I feel compelled to express my sincere gratitude to toast, tonyk, xeroc, Stan, and everybody else in the bitsharetalk forums who helped me in one way or another either by proofreading, explaining concepts to me, and providing links to different posts. Without those people there's no way I would have been able to write my series of articles on Bitshares.

Market Pegging

Market pegging is a term to describe how the value of bitAssets will be equal to about the value of their real world counterparts. Anything in the real world that has value can theoretically be represented as part of the BitShares X banking and exchange platform, examples: bitUSD, bitEuro, bitGOLD, bitBTC, bitDiapers, bitOil etc. At first the software will focus on fiat currencies but later will expand to include other commodities. This will be accomplished through several different iterations of BitShares X which will have different letters attached to the end of their names.

None of these bitAssets will exist when the exchange first comes out. They get created when people place bets that the price of these real world assets will go down, to facilitate these bets, BitSharesX will have something akin to a prediction market, enabling people to profit from the view that a given asset will go down in value. Placing such a bet is called shorting.

When somebody is shorting an asset this means they think the price of said asset will fall with respect to the price of BitShares, the currency that's to be used as collateral for placing these bets. They put an amount of BitShares equal to twice the value of the amount of the asset they want to short up to be held by the system as collateral, and the system creates an appropriate amount of bitAssets to match the value of half that collateral.

The system holds this BitAsset until somebody decides to accept their bet by taking a long position on the asset. When somebody takes a long position against an asset they are simply purchasing the newly created BitAsset from the the person who created them by shorting causing the price of the BitAsset to go down a little, and the system gives the BitShares paid for that bitAsset back to the person who did the shorting.

Now the person who went short has half the amount of BitShares that they put up as collateral back, the person who went long has the bitAsset, and the system is still holding the collateral that was put up by the person doing the shorting until the person shorting it decides to close their position.

At this point, the person who bought the bitAsset can disappear and do whatever they want with it, if they choose. To close their position, the person doing the shorting will have to purchase an amount of the bitAsset from an exchange equal to what's been created so they can reclaim their collateral. When they do this, if they were correct and the price of the bitAsset has fallen, then it will cost them less bitShares to buy the asset back to cover their position and the difference is profit for them.

On the flipside, if the person doing the shorting was incorrect in the thinking the value of the asset would fall then it would cost them more of their bitshares to buy back enough of the bitAsset to close out their position. If the value goes up 50% to 1.5x the starting price then the network uses the collateral to buy the amount of the bitAsset that was created back from the market, destroys it and returns the remaining collateral minus a 5% fee for letting the system close their position for them which gets destroyed. When the system closes a short position for somebody this referred to as a margin call. This removes the extra value from the market that was created when the bitAsset came into existence. The reason for the extra collateral than what would be needed for the system to automatically cover the short is to disincentivise waiting to allow the system to cover for you.

How do we know that the bitAssets that get created through this process will stay the same price as their real-world asset counterparts? This price tracking occurs as a result of the belief by the majority of participants in the market that this bitAsset will be pegged to the price of the real world asset. If the price were to somehow deviate, perhaps from somebody making an incredibly large buy or sell order for a bitAsset, then the rest of the world knows that the bitAsset is supposed to be the same price as the real world asset, and they will buy and sell accordingly, hoping to profit. This self correction is what ensures that the price of a bitAsset will equal the price of a real asset.

Let me explain what I mean by that, the easiest way to do so is to use an example such as the one bitsharetalk forum member and code contributer 'toast' walked me through1). It involves imagining every possible scenario that involves the price of a bitAsset deviating from the price of it's real world asset. The hidden secret here is the precedent established by everybody knowing that a bitUSD should be worth about a dollar. As long as most people agree with that precedent then disagreeing with it will not result in profit for you. Say you're a naysayer, and you think a bitUSD is actually going to be worth ninety cents, this means you would likely short at ninety-five cents or a dollar- but if the price goes up to a dollar you're going to be stuck covering your position, which involves buying some bitUSD helping push the price up. On the other hand, if you think a bitUSD is worth $1.10, it would make sense to buy at $1.05 but if the price falls back to a dollar you would only be able to get out at a loss. Now let's look at how that would play out for somebody who agrees that a bitUSD is worth a dollar. If the price were to fall to ninety-five cents you would buy it, pushing up the price a little, so that you could sell at a dollar. If it were $1.10 you would short it, creating new bitUSD and pushing the price down a little bit, so the cycle is self-perpetuating. Knowing that most other people agree that the price of a bitUSD should be a dollar would cause you to take actions that support that assertion in the interest of your own profit.

This system of market pegging is what makes BitShares X use as a bank possible. The creation of what might be thought of as the crypto equivalent to fiat currencies creates a more stable alternative to traditional cryptocurrencies for the time being, defeating the argument that instability will prevent cryptocurrencies from ever being more widely used. This also enables people who value stability in their currency to truly approach a blockchain as a means of storing their wealth, until the market cap of an actual cryptocurrency is high enough to create stability in its own right.

E-Currency | Cryptocurrency | Bitcoin | BitShares

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