[GLBSE] ABSORB - Emulating BTC/USD margin trading

[Meni Rosenfeld]

tl; dr: If the BTC price reaches $6 before it reaches $4, every ABSORB.1.4-6.LONG bond will be bought for 1 BTC. Otherwise, every ABSORB.1.4-6.SHORT bond will be bought for 1 BTC.

Introduction. Bitcoinica's suspension of operations has left a void among those in need of buying bitcoins on leverage or selling them short. It was only a matter of time until alternative instruments were to be introduced, in particular by utilizing the GLBSE platform. The ABSORB family of bonds aims to be just that - while conveniently satisfying my own need for this functionality.

Operation. The first series to be issued is ABSORB.1.4-6.LONG and ABSORB.1.4-6.SHORT. Their settlement depends on what happens first: BTC is traded on Mt. Gox at a price of $6 USD (or higher), or at a price of $4 USD (or lower). If $6 comes first, every ABSORB.1.4-6.LONG bond will be bought back for 1 BTC, while ABSORB.1.4-6.SHORT will become worthless. If $4 comes first, every ABSORB.1.4-6.SHORT bond will be bought back for 1 BTC, while ABSORB.1.4-6.LONG will become worthless.

The issue price is TBD but is expected to be around 0.5 BTC for each bond. Buying ABSORB.1.4-6.LONG or ABSORB.1.4-6.SHORT, respectively, is very similar to buying or selling BTC at roughly 5:1 leverage (if the BTC price increases/decreases by 20%, the investment will be doubled/erased).

Series details. Initially, 400 ABSORB.1.4-6.LONG bonds and 200 ABSORB.1.4-6.SHORT bonds will be offered. The IPO will be on May 28th 2012, the hour will depend on my availability (I'll have limited availability during that time).

Baseline value. The baseline value of an ABSORB bond is defined as the expected value of the bond, in USD, under the assumption that the exchange rate follows a driftless exponential Brownian motion, translated to today's bitcoins. For a pair of bonds settled by reaching $L or $H, with the current BTC price being $M, the baseline value of the long bond, in BTC, is

[ln (M/L) / ln (H/L)]*(H/M)

And for the short bond it is

[ln (H/M) / ln (H/L)]*(L/M).

The baseline value will be used as a guideline to choosing the IPO price of the bonds, but the final price will be determined by my own needs.

Termination. The issuer has neither the right nor the obligation to buy the bonds back before they are settled. Bondholders are of course welcome to try to sell bonds on the open market, which is likely to react to any changes in the BTC price.

In extreme external circumstances which render the bond meaningless, such as extended suspension of Mt. Gox (according to which settlement is decided) or GLBSE (through which settlement payment is to be disbursed), the bonds will be bought back for their baseline price, with M being the last traded price on Mt. Gox.

Leverage. Under the assumption that the baseline value accurately reflects the worth of the bond, holding long bonds with a total value of 1 BTC is locally equivalent to holding 1/ln(M/L) BTC (that is, an increase of $0.01 in the exchange rate increases the total USD value of the bonds by $0.01/ln(M/L)). Holding 1 BTC worth of short bonds is equivalent to holding (-1)/ln(H/M) BTC.

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[Meni Rosenfeld]

(reserved)

[streblo]

Meni, I'm sure you've considered the following and I would like to hear your thoughts.

1) To clarify, do the securities pay based on the first trade at 6.00$ BTC/USD or 4.00$ BTC/USD (a so-called "one-touch" option) ?
2) By buying the short bonds, one doesn't truly short BTC/USD, because if the exchange rate goes to ~0 BTC/USD, the bonds are effectively worthless in USD.
3) Do these securities make the market more efficient? Suppose a USD-holding party thinks BTC/USD is overvalued and wants buy the short securities (thus shorting BTC/USD), they must buy BTC/USD on an exchange, thus raising the BTC/USD price. Therefore, this party has the opposite impact that they should to stabilize the market.

The crux of #2 and #3 is the securities are BTC-denominated as opposed to USD-denominated, and the argument against denominating them in USD is obvious (regulation, etc.).

[Meni Rosenfeld]

1) To clarify, do the securities pay based on the first trade at 6.00$ BTC/USD or 4.00$ BTC/USD (a so-called "one-touch" option) ?

If I understand you correctly, yes - the first time there is a trade at at least $6, the long bond becomes entitled for 1 BTC no matter what happens later. The first time there is a trade at at most $4, the bond immediately expires.

2) By buying the short bonds, one doesn't truly short BTC/USD, because if the exchange rate goes to ~0 BTC/USD, the bonds are effectively worthless in USD.

It's an approximation which I think would be good for most use cases. It isn't for someone who believes the price will crash to 0 in the middle of the night. But someone who believes in a gradual decline (like the one from $31 to $2) - whether if it is because Bitcoin is going to fail, or because it is currently overvalued and things will get worse before they get better - can buy a short bond, roughly double his bitcoins, and then sell them or reinvest in a new shorting instrument.

3) Do these securities make the market more efficient? Suppose a USD-holding party thinks BTC/USD is overvalued and wants buy the short securities (thus shorting BTC/USD), they must buy BTC/USD on an exchange, thus raising the BTC/USD price. Therefore, this party has the opposite impact that they should to stabilize the market.

I think so. As a matter of general principle, I believe that for every action there is an equal reaction, and that it's impossible to make a bet on a market without it ending up affecting the market itself.

By way of specific mechanism, I as an issuer have a certain position I wish to achieve. If someone buys a short bond, he'll have to buy 0.5 BTC for it, but I will also need to hedge my position by either:
1. Selling 2.5 BTC, or
2. Issuing more long bonds and/or decreasing their price, in an amount sufficient for someone else to buy one more long bond - preventing him from buying 2.5 BTC.

Of course, this is all amortized over many trades, so is more difficult to see on a smaller scale.

The crux of #2 and #3 is the securities are BTC-denominated as opposed to USD-denominated, and the argument against denominating them in USD is obvious (regulation, etc.).

Right. It's an approximation designed to answer specific needs with as little overhead as possible - and it relies on other markets in order to ultimately transfer USD in or out.

[Sukrim]

What happens in the case that MtGox gets eaten by Godzilla tomorrow and closes down before reaching neither 4 nor 6 USD?

I like the fact that GLBSE is becomming a "betting" site more and more...

[Meni Rosenfeld]

What happens in the case that MtGox gets eaten by Godzilla tomorrow and closes down before reaching neither 4 nor 6 USD?

This is to be finalized, but I think we'll first reach an agreement that Mtgox isn't coming back in the foreseeable future, and in this case, I'll buy all bonds according to a simple algorithmic evaluation of their worth, based on the last trade price (I'll give more details later but if the price is $5.5, I'll buy the long bonds for roughly 0.75 BTC and the short bonds for roughly 0.25 BTC).

I like the fact that GLBSE is becomming a "betting" site more and more...

I'd like it even better if we had a proper predictions market. Though I had a few other ideas for margin instruments which are more suitable for GLBSE than a predictions market.

[bitdragon]

thanks for the inspiration !
Do you have a plan if 4 or 6 is reached before the 28th?

[friedcat]

This idea is much less fancy and inspiring than PureMining and Anti-Pirate.

But still a very good idea overall, cleanly designed with no clutter.

[Meni Rosenfeld]

Do you have a plan if 4 or 6 is reached before the 28th?

In this case the issue will be aborted. By the rules of the contract this will settle the bonds' value, which makes it pointless to issue them.

This idea is much less fancy and inspiring than PureMining and Anti-Pirate.

Maybe so, but still badly needed. I've had a few ideas how to achieve this functionality which might be a bit more "fancy", but also more needlessly complicated.

[brendio]

Hi Meni,

I like your constant innovation. Just a point of clarification: How would you handle something like the Mt Gox hack where bitcoins are traded down to less than a dollar, but the trades are subsequently reversed. I would presume that wouldn't count as a trigger for your offer, but it might be good to clarify it.

[Meni Rosenfeld]

Bonds are now being offered, ABSORB.1.4-6.LONG for 0.678 BTC and ABSORB.1.4-6.SHORT for 0.351 BTC. Prices are subject to change.

Hi Meni,

I like your constant innovation. Just a point of clarification: How would you handle something like the Mt Gox hack where bitcoins are traded down to less than a dollar, but the trades are subsequently reversed. I would presume that wouldn't count as a trigger for your offer, but it might be good to clarify it.

Good question. A trade will only trigger the bonds if it is reasonably assured that it will not be reversed, for example if a day passes and there is no report of suspicious activity.

[Bitcoin Oz]

This post reminds me why I love the free market and bitcoin

[S3052]

when will trading start?

[Sukrim]

It already did, you can buy them now.

I'm not that interested in the value finding for the bond itself (according to your example it should be just (1 + your cut percentage) * ( (trade price - lower limit) / (upper limit - lower limit) ) and the other way round for the other half of the deal, what I find interesting is that you decided to do this a bit assymmetrical by issuing 400 long and 200 short bonds. Does this implicate that you believe in short twice as much as long or the other way around, from a mathematical perspective?

if long is correct, you'll need approx. 1 share income pf short to cover for the profit, however only ~ half of long shares have an equivalent short share, so you'd need to pay out of your own cut or pocket for the rest, correct?

[Meni Rosenfeld]

when will trading start?

I've put them on sale a few hours ago. Apparently GLBSE clips the ticker symbol in a strange way, until this is sorted out they can be distinguished by their description, the long says "leveraged purchase" and the short says "short selling".

I'm not that interested in the value finding for the bond itself (according to your example it should be just (1 + your cut percentage) * ( (trade price - lower limit) / (upper limit - lower limit) ) and the other way round for the other half of the deal, what I find interesting is that you decided to do this a bit assymmetrical by issuing 400 long and 200 short bonds. Does this implicate that you believe in short twice as much as long or the other way around, from a mathematical perspective?

I "believe more" in the short bond when taken as part of my entire portfolio. I need more bitcoins than what I want my BTC position to be; so if I buy bitcoins above and beyond my desired position, I need to simultaneously short them. I used to use Bitcoinica for this, now I hope to do this with issuing excess long bonds. I've also priced them cheaper than the short bonds in relation to the respective baseline value. If there's demand for both bonds I'll issue more of both, the difference will correspond to my target position delta.

if long is correct, you'll need approx. 1 share income pf short to cover for the profit, however only ~ half of long shares have an equivalent short share, so you'd need to pay out of your own cut or pocket for the rest, correct?

Right. For me this acts as insurance against a drop in BTC exchange rate. If long is correct I'll need to pay extra, but it doesn't bother me as much since in this scenario my BTC holdings become more valuable.

[Meni Rosenfeld]

SHORT has sold out, but LONG hasn't had a lot of demand. Since I do want to sell them to balance my position, I've reduced their price to 0.62 BTC.

[bitdragon]

SHORT has sold out, but LONG hasn't had a lot of demand. Since I do want to sell them to balance my position, I've reduced their price to 0.62 BTC.

Just bought some !

[Sukrim]

I created a bet on betsofbitco.in that is essentially the same as this asset ("Bitcoin will hit 4 USD before hitting 6 USD"), maybe it will be helpful to use as prediction market or to get in late/with fewer coins invested/no trade fees: http://betsofbitco.in/item?id=423

By the way, from time to time there's really money lying on the street more or less - I still have to loose on a bet and returns are about pirate's rates.

[Meni Rosenfeld]

I've done some more calculations regarding the effective leverage of investing in ABSORB bonds (added to OP), and realized that it's too sensitive to the current price, and not very intuitive. Because of this, I don't believe I will issue new ABSORB series.

Instead, I intend to offer POLY, a margin instrument which is riskier for me, but should be easier to use.

[Sukrim]

Looks like both the bet on betsofbitco.in and ABSORB will very soon pay out on the long side - 5.95 USD per BTC reached...
http://bitcoincharts.com/markets/mtgoxUSD.html