Using a Blockchain Performance Bond to Execute Collaborative Arbitrage
The idea of Collaborative Arbitrage is quite simple. Two traders collaborate to profit from differences in the price of an asset in different markets.
There are two possible collaborative models. In the first model, Bob sells the asset in one market. Alice buys back the asset at a cheaper price in another market and sends it Bob.
In the second model, Bob sends the asset to Alice. Alice sells the asset in another market whilst Bob buys back the asset at a cheaper price.
Counterparty risk is the primary problem with collaborative arbitrage. Will Alice remit the proceeds of the sale to Bob? Will Bob pay Alice the agreed share of the trading profit?
A blockchain Performance Bond provides a cost effective tool for eliminating counterparty risk inherent in collaborative arbitrage. The diagrams below show how a Performance Bond eliminates counterparty risk in models A & B.
Counterparties need to agree terms including the value of the bond, the quantity of asset been transacted as well as how trading profit is to be shared.
The rest of this article provides an overview of the Token Changer Performance Bond DApp.
Performance Bond
The Token Changer Performance Bond is a smart contract that runs on the Ethereum blockchain. There are three parties to the contract. The Bond Writer, the Bond Beneficiary and the Arbitrator.
The bond writer is the counterparty that receives value in a transaction. The writer creates a Performance Bond by sending ether (ETH) to the smart contract. The bond beneficiary activates the bond by sending a percentage of the bond value (ether) to the smart contract.
Both the bond writer and beneficiary need to approve the arbitrator before the arbitrator can intervene in a dispute. If there is no dispute at the expiration of the bond, the smart contract refunds (less fees) the ether deposited by the writer and beneficiary.
The bond writer or beneficiary can file a dispute at any time before the expiration of the bond. Once a dispute is filed, only the arbitrator can decide the amounts to refund to the writer and beneficiary.
After the expiration of a performance bond, the beneficiary cannot file a dispute again. This is why the smart contract provides the option for the beneficiary to extend the expiration time of the bond.
To stop the beneficiary extending the bond indefintely, the writer can stop the extension of the bond. In this scenario, the beneficiary has to file a dispute before the expiration time.
Arbitrators are qualified and registered on the smart contract by Token Changer. The bond writer or beneficiary can appoint any registered arbitrator. However, both the writer and beneficiary have to approve the appointed arbitrator for the appointment to take effect.
