable margin positions, and many market observers believe that such institutions take advantage of this privilege. There is no doubt that a public ledger could improve upon the current trust-based arrangement, but that would not change the fact that market manipulation is more easily accomplished when no one can stand for delivery.
6.5) It is ironic that BitAssets was designed to address the immature and illiquid nature of the Bitcoin market, but BitAssets is subject to the same problems of immaturity and illiquidity. In a future post, I may address that as a “crisis of purpose.”
7) I remember that, while I was reading Bytemaster's Blog, I was thinking that there was a curious lopsided nature to the arrangement which seemed to favor one side of the trade over the other. I didn't look into it too deeply, but I wondered why it wouldn't be a level playing field.
OK, that is much, much shorter than what I wrote the other day, and of a poorer quality. I can't remember what I included in the other that I must be leaving out of this post, but maybe I've covered the basics. Sorry about the loss.