Topic: Bitcoinica model is flawed (Read 2619 times)

Correct.  And like I said earlier, even it it did work optimally, Zhoutong still has to worry about someone changing their position and the order getting filled before he can update it.

Zhoutong said the loss was due to slippage so I would say your speculation is accurate.

realnowhereman I'm quite noob in this matter however I think you forget something
lets say we have 2 positions 1000BTC (long) and -1000BTC(short) open at the same time at price 10$ (I will ignore spread in this example)
price rise at 20$ and the short position is liquidated. Now the system lost the balance. so what does the liquidation mean? I guess that the player with the short position will have the balance at 0 or almost 0. But that's not all. The system should have 1000BTC in it's wallet to cover long position. And it will buy the second it liquidates the short position  at 20$ with the money taken from the player with the short position. So when 1BTC will be 1000$ and long position gets liquidates the system will just sell those BTC on the market.

tl;dr:
without opposing positions market will cover the difference not bitcoinica

Even if they did, it would only help avoid losses in the case of getting those orders executed in front of other potential orders.  But if there's no one willing to buy between $3.51 and $4.00, then even a stop-loss order at $4.00 isn't going to avoid a loss.

I think there were just far too many liquidations compared to the buy book, and once that snowball started rolling, all the liquidations just couldn't be sold at the price they should have been sold at.

Just my speculation though - I don't know the truth behind why zhout took a loss.

Doh.  You're right.  MtGox would have to support stop-loss orders for that to work.

Ah, I think I comprehend now. You're right about even balanced positions having to be backed; you can't balance longs and shorts without holding the reserve just in case one or the other pulls out first.

But then, it still works. Mr. Long's position is backed by USD from the reserve being traded for BTC. Mr. Short's position is backed by BTC from the reserve being traded for USD.

There's still no risk. There's still no betting against the users or having to foot the bill for profits (since the "buys" and "sells" underlying the longs and shorts are all, at least theoretically, executed on the market). All Bitcoinica is doing is lending money for people to use to make a profit, and collecting whatever they loaned out when the position is liquidated - whether by choice or by force.

What am I still missing here?

How can you set up a sell order at $4.00 without executing it though?  If the price is $5.00, and the liquidation for a particular long holder is $4.00, you couldn't pre-set a sell order at $4.00 without it being executed.  Unless I am missing something..?

I believe you are correct SgtSpike.  realnowhereman is also correct that he could avoid slippage by putting orders in place.  This has it's own issues though since if the user closes or changes their position, the order would need to be updated.  If the market took the order before it could be adjusted, again Zhoutong has loss.

Let's do a very basic scenario.

Someone is long with a base of $5 and liquidation at $4.

MtGox has open buy orders of $4.50 and $3.50.

The $4.50 buys are filled, and the "price" suddenly drops to $3.50, because there is nothing at $4.00.

The person gone long is liquidated, but zhout has no choice but to liquidate the Bitcoins at $3.50 instead of $4.00, because that is the going market price.

Normally, the spread between bids is very small, so $4 would be liquidated at $3.995 or something, and zhout makes the money off the maintenance fee (if the liquidation is $4.00 to the user, then the "true" liquidation is actually $3.75 or $3.90 or something).  But with large price movements and lots of liquidations in a short period of time, not enough buyers can be found on MtGox to sell all of the liquidations at their liquidation prices, and they slide the price even further beyond the maintenance fee, causing a loss.

Anyone feel free to correct me if I am wrong - this is all just guessing based on the way I would set it up.

Given that you know what the liquidation threshold is well in advance, why is "speed" a factor?  You could have the order sat on Mt.Gox's books from the moment the position is established.  The market then couldn't move to a "slippage" price without passing through your order.

This... the term is slippage.  He couldn't liquidate fast enough.

Anyone else think it's odd Zhoutong's reply is essentially ignored?  Why pay attention to facts when you can guess about how things work?

People seem to think that Bitcoinica are only using their reserves for the imbalance in shorts and longs; my argument is that shorts do not fully balance longs.  Therefore the reserves have to cover every position, not just the imbalance.

My understanding is that is exactly what is happening.  Why would you think otherwise?

Yeah, I'll just "dump $2 million".

Hahaha.  I think you've mistaken me for a millionaire.

So, dump $2 million on the market after creating several Bitcoinica accounts - some long, some short, and watch how it reacts. I'd be interested on the outcome, especially since the price would jump up and I would be rich!

Well, I demonstrated that even in the case of balanced longs and shorts, there is still danger.  When the losing side is liquidated, the winning side is not covered for any further profit.

If I go long for 100 BTC at $1, then a short for $100 will cover $100 of my profit if prices go up.  What happens when that $100 is used up?  The only possible source to cover more increases in my long profit is to buy enough BTC for my long... i.e. another 100 BTC.


Yes; the numbers will always balance.  The problem is that as the opposing side passes to a negative net position and is liquidated, it is only the numbers that balance.  They start to require the ability to trade negative amounts on Mt.Gox -- which is obviously impossible.  The problem is the further profits after one side is liquidated.


This is the very definition of the problem.  Bitcoinica has to do exactly this for every long and every short.  The imbalance is not the only thing that needs backing, every position needs backing as the shorts only cover the longs to their margin; and the profit for the long can exceed that margin.


I don't think their funds are at risk when people liquidate.  The liquidates are easy.  The problem is the profits.

If you finished reading my post you will know that while I started with the no reserve case; I didn't finish with it.

Okay; here's another situation.  Bitcoin is at $1; and I go long for 100 BTC.  There is no one to short against me, so Bitcoinica's reserves are used instead.  Your only option is to take the opposing position; i.e. to take on the short that no one else will.  At 1:1, I'll have 200 BTC of value, with a $100 debt still owed to Bitcoinica's reserves.

Now, price goes to $10,000 as you suggest.  My 200 BTC is worth $2,000,000; and I owe $100.  Bitcoinica's short can at most have supplied me $100 of that $2,000,000 balance.

While you might reasonably say, "well Bitcoinica has reserves to cover that", it does not matter -- you have lost on that trade.  If you can lose on trades then you are a speculator not a broker.  Eventually the market will move against you and you won't be able to cover your bets.

Now... my actual point was that opposing longs and shorts only balance while the losing side has a positive net balance.  When one side is liquidated, then there is no source for the other side's profit.  Either you find someone else to take over that (now manifestly losing) opposing position or Bitcoinica starts supplying the profit.


Nonsense.  You might be able to cover at the current price, but if the market moves, you will eventually run out of money to supply the unlimited profit potential profit of your customers.  It's certainly not supplied by the losses of another customer as those losses are limited to their deposit; whereas profits are unlimited.

Your only option would be to actually buy every customers position.  So if I go long at 100 BTC 1:1; you have to buy another 100 BTC.  But then if someone goes short for $100 you have to find another $100 to match them (it is not sufficient to sell BTC to cover it; since you would then not have enough BTC to cover the long).


That's lovely for you.  But I don't believe it.  Going long at say 1:10 with 1000 BTC when bitcoins go from $1 to $1000 would require you to find $1,000,000 for me to cash out.  The opposing shorter of $1000 (at $1 per BTC) can at most supply $1000.  What if 100 people do the same thing?  1000?  Bitcoinica cannot possibly have reserves to cover the profit on those positions given that, contrary to what everyone seems to think, the opposing customers cannot be covering it.

(I think I should add that there are organizations that take the opposite position when the shorts and longs don't balance. Such operations are called "bucket shops" and it's against the law in many jurisdictions.)

I think this is the mistake in your reasoning.

When Mr. Short becomes unmatched by a Mr. Long, Bitcoinica doesn't step into the shoes of Mr. Long. Instead, Bitcoinica uses the BTC in its reserve to physically sell the BTC that Mr. Short has "virtually sold" by taking a short position; the new Mr. Long is someone on Mt. Gox who physically bought those coins.

That's the point of the reserves - when the shorts and longs don't balance internally, it's used to translate them to actual buys and sells on the open market.

So things look like this:
Mr. Long buys 10BTC for $50
Mr. Short buys -10BTC for -$50

At 1BTC=$2.50:
Mr. Long is liquidated for $25.
Bitcoinica sells 10BTC from its reserve on Mt. Gox for $25.

At 1BTC=$1:
Mr. Short sells -10BTC for -$10
Mr. Short gains $50 (the price where he opened the position) - $10 (the price at which he closed the position) = $40.
Bitcoinica buys 10BTC for $10.

The numbers balance.

Mr. Long buys 100 BTC for $10.
There's no Mr. Short! So Bitcoinica backs this by going to Mt. Gox and physically buying 100BTC with $10 from its reserve.
A year later, Mr. Long cashes out his position of 100 BTC for $6 each - for a total of $600 minus the $10 from the original long position.
Bitcoinica sells those physical 100BTC for $600, passing $590 to Mr. Long and putting the remaining $10 back into its reserve.

The numbers balance.

The only problem here is that Bitcoinica doesn't have infinite funds to lend out. Their funds aren't at risk; when all positions liquidate, the reserve is just as big as it was when there were no positions at all. They just don't have the capital to materialize an unlimited number of positions.

Why did you lose money?  Just because the price swings were so violent that you weren't able to liquidate positions at the proper price points?

Assuming using only one account you are correct.

Bitcoinica just locks the front door when things get away from them, there are pluses and minuses to that approach.