Author Topic: Introduction to BitShares - Video  (Read 24678 times)

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Offline jimbobway

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If I have MtGoxUSD then MtGox will allow me to withdraw it into my bank account into BankUSD.  MtGox basically guarantees this and this is why MtGoxUSD is "valuable".

If I have BitUSD who will allow me to withdraw BitUSD into BankUSD?  Is this a service that needs to be built?  Or is BitUSD only backed by BitShares?   It seems like if I own BitUSD no one will convert it directly to BankUSD without first converting it to BitShares.

Since I can convert MtGoxUSD into BankUSD easier than converting BitUSD to BankUSD, it seems like MtGoxUSD is more valuable than BitUSD.  Your thoughts?

« Last Edit: December 12, 2013, 03:33:56 am by jimbobway »

Offline bytemaster

This will be an experiment, like Bitcoin.  The closest thing to BitUSD is EuroDollars.   

Eurodollar deposits are redeemable for USD at the maturity of their deposit time.  This redeemability is backed by faith in the solvency of the bank that holds your deposit.  What we have been debating is why the bitshares market in BitUSD would actually track the BTS/USD rate, which would be necessary to redeem your bitUSD from the market for the value of 1 USD denominated in BTS.  So this is a bit tangent to our discussion, and again is a financial product where lump-sum cash flow changes hands at some point in time.  That contractual obligation (modulo trust) is sufficient to maintain a market value for Eurodollars that tracks dollars. 

I asked for an example of a financial derivative traded on a market that tracks an underlying merely via a mechanism of yield-adjustment, without lump-cash settlements that compensate directly and linearly for price changes of the underlying.  I've never heard of such a product, and it's premise seems to me to be ill-founded.

If I had to think of the closest product to bitUSD, I think it would be an equity.  Equities just pay dividends, as bitUSD does, and there's no notion of any terminal value of an equity.  However, equities give ownership in the net assets of a company, hence have backing in this sense.  They also don't track anything other than the value of the company (by definition), which in old-school finance was proposed to be the discounted expected value of the entire future stream of dividends from that company.  This makes sense as a way to value bitUSD also.  However, the future dividends of bitUSD depend directly and merely on its price (in the case where margin depends on bitUSD's price). There's no underlying net profits as there would be for a company to distribute as dividends.  But the price is valued from the dividends.  So we have a bit of a self-referential situation going on here, and it should be clear that in this valuation model there's no reason for the market price to converge to any particular value.

In the case where bitUSDs dividends are a function of an embedded BTS/USD price, then that price can be seen as analogous to something proportional to net earnings of a company.  In that case, we may expect some rational valuation model to work, but I don't see any reason why the value of the dividend stream from bitUSD would converge to a certain specific proportionality factor (the one needed to make the ratio of bitUSD/(BTS/USD) prices be 1) times its net income (BTS/USD price).  The price of bitUSD would be sensitive to all kinds of exogeneous things, first and foremost interest rates in the overall economy.

This is not tracking merely by yield-adjustment.   There are no known financial instruments that operate exactly how BitUSD does just like prior to Bitcoin there were no systems that operated how Bitcoin does.   It is the existence of Bitcoin and its ability to have 'value without contractual obligation' that opens the door to invent new financial assets.   

So let me ask you a question:  Suppose you wanted to buy something called BitUSD and expected it to have the value of a dollar?   How many BTS would you pay?    Clearly not much more than $1 worth of BTS.   Now when no BitUSD exists then it cannot be created without someone willing to borrow a BitUSD backed by collateral.   At what price would some one be willing to borrow BitUSD and sell it for BTS?   Clearly not anything less than $1 worth of BTS.   

Once these first two people Long and Short trade positions you have an agreement on the value of BTS vs USD at that point in time.

TIME PASSES

The only way for Long and Short to exit the position is to agree.    So the long attempts to sell their BitUSD and they ASK for 1 USD worth of BTS at todays price (in their opinion).  If they ask too much, no one else will accept.  If they ask less than 1 USD then there will be many buyers.   

The only thing it takes to shake a SHORT from their position is for someone to BID at 1.5x the strike price of the short position and for there to be no takers.    Once that happens the short is forced to buy.   Now if someone is willing to Bid 1.5x for BitUSD then someone who already has BitUSD could easily sell into it and get their dollar worth of BTS out.

So my question for you is this.... markets always price things based upon expected future value relative to past value.    BitUSD is either correlates with the dollar or is worth nothing.  I don't see any other way for the market to price it.
   
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Offline bytemaster

Why did Bytemaster stop replying to this thread? Is it just me or is this concept still unclear and needs a simple example?

Sorry, I have just been busy and didn't realize I hadn't addressed a post here.
For the latest updates checkout my blog: http://bytemaster.bitshares.org
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Offline nanobit

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Why did Bytemaster stop replying to this thread? Is it just me or is this concept still unclear and needs a simple example?

Offline Winslow Strong

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This will be an experiment, like Bitcoin.  The closest thing to BitUSD is EuroDollars.   

Eurodollar deposits are redeemable for USD at the maturity of their deposit time.  This redeemability is backed by faith in the solvency of the bank that holds your deposit.  What we have been debating is why the bitshares market in BitUSD would actually track the BTS/USD rate, which would be necessary to redeem your bitUSD from the market for the value of 1 USD denominated in BTS.  So this is a bit tangent to our discussion, and again is a financial product where lump-sum cash flow changes hands at some point in time.  That contractual obligation (modulo trust) is sufficient to maintain a market value for Eurodollars that tracks dollars. 

I asked for an example of a financial derivative traded on a market that tracks an underlying merely via a mechanism of yield-adjustment, without lump-cash settlements that compensate directly and linearly for price changes of the underlying.  I've never heard of such a product, and it's premise seems to me to be ill-founded.

If I had to think of the closest product to bitUSD, I think it would be an equity.  Equities just pay dividends, as bitUSD does, and there's no notion of any terminal value of an equity.  However, equities give ownership in the net assets of a company, hence have backing in this sense.  They also don't track anything other than the value of the company (by definition), which in old-school finance was proposed to be the discounted expected value of the entire future stream of dividends from that company.  This makes sense as a way to value bitUSD also.  However, the future dividends of bitUSD depend directly and merely on its price (in the case where margin depends on bitUSD's price). There's no underlying net profits as there would be for a company to distribute as dividends.  But the price is valued from the dividends.  So we have a bit of a self-referential situation going on here, and it should be clear that in this valuation model there's no reason for the market price to converge to any particular value.

In the case where bitUSDs dividends are a function of an embedded BTS/USD price, then that price can be seen as analogous to something proportional to net earnings of a company.  In that case, we may expect some rational valuation model to work, but I don't see any reason why the value of the dividend stream from bitUSD would converge to a certain specific proportionality factor (the one needed to make the ratio of bitUSD/(BTS/USD) prices be 1) times its net income (BTS/USD price).  The price of bitUSD would be sensitive to all kinds of exogeneous things, first and foremost interest rates in the overall economy.
« Last Edit: November 15, 2013, 02:00:00 pm by Winslow Strong »
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Offline bytemaster

I'd also like to pose a question:  Have you stopped to consider why financial markets don't offer products like BitUSD?  I.e. a derivative without a terminal horizon, designed to track an underlying via a yield mechanism as the tracking incentivization?

Financial markets offer many flavors of tracking products - Futures, Forwards, contracts for a difference, etc.  All of these involve cash flows changing hands at points in time, where the amount scales linearly as a function of the change in price of the underlying.  Your BitUSD (if it were to use BTS/USD as the basis for margin requirement) incentivizes via the size of the yield changing as a function of the underlying.  The yield is a rate, i.e. BTS/time.  It's the first-derivative of a cash flow.  The difference between actual cash flows compensating for tracking deviation and changing the first derivative of cash flows to compensate is enormous.  The latter alone can never ever justify the risk in tracking deviation of an abrupt financial downturn, while the former does just fine, as long as margin remains sufficient (which you have ample protection for).

I don't know the exact reasons why products like Bit/USD aren't offered on exchanges, but I'd be highly suspicious that the above lack of risk-compensation is a relevant aspect.  I'd at least want to have investigated this issue by talking to professional traders / exchange operators before launching such a product.  Have you done so? What was their reaction?

Why haven't you simply chosen to implement an established form of financial contract, like futures or CFDs? Do you think it will help you to skirt regulation by doing it your way? 

I also had some impression that you wanted the system to be decentralized, which would prohibit even the incorporation of BTS/USD into BitShares, as it requires a trusted authority.  But if you are open to including that price feed, then you'd be a lot safer implementing CFDs that incentivize via actual cash flows tied to the actual underlying.  Your proposal seems like it's taking totally unnecessary risks in this regard.

This will be an experiment, like Bitcoin.  The closest thing to BitUSD is EuroDollars.   

Stan and I were discussing BitShares one evening and I tried to describe how BitShares is different from an altcoin.   I used an analogy that described bitshares as a crypto-equity in a decentralized bank and exchange called BitShares.  The shareholders of the bank are those who own bitshares.   I then went on to explain how this decentralized bank can lend dollars into existence just like their centralized counterparts.   I will review this analogy here for the benefit of others who would like to engineer their own DACs.

All banks these days operate on what I like to call a fictional reserve basis.  When you approach the bank for a loan to buy a house, the bank creates new dollars from thin air backed by your collateralized promise to pay back the loan.  In this case, your house is the collateral and the bank may call your loan and foreclose if you stop making the required payments or if the value of the house falls too much.   When you pay off your loan the dollars are destroyed and the bank keeps the interest payments and the lien is removed from your house.   The key thing to remember here is that these dollars are nothing more than an IOU from the bank.   People trust the value of the IOUs because they trust the bank to honor their promise to pay a dollars worth of value.

Gold Note

Lets step back one step further, and consider that a dollar use to be defined as  412.5 grains of 99.9% pure silver.   When you received a bank note it was a promise to pay one dollar worth of gold and the law defined the fixed ratio of gold to silver required to give the bank note a tie to the real world.

As you can see the promise to pay is denominated in dollars which are defined as a weight in silver, and yet what is paid out upon redemption is gold.   This example demonstrates that a dollar is just an arbitrary label assigned to a certain amount of value.  Just like you could have a dollar of silver or a dollar of gold, you could also have a dollar of corn, a dollar of oil, or a dollar of anything including a dollar of bitcoin!   When the United States left the gold standard entirely the dollar began to float against all other goods and services and now has value for its own sake even though it is no longer price-fixed against gold or silver.  The dollar is nothing more than an arbitrary measure of value and is still redeemable for $1 worth of silver at the current market price (not the price fixed 412.5 grains of silver).

Lets go back to the world of DACs and consider how a decentralized bank can lend dollars into existence just like their centralized counterparts.   First the bank must identify someone who would like to borrow dollars as it is the collateral behind the borrowers promise to repay that backs the value of the dollars.    Just like real banks,  BitShares requires collateral for the loan and the only collateral BitShares has the ability to foreclose upon is its own equity.    When you borrow money for a house the bank usually requires at least 20% down to protect the bank in the event your house loses value.   In the case of the BitShares DAC the bank requires a 50% downpayment.
Someone wishing to borrow $100 dollars from the BitShares DAC must find $200 worth of equity(bitshares) to back the loan.  Lets assume they have mined $200 worth of equity, they can mortgage this equity and receive 100 BitUSD in exchange for a lean on their equity that can only be cleared by paying back 100 BitUSD.   

BitUSD is the equivalent of the old bank notes that promised to pay $1 worth of value on demand.  In the case of the old bank notes, this value was denominated in gold or silver.  In the case of the BitShares DAC this value is $1 worth of equity, aka bitshares.   The BitShares DAC can almost always make good on this promise because when someone comes to redeem a note and is unable to sell it on the market directly the value of the BitUSD in terms of bitshares will rise until the decentralized bank has the authority to call a loan and repurchase the BitUSD. 

Most people understand why someone would borrow money to buy a house, but why would someone mortgage their BitShares for BitUSD?   The reason someone would borrow BitUSD is so they could sell it and take what is called a short position.  A short position is a speculative bet that BitUSD will go down in value relative to bitshares.  If the value does go down then the speculator can repurchase the BitUSD for fewer bitshares in the future and then pay off the loan while pocketing a nice profit.  This is how speculators on Wall Street make money when stocks go down: they borrow the stock, sell it for $100, and then repurchase it later for $50 and return the stock while making a $50 profit.

Dividends & Interest Payments
All banks attempt to operate for a profit and therefore charge interest on loans along with transaction fees and inactivity fees.  The bank profits are the distributed to the shareholders as dividends.  In the case of the BitShares DAC there are also transaction fees, inactivity fees, and margin-call fees and the profits that result from charging these fees are paid to the shareholders.

When someone wishes to borrow BitUSD from the bank they do not get to borrow this money interest-free.  Instead they pay interest equal to the dividends they would have received on their collateral.    Anyone holding a bank note is effectively lending value to the bank by not redeeming it and anyone holding a balance at a bank is traditionally paid interest.  Likewise, those who hold BitUSD are effectively lending the value of a dollar to the decentralized bank by not redeeming it.  In exchange for lending this dollar the bank pays them interest.  In the case of the BitShares DAC the bank does not take a cut of the spread between the interest paid by the borrower and interest paid to the lender.

It is through this explanation of BitShares that the concept of a DAC was born and a new take on the nature of Bitcoin as a decentralized autonomous corporation rather than just a crypto-currency came to be.
For the latest updates checkout my blog: http://bytemaster.bitshares.org
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Offline Winslow Strong

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I'd also like to pose a question:  Have you stopped to consider why financial markets don't offer products like BitUSD?  I.e. a derivative without a terminal horizon, designed to track an underlying via a yield mechanism as the tracking incentivization?

Financial markets offer many flavors of tracking products - Futures, Forwards, contracts for a difference, etc.  All of these involve cash flows changing hands at points in time, where the amount scales linearly as a function of the change in price of the underlying.  Your BitUSD (if it were to use BTS/USD as the basis for margin requirement) incentivizes via the size of the yield changing as a function of the underlying.  The yield is a rate, i.e. BTS/time.  It's the first-derivative of a cash flow.  The difference between actual cash flows compensating for tracking deviation and changing the first derivative of cash flows to compensate is enormous.  The latter alone can never ever justify the risk in tracking deviation of an abrupt financial downturn, while the former does just fine, as long as margin remains sufficient (which you have ample protection for).

I don't know the exact reasons why products like Bit/USD aren't offered on exchanges, but I'd be highly suspicious that the above lack of risk-compensation is a relevant aspect.  I'd at least want to have investigated this issue by talking to professional traders / exchange operators before launching such a product.  Have you done so? What was their reaction?

Why haven't you simply chosen to implement an established form of financial contract, like futures or CFDs? Do you think it will help you to skirt regulation by doing it your way? 

I also had some impression that you wanted the system to be decentralized, which would prohibit even the incorporation of BTS/USD into BitShares, as it requires a trusted authority.  But if you are open to including that price feed, then you'd be a lot safer implementing CFDs that incentivize via actual cash flows tied to the actual underlying.  Your proposal seems like it's taking totally unnecessary risks in this regard.
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Offline Winslow Strong

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I appreciate your time in replying, again.

I could debate the tracking issue to great extent, but I think the ultimate proof will be when we launch the test network.

Indeed, it will be an interesting experiment.  However, BitShares, and by association Invictus, risk losing some credibility if it fails, so it's worthwhile to think it through carefully first.  I can tell that you are quite confident, although I'm still unable to fathom why from this conversation. 

If my theory is wrong, then all that is needed to 'make it work', is an external price feed.   

I don't agree.  I think this would help substantially, since it would give the yield incentive that you mentioned earlier.  However, as I pointed out, yield incentives are never sufficient to overcome fear of near-term losses in turbulent financial times.  That issue is further exacerbated by the fact that there is no guaranteed convergence of BitUSD at any terminal horizon (as there would be for bonds or futures), because there is no terminal horizon.  With typical financial derivatives, a buyer knows an upper bound on how much time he will have to bear price deviations before convergence.  With BitUSD, there is no such upper bound.

I base my 'price tracking' on the behavior of prediction markets that also have no ties to the real world and yet can track arbitrary ideas or concepts. 

Can you provide an example of what you mean?  The prediction markets that I'm familiar with have a terminal payout.  Do you know of ones that successfully track without a terminal payout?

Here is my challenge to you, role play longs and shorts against one another and see if you can manipulate the price without one side digging in.  Keep in mid that longs are competing against other longs and shorts against other shorts.   Then define the direction the market will move and why.
I'm not quite sure what you mean "longs are competing against other longs."  If I'm long, I'd very much like to see an increase in demand for new longs, as this pushes up the price, making my position more profitable. 

Furthermore, my argument isn't based on game theory, and game theory is superfluous in analyzing my argument.  If BitShares is successful, the market will be big, and typical players will be small.  This means they have negligible ability to manipulate the price.  (Of course in practice there are often big players that can manipulate prices at certain points.  That poses further vulnerabilities for BitShares, but my argument doesn't rely on price manipulation).  I'm only assuming agents will act out of their self-interest and/or emotions.  Crazy price fluctuations do not necessitate price manipulators.  They sometimes occur endogenously (black Monday, 1987), and sometimes are triggered by exogenous events such as the Japanese Tsunami and subsequent Fukushima fallout.  When abnormally large deviations in bitUSD vs BTS/USD occur, this creates some level of fear that tracking is failing.  When participants know that the only reason to believe tracking will succeed is if others believe that tracking will succeed, then this fear alone is sufficient to cause tracking to fail.  It has been so many many times in financial history, with assets that gave market participants more incentive to cause them to track than bitUSD vs BTS/USD gives. 

The main mitigating factor that I see with respect to my argument is that your margin requirements are much much higher than is typical in financial markets, so that should result in reduced feedback effects from selling inducing more selling due to solvency pressure.  As I said above though, reducing this feedback is not equivalent to incentivizing convergence.  When (not if) large deviations occur, it's essential that the market have high incentive to reverse the deviation if tracking is to occur.  I just haven't seen what that incentive might be.
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Offline bytemaster

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These dividends will scale down as margin scales down as shorts reduce their margin, which they will do even if you force them to cover their initial position and reenter a new one to do so. Since the margin requirements are based on the bitUSD price and not the BTS/USD exchange rate, then the goodness of the deal for the longs doesn't depend on the deviation of bitUSD from BTS/USD, so this is not a mechanism that keeps the prices tracking.

Furthermore, in panics yield-incentives typically are surpassed by fear of near/intermediate term price losses. Interest only accumulates linearly in time, whereas prices can change arbitrarily quickly. LTCMs positions had crazy yields at the market prices before they had to liquidate.  Still, buyers didn't enter and didn't cause their illiquid bonds to converge to the values of similar liquid ones.  Whereas in the setup you describe. . .

1.) Yields (dividends) won't effectively increase as bitUSD price drops, because shorts will reduce their margins - by exiting and reentering if you force this upon them.

2.) There's no terminal payout, so no implied yield (price appreciation) as there is for e.g. bonds.
 
I still see no incentive whatsoever for any market agent to buy and sell in such a way that e.g. the price of bitUSD will track the BTS/USD rate, other than the belief that it is common knowledge that they "should."  I still see this as a far fragiler incentive structure that has existed in many instances in financial history where instruments that were expected to track/converge had huge deviations and didn't.  On the plus side, I'll point out that your system requires far higher margin than is typical in financial markets, which should reduce the pro-cyclical feedback that occurs in financial panics.  Reducing this feedback is not, however, the same thing as incentivizing convergence.

I'm open to hearing new arguments or learning where I've misunderstood how the proposed system would work.

I could debate the tracking issue to great extent, but I think the ultimate proof will be when we launch the test network.  If my theory is wrong, then all that is needed to 'make it work', is an external price feed.   I base my 'price tracking' on the behavior of prediction markets that also have no ties to the real world and yet can track arbitrary ideas or concepts.   I can see that you are putting a lot of effort into understanding how it could work, and I encourage you to keep thinking it through until the key insight that you are missing hits.

Here is my challenge to you, role play longs and shorts against one another and see if you can manipulate the price without one side digging in.  Keep in mid that longs are competing against other longs and shorts against other shorts.   Then define the direction the market will move and why.
For the latest updates checkout my blog: http://bytemaster.bitshares.org
Anything said on these forums does not constitute an intent to create a legal obligation or contract between myself and anyone else.   These are merely my opinions and I reserve the right to change them at any time.

Offline bytemaster

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1.) So you're saying that you won't allow shorts to reduce their margin positions even if/when the bitUSD price has moved very much into the money for the shorts? 

This seems silly, as the shorts can still effectively reduce their margin by covering their previous position and initiating fresh positions at their desired level of exposure with new 2x margin, which would be lower than the previous 2x margin. It forces the shorts to needlessly make extra transactions to achieve the same position they could have had by just reducing their margin. Forcing shorts to cover in this way won't cause net long demand, hence won't cause the price to rise.


2.) Fungibility: If you don't allow shorts to reduce their margin when their positions are in the money, then the bitUSD contracts lose fungibility.  This is because the margin requirement of each would be contractually coded in at the time of creation, and would depend on the bitUSD price at that time.  I doubt that this is really the way you intend for things to operate.

This is just an implementation detail.  Point 1 is how they would do it.   Selling a short position cannot be readily fungible because every short is at a different price.
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Anything said on these forums does not constitute an intent to create a legal obligation or contract between myself and anyone else.   These are merely my opinions and I reserve the right to change them at any time.

Offline Winslow Strong

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Thanks again for your reply, bytemaster, during this busy time. In response to your previous points:

BitUSD Short margin requirements are based upon the highest unaccepted bid to buy BitUSD for BTS.

Shorts MUST buy back at some point if they ever want to use their collateral for anything else.   

So you apply game theory between the longs and the shorts.   The longs will hold out for a fair price, and it costs the shorts a lot of money to 'let it ride'.  Also, for someone who is short to maximize the return on their investment they need to cover, take a profit, and re-short at the new price.   As the value of BitUSD falls the collateral backing it goes from 2x to 3x to 10x to 100x... and thus the interest rate earned by those who hold BitUSD rises and the opportunity cost for the short also rises. 

As a result there is constant pressure for shorts to cover and and re-short at the new price.  The only way for them to cover is to convince the longs to give up their higher yield and thus agree to a price near BTS/USD.

Now the longs cannot hold out for ever either because at any time new shorts can enter the market if the longs try to push up the price by holding BitUSD off the market.

1.) So you're saying that you won't allow shorts to reduce their margin positions even if/when the bitUSD price has moved very much into the money for the shorts? 

This seems silly, as the shorts can still effectively reduce their margin by covering their previous position and initiating fresh positions at their desired level of exposure with new 2x margin, which would be lower than the previous 2x margin. It forces the shorts to needlessly make extra transactions to achieve the same position they could have had by just reducing their margin. Forcing shorts to cover in this way won't cause net long demand, hence won't cause the price to rise.


2.) Fungibility: If you don't allow shorts to reduce their margin when their positions are in the money, then the bitUSD contracts lose fungibility.  This is because the margin requirement of each would be contractually coded in at the time of creation, and would depend on the bitUSD price at that time.  I doubt that this is really the way you intend for things to operate.


Ok, those who own BitUSD are earning dividends at 2x the rate of those who own BTS. 
Those who are Short BitUSD are paying interest at 2x the value of BTS.

The only price at which someone holding BitUSD would be willing to sell is the BTS/USD exchange rate. Otherwise, they sell the BitUSD to someone who wants a high yield investment backed by BTS.

These dividends will scale down as margin scales down as shorts reduce their margin, which they will do even if you force them to cover their initial position and reenter a new one to do so. Since the margin requirements are based on the bitUSD price and not the BTS/USD exchange rate, then the goodness of the deal for the longs doesn't depend on the deviation of bitUSD from BTS/USD, so this is not a mechanism that keeps the prices tracking.

Furthermore, in panics yield-incentives typically are surpassed by fear of near/intermediate term price losses. Interest only accumulates linearly in time, whereas prices can change arbitrarily quickly. LTCMs positions had crazy yields at the market prices before they had to liquidate.  Still, buyers didn't enter and didn't cause their illiquid bonds to converge to the values of similar liquid ones.  Whereas in the setup you describe. . .

1.) Yields (dividends) won't effectively increase as bitUSD price drops, because shorts will reduce their margins - by exiting and reentering if you force this upon them.

2.) There's no terminal payout, so no implied yield (price appreciation) as there is for e.g. bonds.
 
I still see no incentive whatsoever for any market agent to buy and sell in such a way that e.g. the price of bitUSD will track the BTS/USD rate, other than the belief that it is common knowledge that they "should."  I still see this as a far fragiler incentive structure that has existed in many instances in financial history where instruments that were expected to track/converge had huge deviations and didn't.  On the plus side, I'll point out that your system requires far higher margin than is typical in financial markets, which should reduce the pro-cyclical feedback that occurs in financial panics.  Reducing this feedback is not, however, the same thing as incentivizing convergence.

I'm open to hearing new arguments or learning where I've misunderstood how the proposed system would work.
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Offline bytemaster

Thanks for the response bytemaster;  I know you're busy today. 
Just to be clear on where I'm coming from, I think bitshares and DACs in general are very cool ideas, and want them to succeed.  I have much to say about what you've written, but can't reply until I get one thing straightened out.

Is the margin requirement based on the price of bitUSD or BTS/USD? 

E.g. bitUSD is .99 whereas BTS/USD is 1.00.  Is margin 1.98 or 2?

The latter would be more favorable for tracking, but since USD are not endogenous to the bitshares block chain, that info would need to be fed into the blockchain by a trusted source.  So the cost would be a bit of centralization, but it might be worth it.

Thanks.

It tracks for the same reason a prediction market can track arbitrary ideas simply by specifying a name.   BitUSD Short margin requirements are based upon the highest unaccepted bid to buy BitUSD for BTS.   This price indicates that the entire market agrees the value of BitUSD is higher than that bid and so anyone with insufficient margin at that bid price is forced to buy into it to cover their position.
For the latest updates checkout my blog: http://bytemaster.bitshares.org
Anything said on these forums does not constitute an intent to create a legal obligation or contract between myself and anyone else.   These are merely my opinions and I reserve the right to change them at any time.

Offline Winslow Strong

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Thanks for the response bytemaster;  I know you're busy today. 
Just to be clear on where I'm coming from, I think bitshares and DACs in general are very cool ideas, and want them to succeed.  I have much to say about what you've written, but can't reply until I get one thing straightened out.

Is the margin requirement based on the price of bitUSD or BTS/USD? 

E.g. bitUSD is .99 whereas BTS/USD is 1.00.  Is margin 1.98 or 2?

The latter would be more favorable for tracking, but since USD are not endogenous to the bitshares block chain, that info would need to be fed into the blockchain by a trusted source.  So the cost would be a bit of centralization, but it might be worth it.

Thanks.
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Offline bytemaster

Ok, those who own BitUSD are earning dividends at 2x the rate of those who own BTS. 
Those who are Short BitUSD are paying interest at 2x the value of BTS.

Shorts MUST buy back at some point if they ever want to use their collateral for anything else.   The only price at which someone holding BitUSD would be willing to sell is the BTS/USD exchange rate.   Otherwise, they sell the BitUSD to someone who wants a high yield investment backed by BTS.

So you apply game theory between the longs and the shorts.   The longs will hold out for a fair price, and it costs the shorts a lot of money to 'let it ride'.  Also, for someone who is short to maximize the return on their investment they need to cover, take a profit, and re-short at the new price.   As the value of BitUSD falls the collateral backing it goes from 2x to 3x to 10x to 100x... and thus the interest rate earned by those who hold BitUSD rises and the opportunity cost for the short also rises. 

As a result there is constant pressure for shorts to cover and and re-short at the new price.  The only way for them to cover is to convince the longs to give up their higher yield and thus agree to a price near BTS/USD.

Now the longs cannot hold out for ever either because at any time new shorts can enter the market if the longs try to push up the price by holding BitUSD off the market.
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Offline Winslow Strong

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When the value of BitUSD falls below a dollar, SHORTS COVER.   When it goes above a dollar new shorts enter the market.   Margin calls force shorts to cover.

Now I'm really confused.  First of all, I thought bitUSD was a price that we hope will track the price of 1 USD denominated in BTS. That's what it seems like from the video anyway, and would be in keeping with std exchange rate nomenclature.  If that's true, then the person on the short end profits from BitUSD falling, so there wouldn't be any margin call in that scenario. 

I think that margin calls unnecessarily complicate this discussion.  Supposing the penalty for a margin call is sufficiently high that nearly all traders keep sufficient margin nearly all the time, then we can ignore them (the calls, but not of course the need to maintain posted margin).

Another thing about your response that confuses me is that it implies the margin requirements depend on the BTS/USD rate, not merely the price of BitUSD.  In that case, the BTS/USD rate must be embedded in the blockchain from some reliable source.  Is this the case, or are margins requirements calculated completely based on the movements of bitUSD itself without reference to BTS/USD?

Regardless of your answer to the above, there is no issue whatsoever with margin when the short side is in profitable territory.  My question remains: what incentive do longs have to enter, and support the price of BitUSD if they find that it's trading more cheaply than BTS/USD?  The only answer that has been provided is that participants believe that participants believe that. . . the price will track. 

This would be an extreme reliance on herd behavior, and is not whatsoever analogous to a prediction market.  In prediction markets, there is a maturity date where it's decided who was right and wrong and the winning party receives payment.  The incentive to be correct is the expectation of future payment upon correctness.  That expectation is based on the type of social contract that Invictus discusses in their literature on protoshares redemption for DAC shares.  It's clearly in the interest of any well-established company sponsoring the prediction market to honor that social contract, so there exists a good incentive structure. 

In the case of BitUSD, the expectation is merely based on the predicted future behavior of the herd.  Anyone who has studied a bit of financial history knows that that can seem to work well for years, until it fails spectacularly.  The collapse of Long Term Capital Management would be a good case study to review.  And what's more, the positions that LTCM held did have terminal values that were highly likely to be (and ended up being) very profitable. There was huge incentive for other players in the market to snatch these up at discounted values.  However, there was even larger incentive for them to drive prices against LTCM forcing a liquidation at even more favorable prices.  And this all occurred with respect to assets that had terminal payouts.  You've proposed assets without such.

What makes you think that expectation alone will be sufficient to make the price track?  Has this been tried somewhere before in financial markets?
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