Augur (and other prediction markets) markets are effectively bounded futures which means you can open a leveraged short or long position. However, as futures they also have time expiry.
While I would love to be able to put my money where my mouth is for all of these terrible tokens/alt-coins, my predictions are all long term, not short term. While I believe people will eventually realize that coin/token ABC is worthless, I also recognize that current crypto markets are completely irrational and even if I had the option to do so, I would not want to open a short position that could be called within a short period of time.
What I want is the ability to say, “In 5 years, this token is more likely to be 0 than it is to be double what it is today” or something similar. If it goes above 2x between now and then, I don’t want my position to be closed on me (like with American options) and I don’t want to have to worry about unbounded losses to keep the position open.
One solution to this would be multi-year European style LEAP options. However, what I would really like to see is some sort of inverse financial derivative where as the value of the asset approaches infinity, my losses for holding a short position approach 0 but never reach 0. Meanwhile, as the asset approaches 0, my gains approach infinity (though I would be content with them approaching some large number). I haven’t spent enough time thinking about how such an asset would work, but it feels like it should be possible to inverse. With such an asset I can then hold it long-term, without a specific date in mind, merely knowing that it will eventually get wiped out.
Yeah an issue with shorting would be the potential for unbounded losses and the smart contract requiring an external oracle. An options smart contract might be better way to short a token.
I don’t think it’s possible for any financial derivative to offer extremely large returns when the underlying asset has a value approaching to zero without it being extremely levered. Having any derivative offering that sort of return would make it very volatile and prone to significant counterparty risk. Someone would have to eventually provide that extremely large payout, which wouldn’t make sense from their point of view, as their upside is limited while their potential downside is close to infinity.
I’ve argued before that crypto markets would be more efficient (and prices accurately lower) if there were shorting mechanisms with symmetric rather than asymmetric risks. Specifically, I’m a fan of binary options. See eg this Twitter thread: “I wish BTC had ‘over/under’ binary betting like this (cf US football). I predict prices would be much lower, more stable - & more accurate.”
I don’t understand a lot about this, but to me it seems very much that the single biggest reason why not much more shorting is available is simply because of liquidity.
Especially for shorting you need a reliable source of liquidity over a longer period of time.
The problem with all the tokens of ICOs is as you can see with most again: liquidity.
People tend to hold on to tokens for the lack of liquidity.
So if we agree that shorting requires more liquidity than normal trading, but many tokens are even too illiquid to trade, it is quite understandable why there is not shorting opportunities.
Think of Bitcoin’s liquidity, at a market cap of 200$ billion we got now roughly 10$ bil / day trading volume.
That is around 5%.
If we now take your example of color.com
if they managed to raise 41$ mil lets put there evaluation at 150$ mil
5% of that is 7.5 mil
So if we assumed their shares to be liquid (which were actually not) and the same ratio of market cap to volume who would take on shorts in such an assets? There is simply not enough money to be made for the intermediaries to put up such a shorting opportunity. I don’t know what the overhead cost for that might be, but I am sure it is considerable.
All in all decentralized system could lower the technical overhead costs by a factor of 10 or more, however the regulatory burden on such trades might still be too high
See also the follow-up thread at https://twitter.com/JaEsf/status/946114726026555393: “Another way to keep long & short risks symmetric is ‘log-space’ bets: bet $10 → make $10 when BTC doubles, lose $10 when it halves.”
It’s not going to work because market caps in crypto are universally fake.
If I own ~100% of a shit token the market price doesn’t really exist - market cap could be in the trillions, all it takes is some wash trading.
Some fool is likely to tag along and buy some for a ridiculous price.
If a token is lost it shouldn’t be counted in the market cap - yet it is. If you knew that only 1BTC is movable - all other coins provably lost - would you short BTC at $1 billion?
It’s even worse because the true supply is impossible to know and can only be estimated.
I would argue that shorting is not a cause but a result of liquidity - liquid markets make shorting possible which is why efficient markets are easier to short.
Shorting illiquid/manipulated tokens would only make price manipulation more profitable by forcing liquidations via a short squezze.
What could help in general is making markets more liquid, but that’s only possible to solve if illiquidity is caused by regulatory and technical barriers.
as having observed in 1977 that efficiency requires short sales, and either Shiller or Miller observes that houses can’t be shorted.
That’s not true, a nonrecourse debt that uses house as collateral is a form of shorting.
IMO availability of shorting will not reduce crypto price volatility towards fiat neither will cause better price discovery for hyped coins.
Seemingly smaller price volatility of major stocks compared to major cryptos is due more to regulatory “acceptable” price guidance or analysis, to stock exchanges price curbs, to company or interested parties buy/sell transactions, to the availability of funds - ETFs, pension, hedge, etc. Stock derivatives are somewhat neutral to the underlying stock price performance longer term.
I understand that there is an acute issue with many hyped up prices of dubious tokens (or even with some long established ones) that brand as cash, blockchain, crypto or similar - as their inevitable flop could cause alienation of investors to other credible projects. That is worrying on one side as fiat means exchange for digital tokens at exuberant price levels that reflect purely rosy expectations.
There are in my mind three solutions:
leave current state of affairs as it is - so that many new projects are born and financed but leave enthusiasts get burned in dubious or ponzi tokens
enhance price discovery and price drivers and enhance learning for the public
invite regulation either self or governmental
Personally I do not think digital assets living on a decentralized and possibly secure and scalable platform should seek solutions or improvements looking back at examples of the existing financial or capital markets environment. So - regulations, options, shorting, futures, yields, IRRs, VARs, etc. - are very important to understand but they should be irrelevant in the long term as long as cost effective salability of distributed digital assets (including digital means of exchange) can be achieved.
There is also a perception issue - some of my younger finance colleagues are saying “why are all media and people saying that bitcoin appreciates against USD - as in reality the USD decreased in value against one bitcoin?”
This caught me thinking - many people believe blockchain “currencies” or new tokens are somewhat predefined in number or purpose against an ever floating unknown number of fiat “legal” currencies …
I wonder if that marketed hard coded maximum number or algorithmic purpose of the crypto (which in reality is not a given eternal state) is not creating a wishful depreciation of the fiat given the existing lax money supply and zirp policy in fiat?
Writing covered calls still result in a positive delta, since you have to buy the token first and you only sell the upside.
I think a put option is also possible in a contract and that will result in a negative delta for the buyer.
The writer of a put option with strike price S, will lock S ether in the contract. The buyer has the right to swap the ether for a token. If the ether is not swapped at expiration, the writer can withdraw its ether.
This works great for betting on a price fall, since in that case the buyer can buy the coin cheap and sell it for the strike price of the option.
Yeah, prediction markets was my instant reaction upon reading the original post. With those you can not only bet on price at a given time (pegged against fiat, crypto, stablecoins, or % of market cap), but you can also bet on technicals (“network will process X transactions at time Y”, “token will have implemented feature X by time Y”, “core team will consist of X people at time Y” (all these will require detailed rundowns to specify what’s what ofc)).
It will be perfectly possible to open a market with “in 5 years, token will be closer to 0$ than to 2X$” and then you can buy shares in a high-percentage position." - and then you can settle your position before the time limit by selling your shares if you want to.
There’s still no direct way of shorting the real market price, so bad investors might simply ignore the prediction markets buy at irrational prices and there will be no way to arbitrage without other shorting tools (I think?), but this will give an on-chain price discovery tool that can be used for shorting, and if it becomes popular and notable it will very likely affect the market price.
The fact that short selling makes markets more efficient is pretty well substantiated in academic literature, and there are many reasons:
Short-selling activities are considerably informative about future stock returns when there is a higher likelihood of private information in stocks. Short-sellers also bring considerable additional information to the market, especially for smaller stocks, that is not fully captured by contemporaneous insider trading. Overall, it seems that on average short sellers bring informational efficiency to the market rather than destabilize them (Purnanandam and Seyhun).
Then in a similar fashion, shorting demand is an important predictor of future stock returns especially in environments with less public information flow, this suggests that the shorting market is an important mechanism for private information revelation (Malloy, Diether and Cohen).
Another study focusing on price efficiency shows that lending supply has a significant impact on efficiency: stocks with higher short-sale constraints, measured by low lending supply, have lower price efficiency, and that relaxing short-sales constraints is not associated with an increase in either price instability or occurrence of extreme negative returns (Saffi and Sigurdsson).
and finally a very interesting paper (Asquith, Pathak and Ritter) found that short-selling constrained stocks significantly underperformed during 1988-2002.
I think a possible semi-conservative approach is the creation of something similar to the 130/30 funds where the 130% (long) exposure is to ETH and and the 30% to short positions on any ETH based token, this will have access to big investors and then some of those funds can be “tokenized” similarly to ETFs, so those tokens will track the value of the 130/30 fund and will be tradeable in token exchanges where smaller investors can have access to them. The former (130/30 fund) can be a simple smart contract that will hold both ETH and other tokens, the latter could be a standard ERC20/ERC223 token.
I also recommend to read the 1977 paper by Edward M. Miller called Risk, Uncertainty, and Divergence of Opinion that I consider to be kind of seminal on this subject, exploring some of the implications of markets with restricted short-selling.
Hey guys, I run the Decentralized Derivatives Association (DDA) but I’ll layout the current landscaped. My company is seeking to do fully decentralized derivative contracts on Ethereum (https://github.com/DecentralizedDerivatives/DRCT_standard ), which to simplify, parties place money in a smart contract and then the contract pays out based on the change in an API that the contract references. The next form you is the traditional exchange doing futures contracts. And lastly is the protocol based shorting (like dydx) which allow for you to loan your token as a short.
Any of the above can work to keep prices in line, but to be honest I don’t think any will work. Crypto as a whole has very little utility at the moment and the subjective/ speculative valuations of every coin (ETH included) are efficient given the current bull rush incoming investors. It has nothing to do with efficiency of the market, but rather just irrational exuberance of the incoming crowds seeing riches in every sub-dollar token. I think if we take anything from the economists it’s that the boom-bust cycle is necessary to shake out the losers and keep the good tokens honest.
Shorting constraints exist because in theory there is infinite downside and bounded upside. On top of general loss aversion, fewer people tend to express contrarian sentiments towards the market.
One way to normalize the notion of taking a contrarian position is to design “friendlier” instruments much like Inverse ETFs. For example, InverseETH - a Basecoin-style peg that follows the equal and opposite movements to ETH could largely simplify the experience of taking such a contrarian bet.
An inverse would (in theory) avoid the use of collateral and the potential indebtedness from shorting. Though, in practice, building such an Inverse Instrument using a Basecoin-like system may require frequent rebalancing and/or lead to price mismatches due to the working of the Basecoin system itself. Any thoughts on how to build a simple Inverse ETH instrument?
Inverse ETFs are usually constructed from other short-selling instruments, so the core issue would remain there: there are not enough short-selling mechanisms.
Regarding the avoidance of collateral, that’ll apply to the reverse fund buyers, but it will remain an issue for those instrument in the fund. In order to be able to bet on the losses of a crypto without using collateral you’d need to find a mechanism that doesn’t require lending/credit, and by definition short positions require borrowing.
True existing Inverse ETFs are simply packaged up shorts. Though the implementation I was suggesting wouldn’t be built from shorts but rather from an on-chain monetary policy implementation like Basecoin has. Basecoin’s system uses multiple tokens (coins, bonds, and shares) to establish a peg. Since they don’t rely on a physical reserve (like Tether), in theory they could peg their coin to any arbitrary value (USD, Gold, or Inverse ETH).
In Basecoin’s system, when the price falls below the peg Bascoins can be exchanged for bonds (reducing supply/ increasing price). These bonds can then be reclaimed w/ interest when the price rises above the peg (increasing supply/ decreasing price). So lending/borrowing would be critical to this system. The difference is that the ordinary unsophisticated retail investor wouldn’t have to be bondholders (i.e. deal with collateral/lending/borrowing) to take advantage of the inverse price.
Well, this is interesting. In theory, there could be a bond-token, that’d be some kind of IOU for bonds, so instead of lending tokens, the investors borrows this IOU, this way losses are capped at the stability price (S). Wins and losses will be limited, and I’m not sure if it’d work at all, but it may be.
I didn’t read all of your post, but I very much agree that one should be able to short any liquid, fungible commodity, not just during token sales. As an example, I’d short the petro token. I tweeted about this recently.
Yep, options would be simplest. CFDs are similar to options and should be fairly simple to implement. With options you just have a buyer or a seller, while with CFDs and futures you need both, so you’d need an exchange or marketplace like localethereum.com. Although with options you still need a way to actually execute the option which could be done on an exchange, but there is just no counterparty to the trade.
As others have pointed out there are other derivatives that are more complicated that have been implemented in non-crypto world as well as prediction markets, and others that AFAIK haven’t been implemented like inverse instruments.
When you have a counterparty they have to take on the potential risks and rewards, which retail investors and institutional investors may not want to do given the volatility of cryptocurrencies.
There are others who may buy up a lot of a security then sell it, e.g. as done with George Soros and the pound. This then has a flow on effect of others reacting to the price change. But to have this effect you need a lot of capital. However, AIUI cryptocurrencies are more sensitive to this effect as there is liquidity can dry up if you sell too much, which happened with the GDAX flash crash. Then orders are triggered which causes much more capital to be sold. Omega One is looking to provide a solution for this.