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Bitcoin is subject to high volatility with little means of hedging. The available ways of hedging being to be short or buy puts on VERY ILLIQUID exchanges that contain no market participants, no market makers, or any order book depth.

could a hedged bitcoin fund with redeemable shares act as a stabilized security?

This, of course, creates a quasi-central banker role, where proper management can lead to stability, but proper management may not always be. But it is more inline with commodity hedging, where a producer (of crops for instance), hedges his output with futures. Such a quasi-hybrid role being fit for a quasi-commodity currency.

As such, an Exchange Traded Fund (ETF) or Exchange Traded Notes (ETN) can be created on existing exchanges. Securitization is practically the wild west even amongst the myriad of regulators, making the leverage and hedging possibilities endless.

Anyway, thoughts on why this would or would not work for bitcoin as the underlying asset?

proper tags: securitization, securities, etf, etn, hedging

  • CQM, could you edit your question to include a clearer question, especially in the title? – Nick ODell Mar 6 '13 at 6:03
  • so I wonder, did my question here predict the future or inspire the future – CQM Nov 1 '13 at 19:03
  • @Gracchus it does doesn't have to be. With derivates, the "tail can wag the dog", this is a phenomena we see in many other markets where the derivatives effect the price of the underlying asset (instead of the other way around), such as on options expiration days – CQM Feb 17 '14 at 21:50
  • @Gracchus like... in the current equities and commodities markets? I think bitcoin can attract that level of liquidity – CQM Feb 18 '14 at 13:37
  • @Gracchus I respectfully disagree, in the year since I've posted this there have been a lot of developments. I am confident that the answer to this question is "yes". There are liquid ways to short bitcoin, there are also CFDs and there are bitcoin futures and there is a bitcoin investment trust. None are very liquid, but correlated is the fact that bitcoin volatility has decreased. – CQM Feb 18 '14 at 15:22
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Yes, this is possible but like cracking a good hash, signature, or key it is improbable.

Assuming that the supply of a coin remains perfectly stable and is expected to do so, some massively overwhelming amount of derivatives could do this, but there would have to be no transaction costs to achieve this level of stability because any cost to trade will be passed onto to the holder as volatility since any cost would reduce the demand for those volatility-reducing derivatives.

A single entity would not be able to do this; furthermore, a large percentage of total world wealth would have to be dedicated to this purpose, all hedging and speculating in random harmony.

Those are the conditions for perfect price stability through relying on derivatives.

Determining liquidity levels is better when cryptocurrencies are compared to their fiat counterparts. Bitcoin is 3x the spread for fiats, last I checked, so there is still plenty of transaction costs. This is not to say that fiats and securities don't have transaction costs. For one thing, locked markets are forbidden, so there will always be transaction costs in the amount of the bid-ask spread for the duration of that restriction. This shows that for the level of price stability achieved by other fixed supply commodities, cryptos would have to be at approximately equal to such commodities respective ratios of notional to underlying.

Most cryptos have a wall on this potential in the form of confirmation times. A dynamic trader cannot exist in a market with one hour delays on trade confirmations even at the periphery since they need to trade between exchanges and other assets. The low confirmation cryptos have the best chance for stabilization by derivative.

However, this isn't to suggest that approaching the ideal isn't possible. The more derivatives that are tied to an underlying coin will result in more price stability for that coin.

  • please elaborate on why this reality is contingent on no transaction costs? Opening a futures or options contract over a commodity or equity costs way more than a bitcoin transaction cost, especially from a retail broker – CQM Feb 18 '14 at 21:09

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