Inert versus volatile currencies - pondering an attack on BitUSD

When thinking about a currency on a simple exchange as a fairly inert object. You can throw money at the market, swing it up or down, but without other actors taking an action by themselves, the market will remain the way you left it. You might cause a panic, or your order might be eaten up by traders with strong confidence in the current price.

Now, consider a derivatives market like BitUSD. While you may have the same market as in a simple exchange, there will also be a lot of collateral in that market waiting to be called upon if one would need to make a margin call. Depending on how the market is structured and how much money is potentially available for margin calls, someone wishing to exploit the market could have a powerful force multiplier waiting to be unleashed. You could call such currencies "volatile" - not in a sense of finances where the price fluctuates a lot, but more of a chemical sense - that there is a latent force in those currencies that could be unleashed for one's benefit.

BitUSD - quick recap

BitUSD is a "market pegged asset" on the BitShares Crypto 2.0 platform. It is created as a derivative of the native bitshares currency. As such, it is a "counterparty-less fiat-denominated crypto". Its value is kept at around 1 USD by an open, decentralized market. BitUSDs are created as a derivative with a collateral of three times the current BitUSD value in bitshares.

The snowball effect

Under normal conditions, the futures market should be stable. You might see some spikes every now and then and perhaps some margin calls being made on an infrequent basis, but the market should track the proper values.

However, it is also possible that a market might have a tipping point - a price at which a snowball effect might take place. Lets say the current market is like this:

• The current price is 100 BTS per BitUSD
• It takes:
• 10k BTS to move the price from 100 to 200 BTS per BitUSD
• 10k BTS to move the price from 200 to 300 BTS per BitUSD
• 10k BTS to move the price from 300 to 400 BTS per BitUSD
• When the price:
• Reaches 200, 5k BTS will be used on margin calls
• Reaches 300, 15k BTS will be used on margin calls
• Reaches 400, 25k BTC will be used on margin calls

If we throw 5k BTS into the market, not much happens - we moved the price a bit. If we throw 10k BTS, we force the market to spend another 5k BTS. We moved the price by 100, and the margin calls moved it further, multiplying the strength of our move by 1.5.

If we throw 15k BTS into the market, we first force the 5k BTS to execute margin calls, adding to a total of 20k BTS. This is enough to trigger the next wave of margin calls - another 15k BTS is pushed through the market on margin calls. This in turn is more than enough to trigger a third wave of margin calls adding another 25k BTS into the market.

This way, our initial push of 15k BTS has forced the market to execute additional 45k of orders (60k in total), thus multiplying the strength of our move by a factor of 4.

A similar scenario was described by James Rickards in his book Currency Wars.

In a centralized world, you would expect the exchange facilitating such trades to trigger a trading curb, perhaps even reverse some trades if they suspect malicious intent. However, a decentralized, anonymous marketplace might have a problem trying to unwind what has happened.

How to benefit from such an attack?

There are several ways one can benefit from executing such an attack. Of course, some preparation is needed.

First of all, one could go to a separate exchange or a prediction market and bet on the price of BTS going down. If the market is well established and has enough participants with open positions, it might be easier or harder to earn some money this way.

Secondly, one could position the open trades on the BitShares market itself in such a way as to benefit the most from the margin calls. In our example, we could slowly build up the price of BTS in preparation for the attack, while also amassing a good portion of BitUSD and creating open sales at over 400 BTS per BitUSD. This way when the final wave of margin calls is executed, we will be able to sell our BitUSD for 4 times as many BTS as they were initially exchangeable for. The amount of BTS amassed could be then used to manipulate the delegate market.

Lastly, there is always a room for competitors to employ some malicious tactics against BitShares. At the current market cap of 12M USD, competing 2.0 platforms like for example Ripple might dwarf the market twice over with their Series A financing to strengthen their own position in the market. While I don't believe any of the Crypto 2.0 platforms would even plan to employ such tactics in the near future, there is nothing you can rule out.

Conclusions

While BitUSD is an innovative creation with a big potential, I would still like to see some practical analysis of how robust the market is. Does it have a tipping point, and if so - what is it? Since all transactions are public, the attackers wouldn't have a problem figuring it out.

In the end, this discussion brings to mind a field of mousetraps - they can be "diffused" or triggered safely in low concentrations, but if you have too many clustered in one place...

Tweet

Subscribe to receive free email updates: