Bitcoinica: How it works

[zhoutong]

Two, steal money (BTC or USD) from the accounts of his customers to allow others to cover.

he just said that the USD accumulated in short sellers accts was already used to buy bitcoins.  did i get that right, Zhou?  so what do you call that Smickles?

Well, we don't really have the second way. Unless Mt. Gox gives us line of credit like real-world exchanges do. But very unlikely.

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[cypherdoc]

if the market went to $5 today and you were short yesterday and wanted to cover but couldn't b/c Zhou is under reserved in USD's, your entire acct would have been liquidated.

This will not happen in the future.

We will only restrict new positions, not existing positions in the future.

see there are problems that you're admitting to.  and you're calling me a troll?

[smickles]

Two, steal money (BTC or USD) from the accounts of his customers to allow others to cover.

he just said that the USD accumulated in short sellers accts was already used to buy bitcoins.  did i get that right, Zhou?  so what do you call that Smickles?

I think I missed that one, where did he say that?

[cypherdoc]

This does not do much to explain the common case at bitcoinica, as you conveniently choose scenarios where Bitcoinica always has a higher balance than the customer's trade, (and the customer uses 1:1 margin).

For example:
If Bitcoinica has a $1000 balance, and the customer executes a $1000 trade at 10:1 margin (which Bitcoinica allows), then bitcoinica does not have the funds available to fully equalize this trade against mtgox.
The trade would then require $10000 but bitcoinica only has $1000. If that trade is very profitable, Bitcoinica will have to pay the customer his earnings, or prevent him from liquidating his position until it is either not profitable, or until another customer opens an opposing position.

In all of your scenarios you say "Bitcoinica has lost money! Wrong!". It is in fact very possible for Bitcoinica to lose money -- the fact that you conveniently avoid this scenario is rather suspect.

At this moment, the reserve is larger than top three accounts combined times 10. Your reasoning might be valid at the earlier days, but definitely not now.

That's why we may occasionally halt one direction trading when we don't have money. Didn't you know what happened yesterday?

if the shorts had USD's in their accts yesterday from their shorting activity, why couldn't you let them use those USD's to cover their positions by buying on gox?

Obviously the money has been used up to purchase Bitcoins for the longs.

You have money in Bitcoinica account doesn't mean it's 100% in reserves, it can be borrowed by someone else to buy/sell Bitcoins. At any point, Bitcoinica is a:

- Full reserve in BTC and fractional reserve in USD, or
- Full reserve in USD and fractional reserve in BTC.

(Yesterday, we had a full reserve in BTC, and a depleted reserve in USD. Users couldn't withdraw USD until the situation was resolved.)

This is how hedging exactly works to ensure that we ourselves and our customers are always having almost the same profits (or we call it internally, rate of change of asset value with respect to market price).

right here.

[smickles]

<snip>

right here.

so the shorts borrow bitcoin to sell to the longs and you think that's what I meant? There's a cost to borrowing that bitcoin. But you did get me to question myself there. good job.

[notme]

Two, steal money (BTC or USD) from the accounts of his customers to allow others to cover.

he just said that the USD accumulated in short sellers accts was already used to buy bitcoins.  did i get that right, Zhou?  so what do you call that Smickles?

Well, we don't really have the second way. Unless Mt. Gox gives us line of credit like real-world exchanges do. But very unlikely.

The other option is to have much larger reserves or trade much less.  You could have reserves, and when a customer takes a position the funds they supposedly hold are not considered reserves as they are now.  Once all the reserves are moved to positions there can be no new positions until you make profits to add to your reserve or some deleverages/closes their position.  But for this to work you need X times customer funds, where X is the weighted average leverage factor of all accounts.  As it stands now, if it had dipped when the shorts had their USD borrowed by the longs, but not enough to force a sale, and no one sold for whatever reason, bitcoinica would be looking at a loss.  Of course it's doubtful all the longs would hold steady, but it is possible they would and you wouldn't have a profit from them accepting a loss to cover your loss due to the profits you owe the shorts you borrowed USD from.

[cypherdoc]

<snip>

right here.

so the shorts borrow bitcoin to sell to the longs and you think that's what I meant? There's a cost to borrowing that bitcoin. But you did get me to question myself there. good job.

huh?  if you want to short btc, you borrow those btc from someone else on Bitcoinica and sell them to a long for USD's which then get credited to your acct.

in order for you to close the position (cover), you need those USD's to buy those btc back from a seller or another short.  if those USD's are removed from your acct by Zhou to buy btc from mtgox to sell to other longs, where are the USD's going to come from so you can you cover?

[cypherdoc]

Two, steal money (BTC or USD) from the accounts of his customers to allow others to cover.

he just said that the USD accumulated in short sellers accts was already used to buy bitcoins.  did i get that right, Zhou?  so what do you call that Smickles?

Well, we don't really have the second way. Unless Mt. Gox gives us line of credit like real-world exchanges do. But very unlikely.

The other option is to have much larger reserves or trade much less.  You could have reserves, and when a customer takes a position the funds they supposedly hold are not considered reserves as they are now.  Once all the reserves are moved to positions there can be no new positions until you make profits to add to your reserve or some deleverages/closes their position.  But for this to work you need X times customer funds, where X is the weighted average leverage factor of all accounts.  As it stands now, if it had dipped when the shorts had their USD borrowed by the longs, but not enough to force a sale, and no one sold for whatever reason, bitcoinica would be looking at a loss.  Of course it's doubtful all the longs would hold steady, but it is possible they would and you wouldn't have a profit from them to cover you loss due to the shorts you borrowed USD from.

this was Ferroh's point.

[cypherdoc]

if Zhou ran out of USD reserves yesterday, where did all the USD's come from to allow the longs to sell their btc?  an avalanche of new customer deposits?

if so, why does that sound like a Ponzi?

[notme]

"We can't fix this without credit" is a disgusting attitude that has infected our global economy.  It seems few understand the idea of working within your means instead of using credit to create artificial growth.  As a 25 year old I am disgusted by the mess being left for my generation to deal with. [/rant]

[notme]

if Zhou ran out of USD reserves yesterday, where did all the USD's come from to allow the longs to sell their btc?  an avalanche of new customer deposits?

That makes no sense cypher... Why would they need USD for the longs to sell.

[cypherdoc]

if Zhou ran out of USD reserves yesterday, where did all the USD's come from to allow the longs to sell their btc?  an avalanche of new customer deposits?

That makes no sense cypher... Why would they need USD for the longs to sell.

the longs liquidate their btc for USD's, no?

[smickles]

<snip>

right here.

so the shorts borrow bitcoin to sell to the longs and you think that's what I meant? There's a cost to borrowing that bitcoin. But you did get me to question myself there. good job.

huh?  if you want to short btc, you borrow those btc from someone else on Bitcoinica and sell them to a long for USD's which then get credited to your acct.

in order for you to close the position (cover), you need those USD's to buy those btc back from a seller or another short.  if those USD's are removed from your acct by Zhou to buy btc from mtgox to sell to other longs, where are the USD's going to come from so you can you cover?

Wasn't that explained earlier?
My point can basically be reduced to:
Zhou didn't steal peoples money, so obviously, because of the reserve situation, people had to wait until opposing positions to occurred to be able to cover.

[smickles]

"We can't fix this without credit" is a disgusting attitude that has infected our global economy.  It seems few understand the idea of working within your means instead of using credit to create artificial growth.  As a 25 year old I am disgusted by the mess being left for my generation to deal with. [/rant]

I hope I'm not coming off as supporting the line of credit idea. I don't want that to happen.

[smickles]

if Zhou ran out of USD reserves yesterday, where did all the USD's come from to allow the longs to sell their btc?  an avalanche of new customer deposits?

That makes no sense cypher... Why would they need USD for the longs to sell.

the longs liquidate their btc for USD's, no?

which can come from Z selling those BTC on MtGox?

[zhoutong]

if Zhou ran out of USD reserves yesterday, where did all the USD's come from to allow the longs to sell their btc?  an avalanche of new customer deposits?

That makes no sense cypher... Why would they need USD for the longs to sell.

the longs liquidate their btc for USD's, no?

When the longs liquidate, we sell Bitcoins for them. Then we have USD to give to them.

You don't understand Bitcoinica accounts at all. The account balance is just a number fully or partially backed by the Bitcoinica reserve. The market maker never has to send money to his users' accounts.

[notme]

if Zhou ran out of USD reserves yesterday, where did all the USD's come from to allow the longs to sell their btc?  an avalanche of new customer deposits?

That makes no sense cypher... Why would they need USD for the longs to sell.

the longs liquidate their btc for USD's, no?

Sure... The USDs came from selling BTC on MtGox.

[cypherdoc]

Sorry, my bad.  I'm heading out to dinner so I'll be back later

[cypherdoc]

Two, steal money (BTC or USD) from the accounts of his customers to allow others to cover.

he just said that the USD accumulated in short sellers accts was already used to buy bitcoins.  did i get that right, Zhou?  so what do you call that Smickles?

Well, we don't really have the second way. Unless Mt. Gox gives us line of credit like real-world exchanges do. But very unlikely.

The other option is to have much larger reserves or trade much less.  You could have reserves, and when a customer takes a position the funds they supposedly hold are not considered reserves as they are now.  Once all the reserves are moved to positions there can be no new positions until you make profits to add to your reserve or some deleverages/closes their position.  But for this to work you need X times customer funds, where X is the weighted average leverage factor of all accounts.  As it stands now, if it had dipped when the shorts had their USD borrowed by the longs, but not enough to force a sale, and no one sold for whatever reason, bitcoinica would be looking at a loss.  Of course it's doubtful all the longs would hold steady, but it is possible they would and you wouldn't have a profit from them accepting a loss to cover your loss due to the profits you owe the shorts you borrowed USD from.

this is actually a good suggestion and helps me understand what Bitcoinica does much better than i did.

phew, as much as i've short sold over the years, i've never had to bother with the mechanics of how brokerages provide the liquidity for me to perform this activity.  its bad enough trying to predict the swings and directions of markets.

thanks for helping me understand.

having said that i still think there are some potential problems identified above but it sounds like Zhou is now aware of these and will try to make things better.

[minorman]

I think credit instruments in Bitcoin should be avoided like the plague.
Getting away from the bankster-issued, debt-backed funnymoney is imho the *prime* benefit of Bitcoin.
For the same reason, am I very apprehensive about leveraged trading, since this is conventionally done with "margin"="credit"=debt/paper money.
Clearly, you can't (and thus don't) sell "paper" Bitcoins on mtGox - yet, so for now it might be ok, but what if credit (promise-to-pay) Bitcoin starts appearing for real within Bitcoin?? I think mtGox credits are a step in that dangerous direction.

 Please people - never forget the difference between real Bitcoin and promisary notes! That leads to the dark side 

-practical question: Does Bitcoinica follow the uptic-rule? If not, why not?