Because the underlying asset of "bitAsset" derivatives is BTS, the volatility is going to cause unnecessary losses for "bitAsset" derivatives holders. What happens during sharp declines of BTS?
The assets stop existing, and the asset holders are given the correct value of BTS, enforced by margin calls.
You might read the statement "the assets stop existing" and think that a terrible failure has occurred, but this is incorrect. This actually prevents the system from going out of control, and stops the holder of the asset from having their asset go to zero.
Instead of the system collapsing when the value of BTS drops too much, and the BTS that people have in collateral cannot support the amount of bitAssets that they are on the hook for, the blockchain issues a margin call. The blockchain takes $1 worth of BTS away from the person who created and sold the bitAsset, and gives it to the person who owns the bitAsset. Essentially, the blockchain unwinds the derivative automatically if the person who created it starts to get in any danger of not being able to cover the value.
How this works is that when the blockchain issues a margin call, it puts out an order to 'buy to cover' the bitAsset of the person who shorted (created) it. Anyone who owns that asset can then sell into that order, receiving the correct value of BTS in return, and then the bitAsset ceases to exist, and the obligation to provide collateral for it also ceases to exist.
Essentially, the system uses a combination of free market forces, plus blockchain issued margin calls, to enforce the peg.
Yes, this is all extremely complicated, and confusing to anyone not extremely familiar with things like shorting, derivatives, etc.
Because of this system, a large decline in BTS over time simply results in trades being unwound. You can see this has occurred to some extent, because the supply of bitUSD is now only $472,000. In the past it has been over 1 million. The people who had bitUSD sold and got $1 worth of BTS (at the time). The people who had 'sold short' the bitUSD, either were forced to buy back due to margin call, or they voluntarily bought back before reaching that point.
BTS has dropped over 80% from its high, and the system remains intact.
Now, if BTS dropped 80% in an instant, things could break. This is a black swan of a level that Bytemaster discussed in a blog post as a danger. However, there are a couple safeguards. First of all, price feeds don't update instantly, so if it was a flash crash but then recovered quickly afterwards, the price feeds wouldn't all update the incorrect horribly low price, and things wouldn't break. There are a couple other safeguards as well.
The system has held up for 8 months, during a bear market in which the overall value of BTS dropped 80%, and the price had several bad crashes. I think that's a pretty good indication that it is resilient. Note that a huge decline of this size in a short period of time is a black swan that breaks other systems as well. The fiat banking system would definitely break under those conditions, as we were seeing in 2008 before the bailouts. Bitshares is actually much higher collateral than the world's normal banking systems, which makes it have a much greater margin of error (which it needs at this time because of the great volatility inherent in cryptocurrencies).
I hope that made some sense. It took me a lot to get my head around at first. There is a reason everyone thinks Bitshares is way too confusing. But cryptography and the concept of the blockchain are very confusing as well if you want to understand the technical details. The experts have grokked these concepts, and the rest of us trust them when they say it works. Bitshares just needs to get to that point as well.
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