Did you just learn about Bitfinex today? People have been taking long and short positions on there for some time now.
in theory all the leveraged positions should lower volatility.
What.
Leveraged Positions should raise volatility, because they up directional volume in the short term, and then crash it when people are forced to cover.
Especially with high, fixed, interest rates, this can do a real number.
Currently, since USD interest rates are higher than BTC, leveraged positions have a higher potential to lower Bitcoin's price than to raise it. Also, there is no recourse (on the stock market, sometimes, if you "owe" after a margin call, brokers can go after you) for Bitcoin loans. If there were, something as inconsequential as the Silk Road crash could cause a gigantic problem for pretty much everyone involved. There was obviously lots of short pressure, explaining why BTC interest rates suddenly spiked, and the price would decline further, forming an "inverse bubble". But this is all short-based, and a short-based bubble explodes in a far more problematic manner than a long-based bubble. Somebody shorting at the bottom is probably stuck paying interest rates comparable to somebody longing BTC during the long-bubble, which was like 300%. Now, when the bubble bursts, the price went from sub-$100 (even without the a shorting-bubble, with a shorting-bubble it could potentially go much lower) all the way up to $132. Somebody shorting at the bottom is unlikely to cover. Now, Bitcoin is $200. Somebody who shorted 10 BTC at 90 would now owe about 9.6 BTC, and be responsible for paying about 28.8 BTC, just in interest, per year if he doesn't pay it off. A ton of people in such scenarios would be stuck bidding for the same Bitcoins, driving the price up even further, getting each other even further into debt. Now, the brokerage also lost Bitcoins in the short term, as it lent to the people who are currently struggling to pay back that debt. So the demand goes way up, driving the price up, making that debt even bigger.
This is effectively what happened in the great depression, only in reverse, where people were "shorting" the dollar, for stock, when the dollar was backed by gold. Whenever you borrow something deflationary to use leverage to trade a volatile instrument, especially if you're paying high interest rates, you're likely to get screwed badly, especially if that debt doesn't "evaporate", but is actually enforceable.
Except that there is a thing called a margin call. And in Bitfinex case, individuals are the lenders not the brokerage exchange.
And if you did your history lesson you would know that when Bitfinex first opened (Bitfinex 1.0 not the current 2.0 version) they did so right before the April crash. The market crashed over 82% and the main exchange Gox went down. Even so, the lenders lost only the equivalent of 9% of their loan equity. And that money was paid back by Bitfinex.
So, I figure if the market crashes 82% and lenders lose 9%, which is the equivalent of about what they make there in a month interest, then these "the sky can fall" predictions are pretty baseless.
Consider if there were a ton of borrowers, like the majority of Bitcoin speculators decided to trade on x5 leverage. Suddenly, bubbles form x5 bigger and when they crash, a huge amount of selling occurs due to margin calls, triggering even more crashing. Eventually, the margin calls can't cover the principal any more, and the person is in debt. In Bitfinex's case, the lenders would absorb that loss, and although it would be a pretty sad thing to happen, it wouldn't be the end of the world. If a brokerage came that actually could enforce that debt, however, then you get stuck into a spiral where the people at the wrong end of the speculation end up owing a sum of Bitcoin or USD that simply doesn't exist on the exchanges, driving the price up and/or down continuously until finally a default occurs.