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Author Topic: A Stable Bitcoin Exchange Service  (Read 2751 times)
mjcmurfy
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October 20, 2011, 09:36:03 AM
 #1

First off, I want to say that I am not an economist so I don't know if what I am going to suggest is viable, but hopefully it will get some discussion started to improve the marketplace for the better.

The big problem as I see it is the extreme volatility of the exchange rate due to it being a very thinly traded market. This volatility is a major problem in conducting business with the currency, as it may lose a significant portion of it's value soon after you buy it. At the moment we have a handful of "reliable" exchanges where the rate is determined in an irrational and speculative way that is open to manipulation by those with excessive purchasing power. This irrational price in fiat currency then becomes the standard "value" many of us attribute to a bitcoin, and make poor buy/sell decisions based on this uncertain information.

Do you think it would change people's behavior for the better if they were guaranteed to be able to sell back any bitcoin they buy for the same price they paid? This ensures that they do not lose any fiat value from the irrational swings in the floating market, giving people a safety net in case the floating price of coin tanks. I think this would cause a paradigm shift in the minds of many. So how to achieve this? Here are my thoughts...

We could conceivably create a not-for-profit exchange that would set a fixed price per bitcoin, well above the floating market rate. This exchange would sell 1 bitcoin at a static price in fiat currency, lets say an arbitrary $3, and charge a small fixed fee to cover expenses. Now, any users who buy bitcoin from this exchange for $3 are guaranteed to be able to sell the coin back to the exchanger for $3 in the future, no more and no less than the exact price they paid for the coin. To do this, the exchange would keep in reserve 100% of all funds. Essentially, we need to create a exchange reserve.

Users of the exchange would only be able to sell as many bitcoins for $3 as they have purchased from the service. So if I have bought 10 coins for $3 each, I am guaranteed to be able to sell 10 back again for $3, by means of issuing guarantee-credits along with the bitcoin. If you want to buy bitcoin to exchange for goods/services, you could also transfer these $3-guarantee-credits along with your purchased bitcoin to the business that you are buying goods/services from so that they could then be guaranteed to sell them for $3. This process could be automated by creating a merchant API.

Price stability AND a merchant API ensures no loss in value, and makes bitcoin much more attractive for new business to adopt.

Once you have exhausted your guaranteed-credits balance, you would not be able to sell any more coins for the fixed price until you buy some more coin from the exchange. If you already have coin, you can simply deposit it with the exchange, and when you want to send coin to a business using the API you would have to pay the difference between market-value and the fixed price to obtain guarantee-credits.

Users are of course free to sell any purchased coins for more if they become more valuable on another exchange. This guarantees people are able to take any appreciation value, but guaranteed not to LOSE any. The static price would obviously be reviewed upwards if the floating value of a bitcoin exceeds the price charged by the not-for-profit exchange.

Any thoughts?

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mjcmurfy
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October 20, 2011, 11:37:23 AM
 #2

Not necessarily. As I said, if the exchange price rises above the static price it would be reviewed upwards and held at a level constantly above the best exchange rate available anywhere else. This would only apply to subsequent transactions. If someone manages to sell all their bitcoins for more on another exchange, when the price inevitably collapses again, they still have a $3 guaranteed price to which they can sell into by buying coins from cheaper exchanges, thus replenishing the coin reserve.

The key point is that this would be a not-for-profit exchange that will self-regulate and ensure price stability for economic activity. The fees charged would be just enough insurance to cover any monetary losses and expenses. If we could work the system out properly, I think that it could be stable over the long term.

And anyway, there are plenty of people out there with thousands and thousands of coins, early adopters who believe in the currency more than they care about short term fiat profit. We just need some philanthropist to allow their coins to be used for the good of the community. After all, they may become worthless without these controls.

A market this irrational needs to be controlled in my opinion. It is the only way to facilitate good honest economic activity.
In the end, that is what will determine the fate of bitcoin.

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mjcmurfy
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October 20, 2011, 01:12:56 PM
 #3

A market this irrational needs to be controlled in my opinion.
If a market is controlled, it's not rational.

Leaving that aside, the market already provides what you want. Suppose you want to buy a bitcoin for $3 with no risk of downside. You would also buy a "$3 put option" from an options market. This would cost you, say, $0.50 per BTC, and in return the counterparty would undertake to buy your BTC for $3 at a later time if you wish to exercise the contract.

This is not about controlling the market, it is about ensuring price stability for consumers and businesses who wish to use bitcoin as a means of exchange. They cannot do that reliably with bitcoin at present, because of the inherent instability of the exchange market.

You say that controlling a market means it is not rational, but what is rational about a free-floating market? What is rational about people buying bitcoin at $30, then watching their investment slowly decline all the way down to $2 without selling it? This is not a rational act. Both of these systems are as irrational as one other, but the latter is much more prone to excessive levels of panic, mania and delusion. With a pseudo-static bitcoin exchange, at least excessive irrationality can not affect the price and you get the added benefit of being able to actually use your coins without risk, because they are backed up by your money via guarantee-credits, so merchants can be sure that their bitcoin can be exchanged back for the same amount of fiat currency.

Think of it as a market that is deluded (i.e. not rational) but in favor of consumers and businesses, rather than speculators.

I understand that this can be done by using an options market (does one actually exist?) but what I want is to create an exchange that takes care of all of this for you and simultaneously facilitates smooth economic activity by providing a merchant API and without the requirement of having a degree in economics just to ensure that you don't lose any of your money after you buy bitcoins to make a purchase. Call it an options market if you want, as I already confessed, I'm not an economist.

I'm not saying all the exchanges should do this, but for businesses who want to accept bitcoin as a means of payment, they could use this exchange to ensure price stability until the transaction is complete. The price paid for a bitcoin doesn't matter so much if this is all you want to achieve. People are still free to trade as much as they want on the irrational floating markets, and the static price of, say $3, would not affect this floating price as you cannot sell into it without having bought at that price first.

It is simply a way of facilitating economic activity without having to rely on a widely volatile and thinly traded exchange markets such as MtGox and others to get your fiat out once the transaction has been completed. If these markets were bigger and had more people and money involved in the collective buy/sell decision making, this would not be necessary. But at the moment, it is necessary, because we cannot offer bitcoin as a realistic commerce solution without the price being stable at least over the medium term.

Why should we let exchanges determine the fiat value of a bitcoin when it is not at all necessary, accurate or for that matter... wise, to do so?

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October 20, 2011, 01:57:05 PM
 #4

You say that controlling a market means it is not rational, but what is rational about a free-floating market?
The rational thing about a free-floating market is that the buyer and seller transact at a price that leaves them both better off.

If I judge the value of a bitcoin to me to be $10, and someone else decides that the value of a bitcoin to them is $8, then they can sell to me at $9 and we're both happy.

A market isn't about guaranteeing anyone a risk-free investment, or anything like that.
mjcmurfy
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October 20, 2011, 02:08:18 PM
 #5

You say that controlling a market means it is not rational, but what is rational about a free-floating market?
The rational thing about a free-floating market is that the buyer and seller transact at a price that leaves them both better off.

If I judge the value of a bitcoin to me to be $10, and someone else decides that the value of a bitcoin to them is $8, then they can sell to me at $9 and we're both happy.

A market isn't about guaranteeing anyone a risk-free investment, or anything like that.

Why do they both have to be better off after a trade? As long as neither is worse off, bitcoin can be used properly in a real economy. The scenario you are suggesting is fictitious. This is NOT what we have now. Do you think people WANT to sell at $2 because they are better off? Of course not, they have no choice in the matter if they want to remain solvent.

There just is not enough liquidity in the exchanges to maintain stability for it to be feasible as a legitimate means of exchange. The way to get around this is to provide liquidity yourself with your own fiat for every transaction you carry out.

Yes, of course a commodity market is not about guaranteeing risk-free investment. But bitcoin is a currency, not a commodity. It has no inherent value other than it's purchasing power. It's function is to facilitate economic transactions, which themselves may be profitable. It is not supposed to be a tool to reward speculators for hoarding. It is NOT an investment vehicle, and I wish people would get that out of their heads.

These misconceptions are dragging the whole community down, and you have been round the block long enough to know better.

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Dan The Man
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October 20, 2011, 02:12:49 PM
 #6

I don't get it. If you have to keep readjusting your price to float it above the market price, then how will it keep a stable price? What is the necessary margin you will need to cover the market fluctuation? You will have to keep adjusting to stay above that margin.

mjcmurfy
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October 20, 2011, 02:29:23 PM
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I don't get it. If you have to keep readjusting your price to float it above the market price, then how will it keep a stable price? What is the necessary margin you will need to cover the market fluctuation? You will have to keep adjusting to stay above that margin.

It could just be set very clearly above the market price, lets say around $10, or even $100. It doesn't matter how much the price is, as long as it facilities trade, and the receiver knows he/she will be able to sell it back for a given price that does not fluctuate in the schizophrenic way the floating exchange rate does. The market price is totally and completely irrelevant for the purpose of this service.

Just like a floating rate, the static price of the coin is an agreed upon delusion between the buyer and seller. You pay $10 for a coin, send that coin to a merchant along with a guarantee that they can trade it back for $10. It doesn't matter how many coins we are talking about, or the price of each one, as long as the transaction can be completed without a loss of the agreed upon purchasing power of the bitcoin.

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mjcmurfy
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October 20, 2011, 02:34:53 PM
 #8

The arbitrageurs would simply eat it alive. Your non-profit would have to be prepared to throw money into a bottomless pit.

How? If the exchange sells 1 btc and 1 guarantee-credit for $100, where is the incentive to sell it for $2 on the open market? The only way you will get your fiat back is to sell it back to the exchange for $100.

The only people who are going to be hurt by this are those buying it on floating exchanges. Example, I buy 1 btc for $100 (plus a guarantee credit for $100). I take that bitcoin and sell it on an exchange for $2. Then I wait for the price to fall, buy another for < $2 and sell it back to the exchange for $100 again. What has happened? I have siphoned off a little from the market capitalization of bitcoin at the floating exchange. This transaction does not hurt the not-for-profit exchange I am suggesting. Equally, if the price rises, I have to pay more than $2 for my new bitcoin, and I have actually made a loss then.

The exchange would not lose money. It receives $100, gives out a bitcoin and a guarantee credit, it then receives a bitcoin and a guarantee credit back and gives out $100. There are no losses. There is no opportunity for arbitrage...

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October 20, 2011, 02:43:56 PM
 #9

We should get it to google android market, if many of the smart phone application can only be bought with BTC, then it will have some real economy back it  Smiley

mjcmurfy
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October 20, 2011, 02:47:02 PM
 #10

The arbitrageurs would simply eat it alive. Your non-profit would have to be prepared to throw money into a bottomless pit.

How? If the exchange sells 1 btc and 1 guarantee-credit for $100, where is the incentive to sell it for $2 on the open market? The only way you will get your fiat back is to sell it back to the exchange for $100.

There is no opportunity for arbitrage...

Let me get this straight. Your exchange would sell 1BTC for the highest available exchange rate plus X, and then buy it back for an arbitrary value, lets say $10.

Is that what you are saying?

Not quite. It would sell 1btc at a price well above the rate, I don't know exactly what price, but one that would take a significant amount of new money in the floating exchanges to get to. Lets just use $100 as an example, it really doesn't matter.

For your $100, you get 1 btc PLUS a transferrable guarantee-credit that will ensure you can trade the coin back in the future for the price you originally paid.

You can then send the coin, plus the guarantee-credit to a merchant, and they can trade it back using the transferred guarantee-credit for $100. This would all take place seamlessly via a merchant API that businesses could implement on their site.

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mjcmurfy
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October 20, 2011, 02:58:55 PM
 #11

Buy 1BTC with left hand for $5, receive $100 credit. Sell 1BTC by redeeming $100 credit with right hand. Repeat.

How are you going to get 1btc for $5 with a guarantee of $100? The only way you will get the guarantee is if you buy the bitcoin from the exchange and pay $100 for it.

You can only sell back however many coins you have already purchased. You can't buy coins from the open market and sell them for $100, as you will not have the required guarantee-credits to do so.

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October 20, 2011, 03:13:05 PM
 #12

So they buy a bitcoin with a note of credit, really what they are buying is a new currency (your note of credit) with a small token bitcoin tagged on. This kinda removes the whole point of bitcoin being decentralised why not use usd as the holder of your notes cant tell if you are buying off the market and issuing more credit notes for profit.

The new exchange would add massive counterparty risk in my opinion which is the major incentive for using bitcoin.

If anything I've said is vaguely useful feel free to show your appreciation
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mjcmurfy
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October 20, 2011, 03:14:34 PM
 #13

So, you say you would differentiate the coins bought from your exchange and somehow bind those transactions with the credit you issue. Is this correct?

If that is the case then you have done nothing but create a subset currency backed entirely by a central exchange.

Again, not quite. There would be no differentiation between individual coins. The important factor is the guarantee-credit. It is transferrable, and is backed not by a central exchange, nor the total market capitalization of the bitcoin system as a whole, but by the fiat currency YOU have paid. You are guaranteeing the bitcoin with your OWN money.

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Dan The Man
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October 20, 2011, 03:17:14 PM
 #14

You could do the exact same thing, but get rid of the $5 bitcoin. Just sell $100 credit notes which is pretty much what you would be doing.

mjcmurfy
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October 20, 2011, 03:20:52 PM
 #15

So they buy a bitcoin with a note of credit, really what they are buying is a new currency (your note of credit) with a small token bitcoin tagged on. This kinda removes the whole point of bitcoin being decentralised why not use usd as the holder of your notes cant tell if you are buying off the market and issuing more credit notes for profit.

The new exchange would add massive counterparty risk in my opinion which is the major incentive for using bitcoin.

Essentially you are correct, but this would all happen automatically under the hood of the merchant API. The end user need not understand that they are buying a promissory note, or transferring it along with their bitcoin via the API. All they need to have is an account with the exchange and some fiat funds.

I get that there is counterparty risk involved, but by making the system transparent and posting realtime statistics, trust could be slowly established. There could not be more guarantee-credits available than there is fiat funds to back them up. Merchants would cash them in immediately. They do not need to exist for very long. As long as both the reserve total and total guarantee credits issued is published in realtime, this will help negate the risk.

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mjcmurfy
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October 20, 2011, 03:24:46 PM
 #16

All you have done in this case is create yet another currency, it has really nothing to to with Bitcoin.

Think of it as a transferrable promise to exchange 1 bitcoin for X amount of fiat then.
No new currencies need to be involved.

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mjcmurfy
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October 20, 2011, 03:38:02 PM
 #17

It is basically Linden Dollars...

Good luck with that.

Linden dollars are exchangeable for US dollars or other currencies based on market-determined rates at currency exchanges. I know nothing about linden dollars other than that. Where is the similarity?

Commerce cannot be carried out with smoke and mirrors. It needs to have a stable means of exchanging value. The decentralized nature of bitcoin has many advantages, but providing a stable means of exchange is not one of them. Bitcoin is failing miserably on this front.

Again, I am not an economist, but I do feel that there is a great need for something along these lines. I am not saying that I have come up with the right solution, but some kind of solution is required if we want bitcoin to be successful.

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October 20, 2011, 03:42:33 PM
 #18

Ok, so from what I can understand, you want to create options and the means to easily (automatically) transfer the contracts. I will not comment on the sustainability of such a system, which I doubt for the moment, but I think it can be made to work.

My question is this: why would anyone want to transfer the put contract, too? Why would someone voluntarily give up his protection? Because, in the end, that's what an option is...

I see this scenario to be common: user Joe exchanges 300 USD for 100 BTC+ the put contract for 100 USD @ 3 USD. He buys stuff, maybe he also gets some coins by selling. He will keep the contract until he will want to exchange his coins to USD. If the exchange rate is higher than the contract, he will sell at spot price and be happy. If the exchange is lower than the contract, he will exchange 100 BTC at 3 and the rest at spot. If he doesn't have 100 BTC, he will buy at spot and use his option for some quick profit.
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October 20, 2011, 03:44:19 PM
 #19

It is issued by a central authority (Linden Labs), backed by (your) dollars, and they guarantee a limited volatility in the exchange rate with the US Dollar.

Ok, well the difference as I see it is that there is no central authority that issues anything. YOU make a promise to pay X amount of fiat for X amount of bitcoin, you transfer that promise to someone else along with the bitcoin, and they can exchange the bitcoin for the value of fiat you have promised.

You are the one backing the coin with your own money. You are not relying on a suitably liquid market to sell the coin back into, nor is there a central authority that promises to guarantee against volatility. There is no volatility. There is just the fiat you have promised to pay to your merchant.

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October 20, 2011, 03:47:57 PM
 #20

Because how else is the receiver of the coin going to exchange it back for the promised amount? And how can he be sure that the promise is good, unless it is locked-in by the exchange?

We need stability, and trustworthy 3rd parties. This is a simple fact. Economics does not work if you don't trust the people you do business with. We need to focus on ways of establishing and quantifying this trust.

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