Why feed-price relative orders will improve pegging and liquidity
My previous post showed that a mechanism allowing sell orders to be set at the median feed price (MFP) would lead to more robust arbitrage of bitCurrency discounts (e.g. bitUSD). In this post I would like to expand that to the ability of all participants to be able to place orders that are set
relative to the median feed price (MFP +/- X%). I believe this should encourage a wider group of arbitragers and market-makers to participate in strategies that help strengthen the peg, but it will have to be determined through debate how much relative benefit this might add. My OP originally allowed orders to be set at the feed price (FP + 0%) via the 'bank' mechanism - this post generalises that line of thinking to MFP+/-X%, again using bitUSD as an example.
If bitUSD is trading at a discount, arbitragers could buy bitUSD and place a sell order at MFP (they can also hedge their reduced BTS exposure elsewhere). We know such an order, if permitted, must be hit within 30 days, unlike any order that can be placed in the current system (see previous post). This means that the discount should never be greater than the return arbitragers demand for tying up some capital for up to 30 days.
In fact, whenever a sell order is placed in the queue at MFP, it's possible to use the queue of short expiries to determine the maximum time it will take for any new sell order to get hit (this would be a useful public metric). This could range anywhere between 0 and 30 days. Arbitragers (and others) can always use this metric to weigh up the discount against the time.
Now in some scenarios, if a high return is demanded by arbitragers, the discount could still be high. Some arbitragers may prefer to capture just part of the discount if they can close the trade more quickly. So on buying at MFP - 4% say, they could place an order to sell at MFP - 2%, and hope to get hit by a new group of buyers or arbitragers coming in at the lower discount before the expiries occur. So allowing both buyers and sellers to trade relative to MFP allows a wider group of arbitragers and bargain hunters to trade exposures relative to the MFP. (*)
With regard to premiums on bitUSD, although there is not a strict arbitrage available, its possible to make the process simpler and less costly for market-makers by introducing self-creation, self-cancelling, and self-rolling mechanisms as I describe here...
https://bitsharestalk.org/index.php?topic=15207.msg196314#msg196314. This would encourage greater market-making activity to exploit premiums. For example, a market-maker could wait for a premium to appear, self-create bitUSD, sell bitUSD at a premium for real USD, wait for a future reversion of the premium, buy back bitUSD with their USD, and use the bitUSD to self-cancel their short. All without ever having changed their exposure to BTS. (**)
By allowing such orders to be conditional on certain levels of discount or premium (in practice, determined by comparing to the highest bid or lowest ask prices), this would allow market-makers to set standing orders and wait, rather than monitoring for the opportunity. They can more easily implement a strategy such as (Sell at X% premium, and close at X-2% premium). Or (Sell at X% premium, and close at 1% discount). These parameters allow for the heterogenous views of market-makers on where they think the trading ranges might be, and how long they are willing to hold positions.
An alternative strategy (especially if there is not a liquid external market in the bitAsset) is to short bitAsset internally at the premium, and sell BTS and buy USD on external exchanges as a hedge. When the premium narrows, close the short and remove the external hedges. For such outright short positions, allowing limit orders to be placed on new shorts at MFP + X%, and limit orders for short covering at MFP +/- X%, might encourage this type of market-making also. This is not really possible in the current system because there is no way a short can guarantee shorting at a premium unless they are willing to constantly change their price limit, and short covers are effectively a market order.
In summary, I'm of the view that the ability for all parties to set orders that are relative to the feed price, and for self-order mechanisms to be conditional on these, creates a rich and effective environment for arbitragers and market-makers to implement their strategies. This in turn will lead to better pegging and liquidity around that.
[ * If the MFP relative trading took place separate to the main market as proposed in the original OP, its possible to incorporate a wider range of possibilities, such as queued withdrawals selling their queue positions.
** This assumes there is a liquid external market for the bitAsset. bitUSD right now has zero volume at BTER]