Trustless, Decentralized Bond Market Draft

[cylonmaker2053]

The challenge is to create a bond market where lenders can earn interest while being 100% protected against default by the borrowers. This means that at all times the blockchain must be able to cover all loans on the market.

Why 100% default protection to lenders? why not mimic traditional bond markets where lenders assume risk for payment? Interest income should come from bearing risk IMO, a necessary condition for circumspection and functioning markets.

you can already do this with UIAs, just issue a token called CYCLON100USDBOND
then issue it to who ever lends you 100 BITUSD and pay them an agreed amount of interest. the market will decide your credit worthiness.

that's a great point. so what would a dedicated bond market add? doing what you just mentioned would cover UIB tender offers and secondary markets.

[JonnyB]

The challenge is to create a bond market where lenders can earn interest while being 100% protected against default by the borrowers. This means that at all times the blockchain must be able to cover all loans on the market.

Why 100% default protection to lenders? why not mimic traditional bond markets where lenders assume risk for payment? Interest income should come from bearing risk IMO, a necessary condition for circumspection and functioning markets.

you can already do this with UIAs, just issue a token called CYCLON100USDBOND
then issue it to who ever lends you 100 BITUSD and pay them an agreed amount of interest. the market will decide your credit worthiness.

[cylonmaker2053]

They do bear risk of leaving an order on the book.  No different than a bank taking risk of you mailing in the keys rather than payment. 

If even one person is left holding the bag for a default it makes the entire block chain look bad. Block chains must have higher standards.

i love the automated collateral for smartcoins to significantly reduce default risk, but for bonds i don't see the same benefit. default risk is core to bond markets, else why would anyone differentiate who they lend to? there's no need to go down a similar moral hazard route as what FDIC insurance has done to deposits.

i see two types of potential bonds we can deal in: system generated "treasury bonds" and UIBs. would it make sense for a small company, for instance, to come to our bond market to raise capital, issue bonds, and there not be default risk embedded in the lending? of course not. i think we're overthinking the bond market, should keep it general, and start with a test case, like the treasury bond idea that recycles market fees as interest.

[sittingduck]

They do bear risk of leaving an order on the book.  No different than a bank taking risk of you mailing in the keys rather than payment. 

If even one person is left holding the bag for a default it makes the entire block chain look bad. Block chains must have higher standards. 

[cylonmaker2053]

The challenge is to create a bond market where lenders can earn interest while being 100% protected against default by the borrowers. This means that at all times the blockchain must be able to cover all loans on the market.

Why 100% default protection to lenders? why not mimic traditional bond markets where lenders assume risk for payment? Interest income should come from bearing risk IMO, a necessary condition for circumspection and functioning markets.

[bytemaster]

The challenge is to create a bond market where lenders can earn interest while being 100% protected against default by the borrowers. This means that at all times the blockchain must be able to cover all loans on the market.

This is difficult because it is computationally expensive to calculate the cascade effect of multiple margin calls and this must be done after every market operation.

The Solution

Someone who wants to borrow an asset may do so as long as there exists enough orders on the book to cover their new position and all other open loan positions at the price of  the least collateralized loan’s DEBT to COLLATERAL. The least collateralized loan establishes what we call the SWAN PRICE, short for black-swan. 

Every time a limit order is created, filled, or canceled the blockchain updates a running total of how much of a given asset is available for sale above the SWAN PRICE.

Every time a loan position is updated and a new SWAN PRICE is established, the blockchain must also update how much of a given asset is available for sale above the SWAN PRICE.

Basic Algorithm

Code: [Select]

    Let TAS = Total asset for sale above swan price.
    Let TD   = Total asset that has been borrowed

    onOrderUpdate   /// create, cancel, fill
       try
          push undo state
          create, cancel, or fill orders on the book
          update TAS
          if( TAS < TD )
                undo changes and throw
          commit changes
      catch
          execute margin call on least collateralized loan
          goto try

Someone looking to borrow an asset makes a request of the network that includes:

1. how much they wish to borrow
2. how much collateral they wish back it with

The borrowing request will be filled so long as they post sufficient collateral. The network will automatically bump lower collateralized positions if necessary.

A margin call can happen for any of the following reasons:
1. If canceling an open order would result in insufficient orders on the books to buy back the debt with the collateral, then a margin call is executed first, then the order is canceled (if it wasn’t used as part of the margin call).
2. If filling an order would result in insufficient orders on the books to satisfy all debt at the SWAN PRICE, then the margin call is executed first.
3. If someone is looking to borrow, offering more collateral than the SWAN PRICE, and there is insufficient orders above the SWAN price then the least collateralized position is called. This will update the SWAN price to the next best.

The impact of these rules is the following:

1. The least collateralized position is always at risk of margin call when there is more demand for loans than orders on the book.
If there are more orders on the book than demand for loans, then collateral requirements can fall and the least collateralized position is safe from potential margin call

2. The ability to move an order, rather than cancel and create a new order must be supported to prevent unnecessary margin calls.
Borrowers will post sufficient collateral to ensure sufficient market depth that they are not at risk of being called.

3. Increasing collateral lowers SWAN PRICE and increases the number of orders above SWAN and thus increases SUPPLY of asset to be borrowed.
Interest Payments

4. Everyone with an open order on the books above the SWAN PRICE is effectively lending money to those who wish to borrow. If there is heavy demand for borrowing then the market response should be to pay interest to the lenders.

In this algorithm, the network charges a “fixed” interest rate on the variable collateral. In this way the interest charged to borrowers grows along with the collateral requirement. Every open order on the books above the SWAN PRICE receives their pro-rata share of the interest paid by borrowers.

Lenders have the ability to “set their interest rate” and “collateral requirement” based upon the price at which they leave their order open on the book. If demand for loans grows enough to find the least collateralized loan  (SWAN PRICE) to be above the order price, then the loan is executed and the lender starts earning interest. If the SWAN PRICE never reaches the order price then the loan is not accepted and no interest is paid.

The impact of interest is to increase the number of orders on the book above the SWAN price which in turn serves to reduce collateral requirements.

The “fixed” interest rate can be configured by the asset issuer. If collateral requirements start to get unreasonably high, then interest rates can increase.


Feedback Wanted