The lack of shorting is a significant barrier

[nazgulnarsil]

to attracting more widespread interest from the world of finance.  I personally know people who would like to make multi-thousand dollar bets against bitcoin but can't because shorting has to be set up by a large trusted third party.  The ability to short increases liquidity and moves more money into the bitcoin ecosystem.

[grondilu]

to attracting more widespread interest from the world of finance.  I personally know people who would like to make multi-thousand dollar bets against bitcoin but can't because shorting has to be set up by a large trusted third party.  The ability to short increases liquidity and moves more money into the bitcoin ecosystem.

Shorting bitcoins is easy straightforward:

1.  Go to some marketplace, whether here, on freenode #bitcoin-otc or wherever ;
2.  Convince someone to lend you some bitcoins ;
3.  Sell those bitcoins, for instance on MtGox ;
4.  Wait for bitcoin to crash ;
5.  Buy enough bictoins to repay your debt ;
6.  Profit ;

[2_Thumbs_Up]

You try to do that with several thousands of dollars and see how easy it really is. I really don't think any newcomer is going to find someone willing to lend them several hundreds of BTC.

I'm with OP here, for shorting to take off, a large trusted third party would have to set it up. It's the only way to resolve the trust issue.

[grondilu]

Basically shorting consists in selling something you don't actually own.  That's why it does make sense if it is economically quite difficult to do so.

You can't sell something you don't own unless you are capable of convincing someone that you will own it in the future.  If you are a nobody, sure it will be difficult, and the more you want to short, the more difficult.   Nothing wrong with that.

Also, if you think there is a market for bitcoin-shorting instruments, what about you offer this kind of financial service ? (instead of just complaining)

[fergalish]

Mtgox trades 30000 bitcoins per day, add in the other exchangers, IRC trades... crap, you'd probably need to dump at least 20000 BTC to make it really noticeable.  Probably more like 50k.  That's half-a-million $ right now.  And even with 50k BTC dumped on the market, it's far from certain that the price would substantially drop - interest in bitcoins is increasing at an extraordinary pace.  Multi-thousand dollars, I reckon, wouldn't get you very far.

[nazgulnarsil]

hur dur.  I'm one person.  Many many many people are probably interested in shorting bitcoin.  These are people willing to bet against us meaning we make EVEN MORE money when it turns out they are wrong.

Bitcoin trading will not be taken seriously until shorting is implemented.

[grondilu]

hur dur.  I'm one person.  Many many many people are probably interested in shorting bitcoin.  These are people willing to bet against us meaning we make EVEN MORE money when it turns out they are wrong.

Bitcoin trading will not be taken seriously until shorting is implemented.

There is nothing to be "implemented".  Basically all you have to do is to borrow bitcoins.  And this is easy.  The simplest way to do that is to issue a bond on biddingpond.   You just have to start with small amounts in order to gain reputation.

Now stop trying to find any more excuses and just do it.

[Stephen Gornick]

I cannot imagine a worse financial situation than having short bets on bitcoin made over the the past month months.

[Adam]

I don't think any reputation based system will be sufficient to create a real economy.  I would like to set up a BitCoin investment bank that has this type of functionality.  I've thought about a lot of the things you would need in place in order to do this.  People deposit their bitcoins with my site and earn interest (in bitcoins).  I take these and lend them out to speculators hoping to profit on the fall in the bitcoin-USD exchange rate.  They pay a slightly higher interest rate to borrow the bitcoins as I pay to the lenders who deposited them with me.  The difference is the bank's profit and goes to the reserve so I can cover short term swings in deposits and withdrawals.

Person A deposits 100 BTC at an interest rate of 6% per year on June 1st.   One month later their bank account has 100.5 BTC.

Person B borrows those 100 BTC at the rate of 8% per year on the same day.  They immediately sell those bitcoins on the market for USD.  They will owe interest of .6667% per month.  If they cover their short in a month they need to return 100.6667 BTC.

Person A profits .5 BTCs, and they are free to cash out at any time so they lose no flexibility.  They gain in purchasing power if bitcoins increase in value, and conversely lose purchasing power if they decrease.

Person B has to pay .6667 BTC in interest for the loan, so he profits if he is able to buy 100.6667 BTC for less than he originally sold the 100 BTC for.

That's all there really is to a short sale.  You need people who want to deposit bitcoins with a third party (my bank) in exchange for interest.  And then I take these bitcoins and lend them out to people who expect to profit from their decline in value relative to the dollar.  The two major concerns:

When I lend out your bitcoins I no longer have those exact coins.  But bitcoins are fungible, so if you want to withdraw it doesn't matter if I give you your exact coins back, the coins of another depositor, or my own coins in reserve.  I need enough depositors to keep the market liquid, and enough of my own bitcoins in a reserve account to cover deposits and withdrawals.  Keeping 10% of the amount on deposit should be sufficient, as I will require anyone who borrows bitcoins to keep cash deposited at the bank to cover all the bitcoins they borrow.  So I have people depositing both bitcoins and cash.  When I have lots of cash reserves and little bitcoin reserves I use the cash to buy more bitcoins, and vice versa.

The second problem is what is to stop the speculator from borrowing the bitcoins, selling them for cash, and disappearing without repaying the loan?  The only way I can see to do this is to require them to deposit cash in excess of the bitcoins they deposited.  Let's say they borrow 100 BTC, worth $1000 today.  I could require them to deposit $1200 with me until they repay the bitcoins.  Furthermore, they would need to maintain a cash balance in their account with my bank of at least 10% more than the current exchange rate.  This excess would be required because when the value of bitcoins rises, let's say to $13, now they owe $1300 worth of bitcoins and only have $1200 in their account with my bank. This brings us back to the original problem of what if they just decide to disappear, now owing more than they deposited?  This is why we would require them to maintain a cash balance of 10% over the amount of their loan at all times.

In my above example they deposited $1200 and owe 100 bitcoins.  If bitcoins rise to $11 each and they did not deposit any more money to cover this they now owe effectively $1100 ($11 x 100) and have a required balance of $1210 ($1100 x 110%).  Since they failed to cover this required balance I take their $1200 balance and buy back on the market place 100 bitcoins for $1100 to cover their short position for them.  They now have $100 in their account and owe nothing.

I think these restrictions address most of the problems with the theory on how this will operate.  I just need to know how to get the software in place to manage these types of transactions and get accounts with payment processors to allow people to get money in and out.  Any suggestions for this or any ideas about things I have overlooked would be appreciated.

[Findeton]

Bitcoin/$ parity can go up as much as we want, but... at some point, it will become a bubble and therefore it will burst. It can take a long time (maybe months, maybe years, maybe decades) to burst (longer even because we can't short), but it's pure economics.

[nazgulnarsil]

I don't think any reputation based system will be sufficient to create a real economy.  I would like to set up a BitCoin investment bank that has this type of functionality.  I've thought about a lot of the things you would need in place in order to do this.  People deposit their bitcoins with my site and earn interest (in bitcoins).  I take these and lend them out to speculators hoping to profit on the fall in the bitcoin-USD exchange rate.  They pay a slightly higher interest rate to borrow the bitcoins as I pay to the lenders who deposited them with me.  The difference is the bank's profit and goes to the reserve so I can cover short term swings in deposits and withdrawals.

Person A deposits 100 BTC at an interest rate of 6% per year on June 1st.   One month later their bank account has 100.5 BTC.

Person B borrows those 100 BTC at the rate of 8% per year on the same day.  They immediately sell those bitcoins on the market for USD.  They will owe interest of .6667% per month.  If they cover their short in a month they need to return 100.6667 BTC.

Person A profits .5 BTCs, and they are free to cash out at any time so they lose no flexibility.  They gain in purchasing power if bitcoins increase in value, and conversely lose purchasing power if they decrease.

Person B has to pay .6667 BTC in interest for the loan, so he profits if he is able to buy 100.6667 BTC for less than he originally sold the 100 BTC for.

That's all there really is to a short sale.  You need people who want to deposit bitcoins with a third party (my bank) in exchange for interest.  And then I take these bitcoins and lend them out to people who expect to profit from their decline in value relative to the dollar.  The two major concerns:

When I lend out your bitcoins I no longer have those exact coins.  But bitcoins are fungible, so if you want to withdraw it doesn't matter if I give you your exact coins back, the coins of another depositor, or my own coins in reserve.  I need enough depositors to keep the market liquid, and enough of my own bitcoins in a reserve account to cover deposits and withdrawals.  Keeping 10% of the amount on deposit should be sufficient, as I will require anyone who borrows bitcoins to keep cash deposited at the bank to cover all the bitcoins they borrow.  So I have people depositing both bitcoins and cash.  When I have lots of cash reserves and little bitcoin reserves I use the cash to buy more bitcoins, and vice versa.

The second problem is what is to stop the speculator from borrowing the bitcoins, selling them for cash, and disappearing without repaying the loan?  The only way I can see to do this is to require them to deposit cash in excess of the bitcoins they deposited.  Let's say they borrow 100 BTC, worth $1000 today.  I could require them to deposit $1200 with me until they repay the bitcoins.  Furthermore, they would need to maintain a cash balance in their account with my bank of at least 10% more than the current exchange rate.  This excess would be required because when the value of bitcoins rises, let's say to $13, now they owe $1300 worth of bitcoins and only have $1200 in their account with my bank. This brings us back to the original problem of what if they just decide to disappear, now owing more than they deposited?  This is why we would require them to maintain a cash balance of 10% over the amount of their loan at all times.

In my above example they deposited $1200 and owe 100 bitcoins.  If bitcoins rise to $11 each and they did not deposit any more money to cover this they now owe effectively $1100 ($11 x 100) and have a required balance of $1210 ($1100 x 110%).  Since they failed to cover this required balance I take their $1200 balance and buy back on the market place 100 bitcoins for $1100 to cover their short position for them.  They now have $100 in their account and owe nothing.

I think these restrictions address most of the problems with the theory on how this will operate.  I just need to know how to get the software in place to manage these types of transactions and get accounts with payment processors to allow people to get money in and out.  Any suggestions for this or any ideas about things I have overlooked would be appreciated.

no need to reinvent the wheel, research how this is done in normal markets.

[Adam]

no need to reinvent the wheel, research how this is done in normal markets.

Yeah, I gave up on the idea of doing it myself pretty quickly.  This is the essence of how it is done in real financial markets though.  Investment banks have custody of shares of stock that they hold for their customers and can freely loan them out to others.  They would of course have to return them to their original owners on demand, but shares of stock are fungible so they have a large pool to draw from.  And the loaning isn't an issue because they would only loan shares to people who had assets with the bank to use as collateral for the loan, so if you never paid it back they could force you to liquidate your holdings.

[benjamindees]

I'll loan you Bitcoins to short.  But I'm probably going to want your house as collateral.

[kjj]

no need to reinvent the wheel, research how this is done in normal markets.

Yeah, I gave up on the idea of doing it myself pretty quickly.  This is the essence of how it is done in real financial markets though.  Investment banks have custody of shares of stock that they hold for their customers and can freely loan them out to others.  They would of course have to return them to their original owners on demand, but shares of stock are fungible so they have a large pool to draw from.  And the loaning isn't an issue because they would only loan shares to people who had assets with the bank to use as collateral for the loan, so if you never paid it back they could force you to liquidate your holdings.

Ha!  You missed a couple of key steps in the security shorting process.

First is the shorting pool at the clearing house.  Say you want to short a stock.  Your broker borrows them from a pool and gives them to you.  You then sell them to someone.  That buyer has no idea that they just received borrowed stocks, and they think they own them.  So, the buyer's broker holds them, and makes them available to the pool so that the next guy can borrow them again.  (Side note: shares include voting rights, and now at least two people think they are allowed to vote, and all but one of them is wrong.)

Second is that the pool is totally unnecessary, since a broker can just fail to deliver (FTD) the shares.  They are supposed to settle all trades by day T+10, but for most brokerages, there is no rush, because:

Third is that there is almost never a downside for letting a transaction go into FTD status.  No jail time.  No fines.  Rarely a sternly worded letter.

[iya]

no need to reinvent the wheel, research how this is done in normal markets.

Yeah, I gave up on the idea of doing it myself pretty quickly.  This is the essence of how it is done in real financial markets though.  Investment banks have custody of shares of stock that they hold for their customers and can freely loan them out to others.  They would of course have to return them to their original owners on demand, but shares of stock are fungible so they have a large pool to draw from.  And the loaning isn't an issue because they would only loan shares to people who had assets with the bank to use as collateral for the loan, so if you never paid it back they could force you to liquidate your holdings.

Ha!  You missed a couple of key steps in the security shorting process.

First is the shorting pool at the clearing house.  Say you want to short a stock.  Your broker borrows them from a pool and gives them to you.  You then sell them to someone.  That buyer has no idea that they just received borrowed stocks, and they think they own them.  So, the buyer's broker holds them, and makes them available to the pool so that the next guy can borrow them again.  (Side note: shares include voting rights, and now at least two people think they are allowed to vote, and all but one of them is wrong.)

Second is that the pool is totally unnecessary, since a broker can just fail to deliver (FTD) the shares.  They are supposed to settle all trades by day T+10, but for most brokerages, there is no rush, because:

Third is that there is almost never a downside for letting a transaction go into FTD status.  No jail time.  No fines.  Rarely a sternly worded letter.

This has nothing to do with Bitcoin though, which is totally unregulated in any case.

Shorting could be setup by a broker or market maker, who must own enough BTC and USD.
If you have an account balance of $1000 and short 50BTC at $10, prices would be allowed to climb to $20 before you get a margin call and your position is forcibly closed.

[Adam]

This has nothing to do with Bitcoin though, which is totally unregulated in any case.

Shorting could be setup by a broker or market maker, who must own enough BTC and USD.
If you have an account balance of $1000 and short 50BTC at $10, prices would be allowed to climb to $20 before you get a margin call and your position is forcibly closed.

Shorting of BTC should be pretty easy to implement and quite effective for a market maker with a huge supply of bitcoins accumulated from fees and from the accounts of people who have deposited but not listed their coins for sale yet.  Then you could charge interest for a loan that effectively costs you nothing.

And now that I think about it the most logical thing to do would be never even give the borrower the bitcoins.  And they could probably afford to short with much more leverage than I originally thought.  In your example you shouldn't need anywhere near $1000 to short 50BTCs. They could probably do it with as little as $100.  You as the banker could borrow these from a depositor or use your own supply and sell them at the current market price right away.  There is no need to ever deliver the coins to the person borrowing them, because they need to keep the proceeds with you for security anyway.  Now they have the $500 from the sale and the $100 they put in for a total of $600 in assets with a liability of 50x whatever the going rate of BTC is (plus interest/transaction fees).  The value of the account would go negative with a BTC price of $12 or more, so you wouldn't need to call in the margin until there are no listings on the market with ask prices of $12 or less.

With how quickly transactions can be completed and how open the information on bid/ask spreads look it seems like someone could make a killing on this by making tons of highly leveraged small bets against bitcoins.

Edit: The more I think about it the more I think maybe this wouldn't be good for the economy.  Naked short selling with unlimited leverage and perfect information on supply and demand?  It might just be asking to be exploited. The path to legitimacy is probably more through increasing the use of bitcoins as a means of exchange for value added goods and services, rather than for value sucking financial derivatives.  I must be pretty fickle... in the span of three hours I went from wanting to start a service to wanting to prevent it from happening.

[nazgulnarsil]

naked short selling is fraudulent.  it's up to the individual exchange that implements this to run it correctly.  if people choose to deal with a party that implements fraud they can expect to lose their money/coins.

[interfect]

I read somewhere that Mt. Gox was looking into margin trading. Maybe they will also add a shorting feature? They're pretty much the closest thing we have here to a trusted party.

Or maybe one of the other exchanges will beat them to it and steal their business?

[asdf]

Basically shorting consists in selling something you don't actually own.  That's why it does make sense if it is economically quite difficult to do so.

Beautiful logic! Breaking the problem down to it's fundamentals.

[bitoption]

I anticipate Gox will allow short selling once margin trading is widely opened up.

I am also launching an options trading site (hopefully tomorrow the web interface goes live); you could buy puts from bitcoin bulls, god knows there are plenty of those. Just convince them to come to the site starting tomorrow. I'll post a note here when it's live.