An Honest Price Discovery Mechanism for Bitcoin

[Papa Scratchy Beard]

http://blogs.perl.org/users/papa_scratchy_beard/2013/04/an-honest-price-discovery-mechanism-for-bitcoin.html

INTRODUCTION

Although the bitcoin protocol itself is fairly robust, our dependence on centrally managed bitcoin exchanges for price discovery creates a single point of failure for the system as a whole.

What is needed is an honest price discovery mechanism that is both decentralized and resistant to DDoS, HFT and other forms of price manipulation.

A DISTRIBUTED EXCHANGE NETWORK

What I have in mind is a distributed network of independent, yet loosely cooperating bitcoin exchanges that all communicate via some well defined protocol. The network as a whole should be very resistant to attack, since if one exchange goes down the rest of the network picks up the slack. The concept is similar to how the Internet itself works.

HOW IT WORKS

Individual traders broadcast orders (bids + asks) to the entire exchange network (or some portion thereof), thus creating a race condition among exchanges to fill orders faster than the competition.  The exchange with the fastest matching engine wins the race and collect a small transaction fee.

From an engineering perspective, race conditions are normally considered BAD.  But from the free market perspective, this specific race condition is GOOD because it creates incentives for fast service and low transaction fees.
 
BITCOIN ESCROW SERVICES

To make it work, people would need an easy way to transfer funds over the Internet. That's where bitcoin escrow services come in. The first step would be to sign up with a trusted escrow service and deposit funds there. Then you'd be free to make trades over the network. Escrow companies would have the job of tracking transactions for their clients and settling up accounts at the end of the day. Note that escrow companies and exchanges could be totally separate entities.

A SIMPLE EXAMPLE

* Trader A deposits funds into a trusted escrow service.
* Trader A  downloads (or updates) a list of all open orders (bids + asks) from the exchange network
* Trader A decides to place a bid and sends the relevant details to his escrow service.
* The escrow service responds with a tx_id as proof of funds.
* Trader A broadcasts his order to a number of different exchanges, including tx_id in the order.
* Trader B decides to fill Trader A's order and sends his escrow service the tx_id provided.
* Escrow companies handle it from there.
* Market price at any given time is determined by the whole network.
* All identities verified with digital signatures, needless to say

SUMMARY

The concept all boils down to a shared protocol that allows traders, exchanges, and escrow companies to communicate in real time. Healthy competition among participants should result in improved quality of service all.  Obviously, this is all just a rough sketch and specifics still need to be hammered out.  If you'd like to contribute ideas or code, please contact scratchybeard@lavabit.com

ABOUT ME

I'm a software developer with 12 years experience in the financial services industry.
Donations also gratefully accepted: 1CuWjseY3ppDeVShwRFkwSpm369CNoFUca

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1)

The network as a whole should be very resistant to attack, since if one exchange goes down the rest of the network picks up the slack. The concept is similar to how the Internet itself works.

Internet is cetralized system, knock out some DNS servers and it will shatter into small pieces

2)

our dependence on centrally managed bitcoin exchanges

Nobody is forcing ppl to use only that one particular exchange. You are always free to use different. If all exchanges will make a hidden treaty, then someon e will setup a new one, caus it will be profitable <--> open market

3)

bitcoin exchanges for price discovery

Exchanges don't set price but merely reflect the price based on demand/supply.

However, I like the idea of decentralized bitcoin regulator ; )
Though, BitCoin hack-proofness is based on the fact that it is much more profitable for hacker to just mine some more BTCs.
Maybe you have in mind some kind of "natural" resistances as well?

p.s.
plz feel free to correct me if I'm wrong somewhere

[melon]

to be honest I think there's an easy way to set up a script that fetches the last price from let's say the top 4 exchanges and an algorithm ( in excel or something) that adds the prices and divides by 4 to get an average market price and then exports back out to a servers url using some scriptwork...when I say easy I mean as a programmer setting api scripts not a regular btc user! ...import(fetch) last prices to excel field boxes / 4 and export back out... I,m sure theres someone who could program an easy api program...in fact isn't Gox weighted average price something like that or maybe its a volume at different price weighting on the site Gox only...?i'll work on that api average price for ya...NOT..lol, im not a programmer just dabbled in some scripting  b4... guess they call that a script kiddie or something...hey ,I'm a noob what can I say !

Advertisement:BTC averaged price needed... preferably as desktop widget that will be fetched every few minutes (or 10)  from a server that uses a software algo to divide the last price off at least ,the top 4 exchanges.( preferably by a geek with plenty of time  on their hands and a BTC donation address at the bottom of the widget for all there hard work!)

there...Maybe that will do the trick

( ps... if there's one out there already, please post a link)