Here's a more concrete idea for how to make money by selling CDSes.

Say, for example, that like many people around here, you've been trying to get an account with pirateat40 for a while. You have 2000 juicy coins and you'd love to be making 7% a week on them. Unfortunately, pirateat40 either doesn't have the capacity to hold your coins or you simply can't get an account with him. But clearly, you don't think he's going to default, or you wouldn't want to put your coins with him in the first place, right?

Instead of letting your 2000 coins rot in your wallet, you can sell 2000 coins worth of CDSes to other people on the forum for rates that approach pirateat40's. You might ask for 10-20% a month for your spread, thus giving you the ballpark of returns that pirateat40 himself offers, without you actually having to deal with him at all. You'll still be as exposed to his default risk as you would be if you had lent him money directly, and you'll be making similar amounts of money off of your exposure. In an ideal world you might lend to him directly, but in effect you're becoming a "synthetic" lender by selling a CDS on him, and will face commensurate risk and returns.

As always, this is not investment advice George Soros thinks naked CDSes are the work of the devil. Deals like the above look very appealing and are easy to become addicted to, simply because you don't actually need to have the coin on hand to back your liability. There's nothing stopping you from claiming you can cover 20000 bitcoins worth of default and making 4000 coins a month on CDS fees. The fact that after 5 months people would have paid you more than the nominal value of the debt isn't a big deal, but would certainly exclude people who aren't compounding their loans. But as tempting as it might be, you need to keep in mind that you are actually liable for 20000 coins (about $100k at current rates) if shit hits the fan. Anyone who tries to sell that much protection should expect a good deal of scrutiny of their reputation and should expect to have to provide real identification and proof of a financial situation to support that kind of liability. Caveat emptor venditor!

Important edit: I most certainly am not advocating being liable for coins you do not have in your possession. This not only means you can lose a lot of money, but exposes you to the wildly fluctuating exchange rates of bitcoin (perhaps you can cover 20000 coins of liability at the current exchange rate, but what if they jump to $30 again and you need to pay up?). I'm not fundamentally opposed to naked CDSes in the sense that I don't care if the buyer of the CDS actually has debt with the reference entity, but I think it's scary/irresponsible to sell insurance when you don't have the cash on hand to pay for it. I realize this happens all the time, but it was also a big part of why the mortgage crisis happened. In theory it's "safe" to be liable for more than you own as long as your liabilities are uncorrelated, but the correlation is impossible to measure, so I don't think it's worth it when the stakes are so high.

The most I'd suggest doing with the coins you're liable for is to lend them out in a "risk-free" manner (i.e., so you aren't making no money off of the coins you're liable for; otherwise why not just lend them to the reference entity directly?). Thinking of it this way leads to one approach to thinking about pricing CDSes, but I'll talk about that some other time.

My point about making 4000 coins a month was to point out how tempting it might be to sell more protection than you can afford to sell (a real slippery slope!), not a suggestion on how to get rich quick. Temptation of that sort is what led many people to financial ruin a few years ago, and it's easy for anyone to fall into that pattern when they're getting what feels like "free money" every month. So, again, do not even think about doing anything of the sort without very carefully evaluating the risks involved. Read a lot about finance before you start, too

People keep throwing the "gambling" term around but I haven't yet seen a formal definition that separates it from what most people call investing. Everything has a tradeoff between risk and return, so is gambling just when you're not sitting on the hypothetical "efficient frontier", perhaps? Or is gambling just when there's a high risk of any sort, regardless of return?

Sure, if you can find someone to trade with. If this becomes "a thing", we'd probably want to agree on some standardized contract amounts and dates, though.

Next up, CDOs (and synthetic ones!). Let's see if we can replicate the mortgage crisis, guys

By now many of you will have seen my sale of CDSes on imsaguy. I just wanted to elaborate on why doing this doesn't make me insane.

Basically, you turn into an insurance company, with all the pros and cons that come with that. The CDS itself is a little more nuanced than straight-up insurance, but the risk/return profile of the CDS seller is about the same.

Think about how much you pay to insure your car, or your house, or your health. It's probably a lot of money, right? And the companies selling you the insurance, most of the time, just sit back and enjoy the cashflow. On the other hand, they're exposed to what is typically called "tail risk" in financial lingo, meaning that they occasionally suffer big losses (when claims must be paid).

Life insurance for 70+-year-olds might be a scary business to get into, but health insurance on young healthy people carries low risk (and lower returns, obviously) but provides some nice steady cashflow for doing very little. Want to supplement your income? Sell catastrophic meteorite insurance!

I consider imsaguy to be one of the most trustworthy people in the community, so have no qualms taking on some of his default risk. Depending on your risk tolerance, you might want to sell CDSes on much riskier loans (much larger spreads mean much more regular income for you), but that's really up to you and your perception of the creditworthiness of the reference entity.

Anyway, my point is basically that selling CDSes can give good, steady income, at the expense of increased tail risk. Furthermore, you can actually be doing other things with the money you're liable for during the term of the CDS, which wouldn't be the case if you the loan directly. Of course, doing this exposes you to currency risk too (if you lose the coins you're liable for, and your reference entity defaults, you'll need to buy more coins to cover your debt).

From the larger community's perspective, this will allow lenders to reduce their risk by paying someone else to take it on, thus making the market a bit more mature (http://charleshughsmith.blogspot.com/2012/03/in-praise-of-hedging.html) and giving people more ways to protect their investments. It also gives us a way (whose validity is certainly arguable) to quantify the community's perceived risk on loan defaults, which might help in the longer run.

I'm definitely not advocating that anyone do this unless they fully understand the risks involved. Most of the time selling a CDS is just "free money", if you do it right, but you need to be able to cover the losses if things go down the drain. As always, this is not investment advice and all the usual no liability bullshit, but I think it could be a good deal for some people.

So, read up on http://en.wikipedia.org/wiki/Credit_default_swap and feel free to ask questions here about how they work. Surely I can't be the only one with the guts to try this around here, right?

tl;dr: no, definitely not. This is stuff you definitely need to understand well before undertaking the risk

I'll sell you CDSes on myself, but you'd have to be pretty stupid to buy them

Nope. We really don't want to give anyone an incentive (or lower the disincentive) to default

Thanks! I would, but I need to think about what degree of exposure I'm comfortable about some more. I'm also hoping, as I said, that I get the ball rolling and other people start offering these too (hey, it's free money until it isn't! what's not to like? ).

Hi all,

I thought I'd get the ball rolling on credit derivatives (because everybody loves credit derivatives, right?) by offering to sell 1000 bitcoins worth of 6-month CDSes with imsaguy's Open-Ended Investment Opportunity (https://bitcointalk.org/index.php?topic=60117.0) as the underlying reference entity.

This offering will be structured as ten 100-coin contracts. Buyers will pay me monthly fees for the contracts, and if imsaguy defaults on his debt, I will pay the buyer the value of the contract. The contract will also cover the less extreme credit event of imsaguy being more than 48 hours late on any payments due to his investors, in which case it will pay less than the full 100-coin liability.

If a buyer misses the monthly CDS payment by 48 hours, I shall consider the contract terminated and will offer no default protection beyond that.

I have contacted nanotube, the founder of the IRC OTC channel and one of the most respected people in the bitcoin community, to act as a neutral arbiter for deciding whether a credit event has occurred.

This offering will be held as a Second Item Auction (sometimes called a Dutch Auction; see http://en.wikipedia.org/wiki/Dutch_auction#A_second_item_auction), so anyone who wants these should just post how many contracts they're interested in and what percentage they're willing to pay as a fee. Bids should be phrased as a percentage, which represents what fraction of my liability you pay me in fees per month. I set a reserve of 1% (100 basis points, if you prefer finance lingo) on the contracts, so bids must be greater than or equal to 1%. To avoid too much clutter, let's do bids in increments of 10 basis points. As the wikipedia page explains, winning bids will pay whatever the lowest eligible bid was. The bidding will run for a week after I post this. Sold contracts will provide coverage for 6 months from that day, with monthly payments on the same day of every month.

As far as my own creditworthiness, I have a good reputation on the WOT (http://bitcoin-otc.com/viewratingdetail.php?nick=copumpkin), and am well respected on these forums. I've also signed a statement on this forum linking my WOT identity with this one: https://bitcointalk.org/index.php?topic=66313.msg769294#msg769294. I have "lots" of coins (significantly more than I am accepting liability for in this CDS offering) and even in the unlikely even that those are somehow lost, I have other assets and a real job.

I will compile GPG-signed (with my WOT identity) contracts outlining all the terms so that buyers may use them as recourse against my reputation in the event of a dispute. To avoid creating perverse incentives for imsaguy, I cannot let him purchase CDSes against himself, and must require that bidders be reasonably well established either here or on the WOT.

So, if you want to hedge your investment with imsaguy (starting at just 10 btc a month for 1000 btc of protection!) or you just want to speculate on him defaulting on his investors, feel free to bid here. Or if you get nothing else out of all of this, you can see this as a monetary vote of confidence in imsaguy's creditworthiness

Free free to ask questions and I'll be happy to answer whatever I can. I'm also open to suggestions on adjusting the specifics of the contract. I can't say I have much experience actually dealing in CDSes, so some things might be a little funny.

Edit: I'll elaborate later on precisely what constitutes a default and what will happen if one happens, but I don't have time to write it out now.

tl;dr: there is no tl;dr Read what I wrote above. This stuff isn't going to cost you much money (but could cost me a lot of it), but it isn't trivial, so make sure you understand how it works.

Good for you for dealing with your responsibilities and not running away, where many others have.

Like Chaang-Noi, I've seen this guy around for a while. I'm not vouching for him, but can't we hold off on the invective and accusations until we have some shred of evidence? I'm not saying to assume innocence until proven otherwise, but there's not much point to throwing baseless accusations around, either.

That's a pretty serious accusation, buddy.

It'd be kind of neat if someone adjusted that image to have the wheel be a giant gold bitcoin

Thanks for the information. Unfortunately, it looks like your screenshot link is just a link to facebook, which we can't see if we aren't you. Can you post another screenshot (possibly on imgur or a similar site)?

Well, if you're going to resort to insulting our intelligence without addressing my points, I'm going to disregard anything else you have to say, as I'm sure many others will. At first I thought you have something insightful to say, but now it's clear you're just being contrary.

Usually people don't take their counterparty making a profit as an insult, if they make a profit too. Would you be less opposed had he lied and said he had no BFLs and was just GPU mining with the increased electricity costs?

Either way, his electricity costs may be lower than many people's because of where he lives and his agreements for bulk power. He has infrastructure for monitoring miners and keeping them running at all times, which is more than most casual miners can say. In short, he's got some degree of an economy of scale. And, regarding risk, as I said before, if hardware fails or some other catastrophic event happens, he either has to buy the bonds back or find some other way to provide 50ghash/s.

The positive response on this thread from everyone but you suggests that you're approaching this from a different angle from everyone else. The information he put out there suggests he's got a decent profit margin on this deal, but it isn't risk-free or "free money" by any means, due to the running costs and so on.

To put this in a different way, say you're happily going to a store and buying your groceries from them, because the food is worth more to you than the money you hand over to them to buy it. One day, you look at their supplier invoices and see that their prices are marked up by 200%. Would you stop shopping there? Would you leave angry notes on the store's door telling the store manager and the store's customers about the purported price gouging going on?

That analysis is too simplistic. Can you do some real math and come back with a more reasonable suggestion?

Why are you so confrontational about this? He's not scamming people, he's not ripping people off, and he's offering a contract priced on par with similar ones. He's invested many many tens of thousands of dollars into his mining infrastructure and has the experience and skill to manage it, and he doesn't work for free. He has to keep paying the electric bills for these things forever, and the hashing isn't tied to a particular rig, so if one of the BFL miners dies or doesn't work for whatever reason, he still owes people 50ghash/s forever (unless he buys it back, in which case he still makes a loss). There's certainly risk in it for him, and risk carries a premium.

He started the thread as a question about what a good price for this type of contract would be. He suggested a price to get the conversation going, and if you don't like it, why not suggest one you think is more appropriate and why you think so. It's generally more productive to be respectful instead of confrontational.

Surely no such system exists!