How A Penny Can Affect Billions
One of the most interesting aspects of blockchain technology to me is the fact that anyone can serve as a facilitator of economic activity. Today, we rely, as we probably should in most cases, on large financial institutions to facilitate most of our economic throughput. But there are limitations to how they serve us versus the breath of options open among themselves.
For example, someone might want to open a 10x leveraged long position on the SPDR® Portfolio Corporate Bond ETF (SPBO). Today, good luck finding a trading platform that lets you invest in bonds using meaningful leverage. You can find plenty of platforms for trading currencies with 10x, 20x, even 50x leverage. With cryptocurrencies you can easily get leverage of up to 100x from the likes of BitMex, et al.
The reason everyday consumers can’t get leverage on corporate bonds or corporate bond ETFs is because even if the asset price drops, the coupons/dividends will easily cover you typically. With 10x leverage, instead of earning about 15% last year on a non-levered position in the SPBO, you would have easily earned 150%, with very, very little risk. And so, the riskier and more volatile the underlying asset, the more leverage you can probably get as a retail investors. This is simply because usually the direct or indirect benefactor to your leveraged position going south is the broker or dealer who you buy securities from. This is also why most online brokers have begun waving their trading fees and the average fee for US and European retail investors is now essentially 0% (Charles Schwab, E-Trade, you name it). If you ever wondered how they make money anymore.
Large financial institutions, of course, can get large amounts of leverage and that is covered (along with postulations of potential future consequences to the rest of society) very well in the recent book The Rise Of Carry. It is very easy for financial institutions to offer to the public corporate bond ETFs when they or their counterparts can collateralize retail investor capital to open large, leveraged positions and earn 10x or more. It’s a great business.
Michael Burry comes to mind here. He was popularized in the movie The Big Short as one of the many people who opened massive leveraged short positions on the consumer housing debt market (specifically MBS products). In the movie, they show the extreme lengths he had to go to, along with others who saw an impending MBS apocalypse), in order to open up levered-up short positions with the likes of Goldman, Citi, etc.
However, what if Michael Burry and others could have just opened short positions against the US housing debt securities from their E-Trade accounts? In this fantasy world, they could have either created facilities for the short positions of others or acted as counterparties in existing facilities offering leveraged short positions (made by people who were very confident of US mortgage bond price security). Today, I would gladly be that counterpart, at least for the next year.
Soon, this will be very much a thing that everyday people can participate in thanks to smart contracts on Ethereum currently under development. I, for one, cannot wait until someone (who believes that the US corporate bond market will collapse) opens a 10x Long SPBO facility. I will gladly risk capital to earn 150% in a year with the hopes that the largest US bonds will not drop by 10% after coupons. Additionally, these facilities can offer counterparties zero risks and deterministic expectations due to rule-based escrow and custody of variable and stably priced collateralized assets, granted there aren’t any bugs in the smart contracts.
One of the most important aspects of these user-generated facilities will be the point-of-truth around pricing. The immense value of pricing provision, I think, is a bit lost to some. Though, I think it this will change and I will get to that in a moment.
Let’s look at BitMex: There are two important prices for any given swap, such as XBTUSD (Bitcoin). There’s the Fair Price, Mark Price, Index Price and Last Price. The last (or market) price is simply where things are trading at… This does not affect leveraged positions that might be 100% and could liquidate at a 1% price movement in the wrong direction. This is because, as people get liquidated, it causes a cascading effect that can be temporary but brings the whole market down. The Fair Price is meant to be the real price (for margin position-holders) and is gained from activity happening on other exchanges not affected by massive Bitmex liquidations as well as specialized BitMex activity algorithms, as so to prevent price manipulation to cause massive liquidations and the price from going to, well zero or $100,000, often.
For the new leveraged position markets on top of Ethereum getting the “fair” price will be very important to some. However, a big question is: who should provide that information? That of course will be up to the facility creator (the guy who let me go 10x long position on US Corporate bond returns). However, if he’s the one who determines the settlement/fair price, then I probably wouldn’t do business with him. However, if there are a group of reputable third parties that he selects that create an average price while removing outliers, I would probably be more inclined. Others might be more open to the aggregation of thousands of anonymous price providers’ data. While regulated entities might need to rely on one specific party for settlement and fair price data, as many of them are required to do by law today. The truth of pricing is essentially relative.
Our open -source project OrFeed seeks to allow facility creators to tap into a marketplace of pricing providers, both decentralized from the likes of Uniswap or Kyber, hybrids such as Chainlink or Synthetix, trusted organizations and/or groups of anonymous people. This is essential for a future of user-generated margin position facilities. Some people might want the last price as settlement, while others might want the mark price, as well. It really depends on the counterparties, the volatility of the underlying asset, the liquidity of specific assets or markets (not to mention where the pricing data is coming from of the underlying of the underlying of the underlying of these), and so much more.
When an asset is trading for a dollar and a penny represents 1% inside of a facility with 50x leverage, the smallest decision as to the data provider or type of pricing can affect millions to billions of dollars… and people.
