BSIP: 0058
Title: Global Settlement Protection Through Price Feeding
Authors: Jerry Liu [email protected]
Status: Accepted
Type: Informational
Created: 2018-12-30
Discussion: https://github.com/bitshares/bsips/issues/135
This BSIP proposes that witnesses prevent global settlements from happening by not permitting the published feed price to drop below the global settlement price × MSSR. This BSIP will only apply to specific smartcoins that are subsequently approved by Poll Worker voting.
BitShares has a mechanism to handle debt positions whose collateral is valued less than the debt itself ("bad debt"). This mechanism is called global settlement ("black swan") and is triggered when the published feed price (FP) is less than or equal to the product of the global settlement price (Pgs) and the maximum short-squeeze ratio (MSSR).
FP ≤ Pgs × MSSR
If this does occur it means that the collateral ratio (CR) of at least one debt position is less than the MSSR.
Global settlement is not a good way to handle bad debt, as can be seen to what happened to bitUSD. After global settlement was triggered for bitUSD in December 2018:
- traders could no longer borrow bitUSD;
- the price of bitUSD dropped below USD because of insufficient collateral; and,
- it will take a long time for bitUSD to be revived.
The community has had extensive discussions about how to handle the bad debt in a better way in the future. Two ideas have emerged about what should happen when bad debt appears. At a high-level,
- the ability to update the collateral of a debt position (debt position update) should still be enabled, and
- the bad debt position should be handled independently of the good debt positions.
Before these advanced features can be implemented in the BitShares core software, this BSIP proposes an easy way to realize these benefits by something currently under the control of the witnesses.
Compared to a global settlement, this "global settlement protection" approach (GSP) will provide several benefits.
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If a global settlement occurs the debt position update feature is disabled which is very troublesome to users. But under global settlement protection, the collateral backing a debt positions can still be updated by the debt creators.
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Under global settlement protection, the margin called orders can still be filled independently. Their filling will cause the global settlement price to drop further and will also increase the collateral ratio of the remaining debt positions. This can help to protect the smartcoin from devaluing.
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Global settlement is always a great concern for BTS users. Global settlement protection will remove the possibility of global settlements which will bring much confidence to users.
After the community abandoned BSIP-42, there is now a strong consensus that the feed price should be the market price. Given this pre-condition, global settlement protection will ensure that this consensus does not cause future problems.
It is possible that the smartcoin may devalue even under global settlement protection (such as may happen if GSP needs to be activated by feed publishers). However, if the community permits global settlement to be triggered, the devaluation will be even worse.
The global settlement protection price (PGSP) for an asset is defined as
PGSP = 1.01 × MSSR × Pgs
Witnesses who publish price feeds should ensure that their published price feed (FPP) is greater than or equal to the global settlement protection price. This can be calculated as
FPP = max(FPN, PGSP)
where FPN is the natural feed price
If there is no global settlement price, then the natural feed price should be used.
This BSIP provides a general solution to handle the issue of bad debt smartcoins. Whether this BSIP will be applied to any specific smartcoin will depend on voting results from a Poll Worker. Two related poll worker proposals, including FOR and AGAINST, will be created for voting on each specific smartcoin.
This section analyzes the possible effects of enabling Global Settlement Protection (GSP) BSIP. It describes some possible consequences of enabling GSP but it rarely estimates the likelihood of people executing those consequences. Predicting the likelihood of action by people is highly uncertain, time-varying, and subjective and is not the focus of this section.
Both GSP and global settlement (GS) can be triggered if the collateral price behind a single debt position falls enough to cause the collateral ratio to fall below the maximum short squeeze ratio (MSSR). (Note that MSSR > 1.) Both GSP and GS have characteristics that are considered undesirable by holders and borrowers of a smart asset in comparison to normal operations. This section mostly compares GSP to GS and not to normal operations.
Different effects are analyzed while GSP is activated.
- Ratcheting of Feed Price towards Natural Feed Price
- Effects on Holders
- Effects on Borrowers
- Possible Effect on Supply
- Effects on Public Perception
- Summary of Identified Risks
| Term | Definition |
|---|---|
| CR | Collateral ratio |
| LCDP | Least collateralized debt position |
| GS | Global settlement |
| GSP | Global settlement protection |
| Activated GSP | When FPP = PGSP |
| Deactivated GSP | When FPP = FPN |
| XK/D | Price measured in units of the smart asset divided by the collateral (e.g. 2 bitCNY per BTS) |
| XD/K | Price measured in units of the collateral divided by the smart asset (e.g. 0.5 BTS per bitCNY) |
The GSP feed price is limited from moving towards the natural feed price by the least collateralized debt position (LCDP). The collateral and debt in that position determines Pgs which is used in the GSP rule.
The LCDP can change quickly for a few reasons.
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If matched with another limit order, it can be partially filled. Partial filling will increase its collateral ratio (CR). If the CR is large enough, it may no longer be the LCDP.
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If matched with another limit order, it can be completely filled. Another debt position will become the new LCDP.
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The borrower of the LCDP may increase the collateral enough such that the debt position is no longer the LCDP.
The new LCDP may have a lower ratio of debt to collateral (D ÷ K) than the old LCDP which permits Pgs to move towards FPN.
There are multiple effects on holders of a GS-protected asset versus a globally settled asset.
Holders of a GS-protected asset can continue holding a smart asset even after activation of GSP. The collateral behind the entire supply of the smart asset continues to be backed by all the collateral that is required to maintain a debt position.
Comparison to Globally Settled Asset |
|---|
| Holders of a smart asset may also continue to hold the smart asset. When global settlement is triggered, all debt positions are closed and all the "safety collateral" (i.e. the portion of the collateral that makes CR > 1) is returned to the borrowers, and the remaining collateral is placed into the global settlement fund. The blockchain begins the GS period with (a) the supply when GS is triggered, and (b) the collateral required to make the collateral ratio of the entire supply to equal unity (i.e. CRsupply = 1). Absent bidding that is permitted under BSIP-18, the collateral behind the GS supply is not increasing. Therefore, if the price of the collateral continues to fall after GS is triggered, the valuation of the collateral continues to fall which results in CR of the entire supply falling well below unity (1). Under GSP, the "safety collateral" behind every debt position, while it exists, is still backing each debt position. The entire supply is backed by more collateral during GSP than during global settlement. The true valuation of the collateral and its associated true collateral ratio is dependent on old debt postions, new debt positions, and market transactions which is another complex matter. |
A smart asset can be traded against its collateral as long as the asset issuer has not restricted the markets against which it can be traded. In the case of the smart assets that are issued by the BitShares Committee (e.g. bitCNY, bitUSD, etc.), these assets will continue to be available for trading on the DEX.
Margin calls will still be present on the DEX order book during GSP. This allows holders of the smart asset to trade for often more collateral than is possible to obtain than by force-settling their holdings.
Furthermore, the GSP price is dynamically being updated as (a) margin calls are filled, and (b) collateral behind debt positions are updated by borrowers. These updates will permit the dynamic GSP price to move towards the natural feed price. The consequence is that margin calls might be present on the order books and provide additional offers for holders to consider.
| Comparison to Globally Settled Asset |
|---|
| Trading of a globally settled asset is also possible. Under GSP, the possible presence of margin calls on the DEX order books provides holders with more collateral per smart asset (e.g. more BTS per bitCNY) than under under global settlement. Futhermore, the dynamic GSP adjusts the price of these margin calls which provides holders with collateral offers/prices that are higher than with the force settlement price under global settlement. |
Besides using the DEX to exchange a smart asset (e.g. bitCNY) to trade for its backing collateral (e.g. BTS), a holder of a smart asset has the ability "force-settle" (FS) a smart asset directly into the collateral subject to a delay of 24 hours and subject to a penalty that is specific to a smart asset (e.g. 5%). This FS ability is true both when an asset is globally settled or not. When it is not globally settled, the force settlement price of D units of a smart asset can be force settled for collateral equal to
K = D × FSR ÷ FPPK/D = D × FSR × FPPD/K
where
- D: amount of the smart asset that is held
- FSR: force-settlement ratio (e.g. 95%)
- FPPK/D: published feed price 24 hours after the force settlement is initiated denominated in terms of smart asset divided by collateral (e.g. 2 bitCNY per BTS)
- FPPD/K: published feed price 24 hours after the force settlement is initiated denominated in terms of collateral divided by smart asset (e.g. 0.5 BTS per bitCNY)
A GS-protected smart asset can be force-settled just as in normal operations albeit at an amount of collateral that is a function of the GSP price.
K = D × FSR ÷ (1.01 × PgsK/D) = D × FSR × (PgsD/K ÷ 1.01)
PgsK/D is not held constant and will vary as the margin called debt positions are purchased on the open market. This can be re-expressed for clarity in terms of the ratio of collateral and debt of the current least collateralized debt position (PLCDP).
K = D × FSR ÷ (1.01 × PLCDPK/D) = D × FSR × (PLCDPD/K ÷ 1.01)
Comparison to Globally Settled Asset |
|---|
| When a smart asset is globally settled, it is still possible to force settle with three differences in comparison to normal operations: - force-settlement has no delay; - force settlement has no offset penalty (e.g. 5%); - the price used is the global settlement price (PgsK/D), instead of using the feed price 24 hours in the future. This price is held constant until the smart asset is revived from global settlement. K = D ÷ PgsK/D = D × PgsD/K While GSP is active and PLCDPK/D ≤ PgsK/D × (FSR ÷ 1.01), a holder of a smart asset will obtain the same amount or more collateral by force-settling than if the asset had globally settled because the GSP price will ratchet towards the natural feed price (FPN) as margin calls are filled. While GSP is active and PgsK/D × (FSR ÷ 1.01) < PLCDPK/D ≤ 1.01 × MSSR × PgsK/D, a holder of a smart asset will obtain less collateral by force-settling than if the asset had globally settled. While 1.01 × MSSR × PgsK/D < PLCDPK/D (i.e. GSP has deactivated) and FPNK/D × FSR ≤ PgsK/D, a holder of a smart asset will obtain the same amount or more collateral by force-settling than if the asset had globally settled because the GS-asset force settles at the constant Pgs until the asset revives. While 1.01 × MSSR × PgsK/D < PLCDPK/D (i.e. GSP has deactivated) and PgsK/D < FPNK/D × FSR, a holder of a smart asset will obtain less collateral by force-settling than if the asset had globally settled because the GS-asset force settles at the constant Pgs until the asset revives. After GSP has deactivated for a smart asset and its hypothetical GS-twin has revived from global settlement, no comparison applies because both hypothetical assets returns to normal behavior. |
The reference-denominated price (RDP) of a smart asset (e.g. bitCNY) with respect to its reference asset (e.g. fiat CNY) is always fluctuating wherever the smart asset is trading relative to its reference asset outside of the DEX (e.g. centralized exchanges, peer-to-peer exchanges, etc.). The RDP is based on supply and demand which is affected by various factors that are valued differently by different market participants. Two of these factors are current and anticipated prices of the collateral, and arbitrage of the smart asset across markets.
Under GSP, the RDP tends to track the price of the collateral because (a) force-settlement is always possible for a smart asset, and (b) the feed price during GSP is less flexible than during normal operations. As the collateral price falls, the RDP price will tend to fall. As the collateral price rises, the RDP price will tend to rise. When GSP is deactivated, the price of these two assets will likely become disconnected again.
Arbitrage between open markets (e.g. between an open centralized exchange and the DEX) will tend to even out prices after accounting for transaction costs and delays. Even if the supply of the smart asset increases while GSP is active due to the lower risk of borrowing new smart assets into existence, arbitrage to the DEX, where force settlement is available, might nullify the effects on the RDP.
Finally, if there was a premium on RDP before GSP is activated, which is a likely scenario if the collateral price has been falling enough to trigger GSP, then a possible fall in RDP will reduce this premium.
| Comparison to Globally Settled Asset |
|---|
| During GSP, the possible increase in supply of the smart asset could have a downward pressure on the RDP. Force-settling and arbitrage might reduce this effect. While GSP is active, the GSP rule permits the feed price (FP) to ratchet down towards the natural feed price (FPN) which means that holders of the smart asset can likely obtain more collateral through force-settling sooner with GSP than under GS revival with BSIP-18. This might mean that the RDP might fall less than under GS. These multiple counteracting forces make any predictions uncertain. |
There are multiple effects on borrowers of a GS-protected asset versus a globally settled asset.
GSP ensures that the blockchain keeps old debt positions open and ensures that:
- the borrower still owes the blockchain the original debt/smart asset, and
- the borrower still owns the collateral behind each debt position that is held in escrow by the blockchain.
This is both beneficial and detrimental to old borrowers and depends on what happens while GSP is activated.
GSP activation provides time to old borrowers whose debt positions were openly under margin call threat to supply more collateral and increase their collateral ratio above the minimum collateral ratio. This is a benefit to the borrower if the borrower can provide more collateral before the margin call is completed. This is an opportunity to secure their prior collateral by adding new collateral.
Comparison to Globally Settled Asset |
|---|
| Debt owed to the blockchain are closed by the blockchain confiscating enough collateral to equal the debt in a position at the global settlement price. This confiscated collateral is moved to the settlement fund. The excess collateral is returned to the borrower. Under GSP, if the borrower cannot provide enough collateral before the margin call is completed, then the borrower will lose more collateral than under global settlement. |
If the borrower can avoid having his or her debt position margin called during the GSP period, then the borrower's previous collateral is secured.
| Comparison to Globally Settled Asset |
|---|
| There are no old borrowers after a globally settled settle is revived per BSIP-18 because old debt positions are closed when global settlement is triggered. |
Creating/borrowing new debt positions are still possible under GSP. Borrowing new debt positions still requires a multiple of the backing asset based on the MCR multiplier. The debt-denominated price of the total collateral behind the debt position equals
KD = K × FPPK/D
The maximum debt that can be obtained for that collateral is
D ≤ Dmax = KD ÷ MCR
or
D ≤ Dmax = K × FPPK/D ÷ MCR
But the valuation of that collateral is based on the protected feed price FPP which is by definition higher than the natural price of the backing asset on external market.
FPP = max(FPN, PGSP)
This has the following implications:
- The true price of the collateral backing a new debt position is worth less than if that natural price were used.
- If the natural price of the collateral continues to fall:
- Some old debt positions might have their true collateral ratio fall below unity (1) (i.e. fractional reserve).
- It is possible for new debt positions to be created with a true collateral ratio less than unity (1).
| Warning |
|---|
| New borrowers should be cautious about their collateral ratio while GSP is activated because as the least collateralized debt position changes, either due to being filled or due to being adjusted, the feed price may change by relatively large amounts. This will cause relatively large changes to the call price of every debt position which may suddenly reveal new debt positions to be in margin call territory. |
| Comparison to Globally Settled Asset |
|---|
| New supply cannot be created for a globally-settled asset. |
It is still possible to update the collateral behind a debt position.
| Comparison to Globally Settled Asset |
|---|
| Debt positions cannot be updated for a globally-settled asset because they are closed when global settlement is triggered. |
It is still possible to close (pay back) a debt position.
| Comparison to Globally Settled Asset |
|---|
| Debt positions are automatically closed when global settlement is triggered. |
Debt positions that were margin called prior to the activation of GSP, will remain margin called until their margin call position is matched or until their collateral ratio is raised by either adding collateral or by the price of the collateral increasing.
New debt positions (i.e. debt positions created after activation of GSP) are less likely to be margin called during GSP than without GSP because the feed price is protecting the least-collateralized debt position's collateral ratio from falling.
| Comparison to Globally Settled Asset |
|---|
| Margin calls are not possible because debt positions are closed when global settlement is triggered. |
During GSP, a decrease in the feed price is limited by the need to protect the least-collateralized debt position's CR from falling below MSSR. The feed price can decrease only when the least collateralized debt position's CR increases (i.e. which will cause its debt-denominated call price to decrease). This CR increase can occur either by the debt position's owner (i.e. the borrower) increasing the collateral, or by its margin call order getting partly filled; partial filling of a margin call increases its CR as perceived by the blockchain.
In addition, during significant downtrends of collateral pricing, many debt positions are often being margin called which create large "walls" on the DEX order book which must be filled before Pgs can decrease significantly.
Therefore, while GSP is activated is a relatively low-risk time for new debt positions to be created because of the difficulty in triggering margin calls on them.
| Comparison to Globally Settled Asset |
|---|
| New supply cannot be created during GS. The supply can decrease if holders of the smart asset choose to force settle their holding. |
This increased supply might be considered undesirable by some because this new supply might decrease the reference-denominated price if it is offered on external markets.
This opportunity can be mitigated by increasing the MCR to make the borrowing of new supply to be ever more expensive.
GSP of bitCNY was informally activated during December 2018 at the trailing end of the application of BSIP-42. For several days, the true collateral ratio of some debt positions was below unity (1). This fractional reserve situation of some debt positions was viewed negatively by some as a poor reflection on BitShares as a whole. If a person focuses on the published feed price, which is different than the natural feed price, the perception may be negative.
Only some of all of the debt positions, depending on the natural feed price, will have true collateral ratios below unity. The entire supply may have a true collateral ratio well above unity. Therefore, the public perception might be positive if it considers the true collateral ratio of the entire supply. It might be helpful to publicize the true collateral ratio of the entire supply during GSP.
Public perception will be mixed depending on whether a person focuses on the published feed price, or the collateral raio of the entire supply, or the reference-denominated price.
| Comparison to Globally Settled Asset |
|---|
| Under GS, the entire supply becomes backed by just enough collateral to make the collateral ratio equal to unity (i.e. CR = 1). Thereafter while the natural price feed is below the global settlement price (FPNK/D ≤ PgsK/D), the collateral ratio of the entire supply is below unity (1); and vice-versa. Some people will consider the fractional reserve of the entire supply to be negative. Some people might also consider the unaltered feed price to be be positive. |
The following risks are present if GSP is activated.
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When GSP is initially activated, holders of a smart asset incur an additional 1% penalty to force-settle their smart asset. This is a result of the GS-protected price which is 1% higher than the global settlement trigger price. But after the least collateralized margin calls are filled, the feed price will move towards the natural feed price, FPGSPK/D. If the feed price falls enough, force-settlement under GSP will return more collateral to the holder than under GS.
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GSP may permit some debt positions to fall below a true collateral of unity (1). Such an occurrence for an active asset will be viewed negatively by some of the public. In contrast, the entire supply will initially be under-collateralized under GS.
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Borrowers of the old supply of the smart asset (i.e. the supply from before GSP was activated) risk losing more collateral under GSP than under GS because the old debt positions are kept open by the blockchain.
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New supply of the smart asset can be borrowed/created with lower risk to the new debt positions being margin called because the published feed price (FPGSPK/D) will be slow to drop further because it is protecting the least collateralized debt positions.
- A borrower may take this opportunity to increase the smart asset supply significantly.
- If the borrower then offers this new supply on the market pair with its reference asset (e.g. bitCNY:CNY market on an external exchange) then the reference-denominated price of the smart asset might fall.
- An attempt might be made to limit the creation of new supply by increasing the MCR which forces new borrowers to provide more collateral.
- Increasing the MCR while GSP is activated raises the call price of all positions.
- A borrower may take this opportunity to increase the smart asset supply significantly.
- Suggestion on bitCNY rules update after BSIP42
- New mechanism to handle bad debt (black swan)
- Another idea to handle black swan: margin call execution price floor
It is important to eliminate concerns about global settlement. This can currently be achieved with the technical options that are available to the witnesses.
This document is placed in the public domain.