I have created a much more complete white paper that should answer your questions:
http://the-iland.net/static/downloads/BitSharesWhitePaper.pdfYou can update your collateral at any time by creating a transaction that takes your position + extra collateral and generates an output with additional collateral.
From the white paper:
Economics of BitShares BitShares attempts to arrange for all actors to act proactively to ensure that collateral requirements are met even during the most extreme market fluctuations. To illustrate how these market forces will interact with the BitShare block-chain rules lets consider some example market situations.
Rapid Fall in BitShare Value If the value of a BitShare starts to fall rapidly against crypto-Gold, then all shorts in the system will be faced with a ‘squeeze’ which will force them to buy proactively before their margin is called. If their margin is hit, then they will suffer a 5% fee or worse, complete loss of their collateral. The result of this short-squeeze is that the value of ‘crypto-Gold’ would rise dramatically above market value causing even more shorts to face margin calls. This would create an opportunity for new shorts to enter market with full collateral backing their new position. These new shorts would profit when the price settles down after the short-squeeze is over. As a result all market participants will be pro-active about monitoring the price and their collateral which should result in the minimal amount of volatility.
Rapid Rise in BitShare Value If the value of BitShares rises rapidly against crypto-Gold, then all shorts would have an opportunity to cover their positions at a profit. If they fail to cover their position then the result will be opportunity costs associated with maintaining more than the required margin and crypto-Gold paying even higher dividends.
Connecting Gold to Crypto-Gold Price All market participants have something to gain if a common understanding can be reached that crypto-Gold is an IOU for a 1oz gold coin. However, initially there will be no ‘trust’ in what crypto-Gold actually means. As a result market participants will start out placing orders with a wide spread. As the market depth increases the spread will also decrease until a price is reached that has market consensus and is near parity with gold.
What happens if a sub-currency goes ‘no-bid’? The first thing that must be understood is that a sub-currency always has value proportional to the dividends backing it. Therefore, the short-position incurs a constant opportunity-cost by not covering. Likewise, the long is still receiving a revenue stream that has value independent of the value of a BitShare and therefore ‘above-market’ interest rates will attract new buyers to that sub-currency which means that all sub-currencies are always ‘liquid’ based solely on relative interest rates. As a result no sub-currency will ever go ‘no-bid’.
For this reason the early adopters face limited (if any) risk in being the first to purchase crypto-Gold. They would be trading BitShares at 10% APR for crypto-Gold that paid twice the BitShares-per-block and therefore profit even if they are the only buyer. When it comes time to ‘unwind’ this one trade, the price will be determined by whom ever wants the liquidity more. If the short wants to stop the bleeding opportunity cost, they will be forced to buy back at a higher price. If the long wants to convert to another asset then they may sell at a lower price. Either way, it is unlikely that there would ever only be two players in any given sub-currency market based only on the opportunity to ‘profit’ from higher interest rates.
What happens if there is a market crash that causes margins to be insufficient? In this event the longs will be paid out via dividends with the capital from the defaulted short positions. The market would then re-establish at the lower price with new collateral. Only the most severe crash in the value of BitShares could trigger such an event as it is unlikely that any other asset class could ‘rise in value‘ relative to a stable BitShare value that fast. Market participants will select margin requirements based upon their estimate of volatility and as a result receive sufficient interest to justify their risk.
If BitShares lose all value it would be a complete collapse of the entire system and everyone would lose. This would be a very unlikely event barring an breach in the block-chain algorithm or encryption. Early adopters would receive higher interest rates due to the smaller monetary base and therefore be compensated for taking a greater risk. Those who come later will have much more confidence in the algorithm and therefore receive a lower dividend rate.
