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.
Why exactly does it cost so much? If you’d like to short 1 ETH of EOS for example, you’d have to borrow 1 ETH of EOS and as long as you pay that back you’re fine. If the price doubles you may not have the money to pay it back, so let’s say we need 2 ETH as collateral instead. Then you’re at least covered till the price doubles. I don’t quite get where the 30x comes from?
The amount of capital required is basically a function of the time horizon you think the average short-seller in your proposed market would have. The goal here is to avoid people getting stopped out to often as this would likely diminish the appeal of the platform.
Initial smart contract proposal
Short-sellers in the crypto market would I think quite often be relative value players.
For example: I might be long 10 ETH and be looking to sell some cryptoasset XYZ short. I want to keep my ETH and I don’t mind ‘bonding’ them for the duration of the trade.
I would then enter a fixed-maturity smart-contract with a counterparty looking to go short ETH.
Assuming that when both of us send our deposits ETHXYZ trades around 1, I send 10 ETH to the contract and the counterparty sends 10 XYZ.
Once the smart contract receives both of our coins, it will check (with an Oracle feed) what min { 10, 10 * ETHXYZ } is and offer some margin choices to the two counterparties with a fixed cap of say 0.5x.
The cap would vary depending on the currency pair.
During the life of the trade, the smart contract would check daily at a given time at what level ETHXYZ trades (with the Oracle feed) and terminate the trade if my deposit’s current XYZ value or his deposit’s ETH value get too low.
Note that when I go and sell the XYZ I received from the smart contract on an exchange, I don’t need to sell them against ETH, I can do whatever I want with them during the life of the trade (or until my counterparty’s position or mine get liquidated).
At the end, there is a 4-hour time window when I can send my remaining XYZ back and my c/p can send its ETH back. For example if ETHXYZ went up, I will be left with less than the 10 ETH I initially sent. If I don’t send any XYZ to the contract during the time window, the contract will go ahead and convert some of my ETH into XYZ on a decentralized exchange before sending me the remaining ETH from my deposit.
Potential improvements to the above smart contract
In order to manage supply-demand dynamics and maximize volumes, we would need to introduce interest rates associated with each cryptoasset so that if ETH is in low shorting demand, depositing it would attract a negative interest rate while if a lot of market participants are looking to sell XYZ the long-term holders of XYZ willing to deposit it would then receive a positive interest rate.
The smart contract could issue margin calls: for example if my deposit’s XYZ value gets close to (but still above) the liquidation threshold, the contract would send me a message to notify me and let me know how much I need to top up.