Author Topic: BitAssets and Black Swan Events [BLOG POST]  (Read 4855 times)

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Offline arhag

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Who makes good on this IOU?

The blockchain takes any new BitAsset fees (mostly new short interest) and instead of putting it in the yield uses it to convert as much of the BitAsset-IOU in circulation back into the corresponding BitAsset (in proportion of course so it is all fair). In reality, I expect the implementation to have some global fraction parameter for each BitAsset that distinguishes how much of each user's balance is BitAsset vs BitAsset-IOU, and the DAC simply adjusts the parameter as it is able to in order to ensure the amount of outstanding real BitAssets is always at least 100% backed by the BitAsset debt owed by the open short positions.

What if income from USD fees is not able to make it whole?

Anyone could take their real BitUSD and sell it for BTS on the exchange as usual. But the BitUSD-IOU would be in a separate market and since BitUSD-IOUs cannot be used to cover short positions, the margin called / expiring shorts cannot match against the BitUSD-IOU. This means that (assuming further undercollateralization didn't happen beyond what had already happened) all of the BitUSD holders could exit out into BTS unwinding all of the short positions. What would be left over is some amount of BitUSD-IOU that would likely be worthless (although maybe not because they are claims on the future interest paid by any new shorts that reappear in the fresh BitUSD/BTS market). The DAC would not put any new BitUSD into the yield pool until it paid off all of the BitUSD-IOUs first.

Also, it is true that if undercollateralization occurs, then some people exit out into BTS, and then the price drops again and further undercollateralization occurs, the people leaving after the second undercollateralization event would be worse off than the ones who left after the first but before the second undercollateralization event. But one can make the same argument comparing to sellers before the first undercollateralization occurs. The ones who sold their BitUSD for BTS and then for real USD before the first undercollateralization event would be better off than the people who sold (or were forcefully liquidated) after undercollateralization into BTS and then converted their smaller amount of BTS into real USD. I think this is an acceptable risk because I imagine undercollateralization events like this will only happen after some sudden news breaks out to cause a sudden flash crash, and I'm not as concerned about a black swan happening on top of a black swan before people are able to place their relative BitUSD sell orders just under the price feed after the first black swan event.

How do we draw the line and declare the system insolvent and in need of liquidation?

When undercollateralization occurs the system is already insolvent. I am just arguing for a more graceful way of handling the resulting outcome than forceful liquidation. It could allow the DAC to earn enough BitUSD income to repay the old BitUSD holders that weren't able to get their full promised value back because of the undercollateralization.

Offline bytemaster

*If all goes well*.... what happens when your system hits a black swan?   

I discussed this. The worst case scenario is essentially equivalent to the liquidation mechanism you described. But the best case scenario is that BitUSD holders never notice any problems (other than lower yield than usual).


2) We cannot build a system that depends upon BitAsset IOUs  the IOU issuer would be centralized and a point of failure.

I think you are confusing my nomenclature. When I say BitAsset IOU, I don't mean from a centralized counterparty but from the DAC itself. It is just a way to distinguish between 100% reserve backed BitAssets and the rest of the BitAsset liabilities by the DAC that is at the moment not backed.

Who makes good on this IOU?   What if income from USD fees is not able to make it whole?   How do we draw the line and declare the system insolvent and in need of liquidation? 
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Offline arhag

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*If all goes well*.... what happens when your system hits a black swan?   

I discussed this. The worst case scenario is essentially equivalent to the liquidation mechanism you described. But the best case scenario is that BitUSD holders never notice any problems (other than lower yield than usual).


2) We cannot build a system that depends upon BitAsset IOUs  the IOU issuer would be centralized and a point of failure.

I think you are confusing my nomenclature. When I say BitAsset IOU, I don't mean from a centralized counterparty but from the DAC itself. It is just a way to distinguish between 100% reserve backed BitAssets and the rest of the BitAsset liabilities by the DAC that is at the moment not backed.


These are called Black Swans because they shouldn't actually happen.

By the way, the "black swans" will be far more probable if we allow any user to create a BitAsset with a custom margin call limit and any BitAsset as the collateral backing asset. This would be useful to allow margin trading of a BitAsset tracking Euros backed by BitUSD with 20x leverage, for example.
« Last Edit: January 27, 2015, 09:38:38 pm by arhag »

Offline bytemaster

http://bytemaster.bitshares.org/article/2015/01/27/BitAssets-and-Black-Swan-Events/

Quote
Anyone who is holding BitUSD at the moment of a Black Swan will have it instantly converted to BTS.

As I said on the GitHub thread, please don't do it this way.

Often times, the system could recover from the black swan. New shorts may enter paying interest which would all go towards covering the deficit between the BitUSD debt owed to holders by the network and the BitUSD debt owed to the network by the existing shorts. In that case, users would unnecessarily be forced out of their BitAsset position, which is incredibly annoying for our customers.

I understand and respect the position that socialize this risk to BTS shareholders or BitAsset shorts that maintained enough collateral. I also understand that letting the BitAsset liabilities stay as they are with undercollateralization can lead to a bank run in which the early movers get out to BTS with nearly $1 for every BitUSD, while the very slow movers can be stuck with worthless BitUSD with 0 BTS collateral backing.

This is why I propose dynamically adjusting the BitAsset holdings of the customers between the real BitAsset and the BitAsset IOU as necessary to maintain full collateralization. If all goes well, the new shorts paying interest will cover the extra liability and any BitAsset IOUs will be covered fully back to real BitAssets. Users may not even have to be aware a black swan happened. On the other hand, if things aren't returning back to normal, users are all able to exit out back to BTS while sharing the losses proportionally (not giving an advantage to the early movers). Furthermore, people can sell the BitAsset IOU as a separate asset on the exchanges which would have its own price depending on the market's belief that the network will be able to cover the deficit in the future and make BitAssets fully collateralized again.

*If all goes well*.... what happens when your system hits a black swan?   

1) Our customers should never be annoyed because this shouldn't happen that often. 
2) We cannot build a system that depends upon BitAsset IOUs  the IOU issuer would be centralized and a point of failure.

These are called Black Swans because they shouldn't actually happen.   If they do happen then it is likely an event far in excess of the limits of the system rather than "just barely outside our limits". 

The game theory in the event of uncollateralized shorts always results in a bank run. 

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Offline arhag

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http://bytemaster.bitshares.org/article/2015/01/27/BitAssets-and-Black-Swan-Events/

Quote
Anyone who is holding BitUSD at the moment of a Black Swan will have it instantly converted to BTS.

As I said on the GitHub thread, please don't do it this way.

Often times, the system could recover from the black swan. New shorts may enter paying interest which would all go towards covering the deficit between the BitUSD debt owed to holders by the network and the BitUSD debt owed to the network by the existing shorts. In that case, users would unnecessarily be forced out of their BitAsset position, which is incredibly annoying for our customers.

I understand and respect the position that we should not socialize this risk to BTS shareholders or BitAsset shorts that maintained enough collateral. I also understand that letting the BitAsset liabilities stay as they are with undercollateralization can lead to a bank run in which the early movers get out to BTS with nearly $1 for every BitUSD, while the very slow movers can be stuck with worthless BitUSD with 0 BTS collateral backing.

This is why I propose dynamically adjusting the BitAsset holdings of the customers between the real BitAsset and the BitAsset IOU as necessary to maintain full collateralization. If all goes well, the new shorts paying interest will cover the extra liability and any BitAsset IOUs will be covered fully back to real BitAssets. Users may not even have to be aware a black swan happened. On the other hand, if things aren't returning back to normal, users are all able to exit out back to BTS while sharing the losses proportionally (not giving an advantage to the early movers). Furthermore, people can sell the BitAsset IOU as a separate asset on the exchanges which would have its own price depending on the market's belief that the network will be able to cover the deficit in the future and make BitAssets fully collateralized again.

Edit: In other words, a black swan really just means temporary fractional reserve. However, unlike regular fractional reserve banking we could make a distinction between the portion of BitUSD held that are 100% backed and the rest (which are the BitUSD IOUs), in order to prevent bank runs. Worst case scenario, the BitUSD IOUs become worthless and that is equivalent to all BitUSD holders taking a proportional hair cut because of the black swan event (which is equivalent to forcing liquidation to BTS at the moment the black swan event occurs).
« Last Edit: January 27, 2015, 10:04:50 pm by arhag »

Offline graffenwalder

Great. I didn't quit understand it on github.

This makes sense.

Offline bytemaster

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.