tl; dr: Every POLY.10.n bond will have a face value of (X/10)^n BTC, where $X USD is the last trade price of BTC on Mt. Gox, and n is a value specific to the particular bond.

Introduction. This instrument emulates BTC/USD margin trading, acting as an alternative to margin trading platforms and as a substitute while they are inactive. Unlike the margin emulation asset ABSORB, POLY is persistent (in principle the same asset can be used indefinitely) and embodies a much clearer effective leverage, allowing traders to more easily control their position.

Operation. Specific bond offerings will include for example POLY.10.1 and POLY.10.-2. In general, every POLY.10.n will have a face value of (X/10)^n BTC, with $X being the last traded price of BTC on Mt. Gox. Bondholders have the right to sell the bonds back to the issuer at their face value.

Position equivalence. Holding 1 BTC worth of POLY.10.n bonds is locally equivalent to holding (n+1) BTC, in the sense that for small a, an increase of $a in the BTC exchange rate causes an increase of $a*(n+1) in the USD worth of the held bonds. Unlike normal margin trading, holding POLY bonds means profits are immediately reinvested in increasing the position, and losses are immediately liquidated and deduct from the position.

To see this, we first consider some trivial cases. POLY.10.0 bonds always have a face value of 1 BTC, and holding 1 BTC worth of the bonds (1 bond) is equivalent to holding 1 BTC. Investing in such bonds is uninteresting, since one may as well keep the bitcoin.

A POLY.10.-1 bond has a face value of (10/X) BTC, and since each BTC is worth $X, each bond is worth $10 regardless of the BTC price, and thus holding a bond is equivalent to holding no BTC at all. This again is uninteresting because one may as well sell the bitcoin for USD.

A POLY.10.1 bond has a face value of (X/10) BTC. 1 BTC gives you (10/X) such bonds, initially worth $X. If the exchange rate rises to $(X+a), the new face value of the bond is (X+a)/10 BTC, so the value of all (10/X) bonds is 1+a/X BTC, which at $(X+a) per BTC is worth $(X+a)(1+a/X) = $(X+2a+a^2/X) ~ $(X+2a), an increase of $2a, so the position implied by 1 BTC of bonds is indeed 2 BTC (so investing in such bonds is equivalent to taking a long position with 2:1 leverage). With the new price of $(X+a) per BTC, the held bonds are now worth 1+a/X BTC, so the position is now 2+2a/X BTC, meaning that the profits have been reinvested in an even longer position. If the trader wishes to maintain the same position, he will have to sell some excess bonds (or buy new bonds in case of loss).

More generally, a POLY.10.n bond has a face value of (X/10)^n BTC. 1 BTC gives you (10/X)^n such bonds, initially worth $X. If the exchange rate rises to $(X+a), the new face value of the bond is ((X+a)/10)^n BTC, so the value of all (10/X)^n bonds is (1+a/X)^n BTC, which at $(X+a) per BTC is worth $(X+a)(1+a/X)^n = $X(1+a/X)^(n+1) = $X(1+(n+1)a/X+O(a^2)) ~ $(X+(n+1)a), an increase of $(n+1)a.

In particular, holding 1 BTC worth of POLY.10.-2 bonds is equivalent to holding -1 BTC, so starting with USD, buying 1 BTC and using that to buy POLY.10.-2, is equivalent to short selling 1 BTC.

Calling. The issuer has the right to buy back the bonds, at a multiple of the face value which varies according to the specific bond. For POLY.10.1 and POLY.10.-2, the multiple will be 120%.

Termination. If the trade prices from Mt. Gox become terminally unreliable, such as if it ceases operations, the bonds will be bought back for their face value, determined by the agreed upon last meaningful trade price.

Challenges. Assuming, as is likely at this point, that the BTC exchange rate will eventually reach either arbitrarily high or arbitrarily low values, it is easy to see that by buying both a ^1 (long) and a ^(-2) (short) bond, the trader is guaranteed profit, meaning the issuer is guaranteed loss.

This is because of the trader's implicit right to to reinvest all profits in extending his position, regardless of the issuer's ability to hedge the position. Normal margin trading platforms have multiple ways to control this. They can simply refuse to extend the position; they can increase the fee; they can charge interest for taking an unfavorable position, and pay out interest for depositing funds they can use for hedging.

With the way the POLY contract is set up, none of this is possible. The issuer has only two mechanisms to handle this: Calling the bonds when the position becomes intolerable, which is expensive; and using the time value of money to compensate for the future losses. Since there is no way to control interest rates, the effectiveness of this is limited.

Since this is risky for the issuer, the offering price of the bonds will have to include compensation for it. The trader will have to weigh the advantages of an unlimited permission to extend his position (up to the issuer's right to call the bonds at a profit to the trader) against the higher price.

Even so, this is only sustainable with a market maker bot constantly balancing the issuer's position, and with enough trading activity to make sure that increases in the face value of a bond can be matched with traders looking to sell bonds.

Series details. As an initial proof of concept, 200 POLY.10.1 bonds will be offered. POLY.10.-2 should soon follow. The IPO is scheduled for June 14 2012, but bonds will start selling only after the necessary preparations are made.

In the future, higher-leveraged bonds might be offered, and additionally, if the price of BTC changes so that the value of each single bond becomes hard to work with, new series such as POLY.100.n may be offered.

Update: Currently POLY.10.1 and POLY.10.-2 are offered.

POLY.10.1: You can buy at 110%, sell at 106%, target is 400 BTC.
POLY.10.-2: You can buy at 104%, sell at 100%, target is 400 BTC.

Will you provide the market maker bot as well?

What would be a benefit for me as an external trader not associated with you to act as a market maker or would this only make sense for you if you are the market maker yourself?

interesting thought process. Glad to see you are taking this a step further.
Couldn't there as well be a limit price and/or knock out price to limit the risk ?
As I would imagine you have an idea of how far you are willing to stretch this.

Is this the reason for the CFD you recently offered?

intriguing!

Meni, I admire you: you got 2 things in one package that seldom come together: brains and balls. (the brains to think up such a scheme and the balls to actually offer it)

I just don't see yet how you can implement this... will read again and think...

For the less mathematically imaginative, I made a little google spreadsheet "simulation"

You can enter the current exchange rate, amount of BTC to invest and which N to invest in (the yellow fields) and see what happens for price moves.



https://docs.google.com/spreadsheet/ccc?key=0Au-mVSBh0PA4dExJcHM3aUhpT2ItZ3BFazZ1UlVnRlE

^{(you need to make a copy of the spreadsheet to be able to edit using "File -> Make a Copy...")}

Can someone sanity-check it?

I have a consistent methodology for these things: Start small, see if it works, then expand. This way I can try out many different ideas without taking excessive risk.

Based on your description it looks like more of an order placement assistant. What I'd need for now is something that runs every ~1 minute and does the following:

• Cancel existing orders on GLBSE
• Collect data on the number of outstanding bonds, the mtgox last price, and some parameters such as my desired position, my net worth, and price volatility.
• Calculate the marginal value for me of each bond (I still need to work out some details with this).
• Place bids on the bonds at a little below the value, and asks at a little above.
• Alert me when my position becomes too unbalanced despite its efforts, so I can balance it by trading manually on Mt Gox, making CFD deals, or in the worst case, making a forced buyback of bonds.
• Send me a daily summary of its status (number of outstanding bonds, position, account balance...)

For now it seems simple enough that it would be better to develop it on my own. Going forward I'll consider getting something more professional made.

Great, this can be handy.

It seems this option is disabled for outsiders. "Download as" works but is a bit difficult because Google uses a different function name for POW than Excel/OO.

If you could either change the privileges, or add another sheet with -1, it would be good.

Looks good. It's important to clarify that all USD profits given are assuming that the alternative is to keep USD. This is made somewhat confusing by the fact that the field to enter is "BTC to invest".

Yes, GLBSE has a forced buy back feature - The issuer specifies an amount per bond, this is paid to bondholders and all bonds move to the issuer's account. Very useful. I haven't tried it yet but i hope it works.

The bond face value is never negative. Any losses cause the investment to shrink, so this is equivalent to margin trading while always being on the allowed margin - any losses cause immediate forced liquidation in the amount required to cover them. This is unrelated to the calling clause.

Seems doable to me, however, I probably couldn't provide more professional quality than you can produce yourself.

Keep me in the back of your head if you like should you need any (non-professional) help going forward.

The IPO is scheduled for June 14 2012, but bonds will start selling only after the necessary preparations are made.

Due to limitations in the characters allowed in a GLBSE ticker, the bonds are renamed to POLY.10.n.

POLY.10.1 is now offered at 107% of face value. There's a bot that updates prices every 2 minutes.