[Discussion] Mitigating BTC volatility risk of T4 funds, hedging in USD

For a while we’ve been discussing the risk of having large amounts of T4 funds in BTC. The obvious volatility of BTC poses a risk to the actual worth of our reserve as calculated in USD. The problem scenario we are faced with would be a sharp decline in BTC value endangering the strength of our reserve and thus the peg. If BTC price would fall by say 40% we are faced with a strongly diminished value of our T4 reserves thus leading to less buy power to maintain the peg incase a lot of NBT are sold back to Nu.

To mitigate this we’ve started NSR buybacks to keep value within Nu free of BTC volatility. While the buybacks have been in my opinion very successful the problem with having only buybacks as hedging strategy is that we are reliant on buyers of NSR in case of emergency. Just like BTC volatility this poses a risk as we cannot guarantee we can sell enough NSR for a high enough price quickly enough to maintain the peg.

In the future other hedging options might present themselves but so far the other “stable” cryptocurrencies/assets have proven very lackluster. This means we are left with the option of hedging part of our T4 BTC in USD. Hedging in USD causes several problems for us as a decentralized organization such as Nu without a bank account. Since we cannot create a bank account or anything similar funds would have to be held in a centralized fashion. A problem with this is that a sudden transfer of large funds to someone’s back account will most likely create problems for that person with government agencies so this is out of the question.
Besides this incase these money is actually needed its most likely going to be needed on a relatively small timescale meaning transferring from a bank account to an exchange to buy BTC (or other assets we need to maintain the peg) will probably take too long. We are thus left with the option of holding the funds on an exchange account. Having them on an exchange account would enable us to relatively quickly buy BTC and transfer them to our buy side should the peg be endangered.

There is 2 problems to this strategy, 1 we need to solve the issue of centralization and 2 we are facing the risk of exchange default. To combat problem one the best solution would be collateral, aka the one holding the USD gives Nu crypto’s or other assets of equal value as collateral to mitigate the risk of theft. Problem 2 can only be solved in 2 ways, either shareholders accept that incase the exchange defaults they lose the USD or the person holding the USD on an exchange account accepts this risk.

The obvious advantage of this strategy is that part of our T4 reserve is in USD protecting us from BTC volatility and guaranteeing X amount of USD funds as a reserve incase the peg is endangered.

I’m considering stepping up and fulfilling this role if shareholders so desire, but I’m very keen to hear all of your thoughts about this.

So I see 2 issues with holding USD in a bank account as you’ve said:

  1. Frozen Account

  2. Speed of withdrawal

1 is very comparable to an exchange default risk. The difference is that bank accounts are frozen individually (whereas exchange default wipes out all exchange accounts at once) and usually only for large volumes. The cure is to have many bank accounts participating, which is of course difficult to pull off

2 is actually not so much an issue if we’re talking T4 (deep pockets). Use the BTC sitting in T4 to buy back the NBT, use the USD to buy BTC via coinbase (or whatever) to put back in T4 for next week.

So I don’t think bank accounts are completely out of the question. As you already know, we’re talking about paypal and bank accounts here:

  1. Frozen account is one thing but there’s also taxation problems, probably differs per country but I’m pretty sure I would get into problems with the IRS if I suddenly had several thousands of USD credited to my account without documentation as to where this came from.
  2. I have no experience with coinbase so I don’t know fast you could get USD from bank to BTC. But bank transfers for example can’t happen in the weekend or overnight thus slowing down the speed at which we could liquidate our USD into BTC. Although the scenario where we don’t see “it” (the emergency) coming a few days ahead does seem very unlikely.

I’m slightly surprised that this thread hasn’t seen more reactions yet. Are shareholders not interested in hedging T4 or do they feel this is not a good way of doing it?

So you would take some of our T4 btc and buy usd on an exchange with it and just hold it there? Which exchange? So we lose the volatility risk, but we risk exchange default in addition to trusting the single owner of the account.

My proposal would be to put down collateral of equal value to the amount of T4 funds that we want hedged. Also I would be willing to take up the exchange default risk if I can store the USD on the exchange of my choosing + a small fee. In this scenario might the exchange default or I run away with the funds Nu holds collateral of equal value to reimburse shareholders.

1 Like

I’m sorry, I still don’t get it.

Current model: T4 holds 10 btc. Assume btc price is $100/btc. Therefore T4 holds $1k. This is subject to full btc volatility, so if btc price goes to $50/btc we now have $500 in T4.

New model: @Dhume holds $1k in USD on exchange and puts up 10 btc as collateral. Therefore, Nu still holds 10 btc. If the price goes to $50/btc, @dhume has no reason not to default and walk away with the money and we are still left holding 10 btc at a total of $500 in T4. I don’t understand how you holding USD on exchange helps Nu.

I would offer up BKS as collateral, under the assumption that it is more value stable and less prone to downswings then BTC.

But how is that different from Nu just holding BKS without you? Or even buying it from you.

I don’t understand what do you mean? I pledge to hold X amount USD for Nu while putting up X amount of BKS as collateral. It’s not a trade of any sorts both parties do not touch the funds until they are returned. I am not willing to either trade or sell my BKS its merely to be collateral to insure Nu that I would not run away with the funds, or in case of exchange default that Nu can use the collateral to compensate shareholders.

So let’s go through the possibilities.

  1. BKS price goes up. Collateral is now worth more than USD. Nu acts with impunity, so will return the collateral upon request. This is all well and good, but it gives the USD holder every incentive to trade the USD back for the collateral, as it is worth more.

  2. BKS price goes down. USD holder has every incentive to buy back more than the collateral on the open market using the USD and let Nu keep the collateral that is now worth less than the USD.

  3. Exchange defaults. Nu keeps the BKS.

In all of the above cases, the situation with the most incentive is the one where the deal either ends immediately or never. The only situation where this model functions as intended is the one where BKS price remains constant and exchanges don’t default, in which case Nu just holding the BKS has no risk anyway.

Reason I am willing to put up collateral is that I’m not planning to sell or trade the BKS for a long time. Even if price would shoot up 300% I would not suddenly be inclined to sell. To insure that this doesn’t happen I have no problem with agreeing to timeframes, let’s say 3 months at a time in which I agree to hold the USD regardless of price movement (and Nu thus holding the BKS). It’s not possible for me to cancel the agreement in between those 3 months, it is however always possible for Nu to demand the USD back.

It’s true if a significant drop in BKS price would occur (although this seems unlikely at the moment) that the collateral would not cover the full amount of USD funds anymore. I am however willing to conservatively estimate a BKS’s worth as to insure the BKS would still cover the USD amount even in case of a BKS price drop.

The deal would never end in between periods (3 months) unless Nu requires the USD back, moreover BKS estimated value upon initiation of the contract is to be set below market price to insure the collateral still covers the USD funds in case of a BTC price drop. Exchange default risk is taken on by the contractor to insure that Nu never loses funds.

These are probably the most risk free terms for Nu I can think of.

OK! With a time limit and >100% collateral it makes sense to me. Feel free to make a motion. I assume you’d want the BKS under multisig, it might be simpler to start with BTC as we already have FLOT working with BTC.

I would like to hear some more shareholders speak out for this idea before I make a motion. I’ve been thinking about where to store the BKS collateral and storing it in FLOT multisig would be fine for the moment although in the future I would prefer them to be held by @JordanLee for example so that he can use them for voting. If I have to hold a significant amount of USD then the collateral would have to be a significant amount of BKS as well. From my understanding if they are held in a multisig address by FLOT they cannot be used for voting. Seeing as not all shareholders are quite active with voting it would be a shame to have X% of BKS shares not voting because they are held in a FLOT multisig address as collateral.

Would like to hear @JordanLee thoughts about my proposal, and also if he would be willing to hold BKS collateral and use it for voting on BKS motions.

I had similar concerns when talking about using NSR as collateral for T3 operations.

Making a draft is a great way to fully express your idea and get others to comment on it.

I’m sorry that you got the impression no reaction means no interest.
This is one of the topics I’m most interested about together with sorting out the liquidity model in practice.
It’s just that a lot of us have day jobs, other responsibilities (family, friends, hobbies) and are not always on.
And even if we are, more urgent topics might need our focus.

Hedging BTC volatility is important for a lot of community members - sadly parts of the ideas are burrowed in threads where you might not expect to find them:

1 Like

hey, if we do not like UP and DWON with BTC price, only trade at fiat market please:joy:

NBT seems to be going for >$1.01 pretty consistently on NBT/CNY at Bter with respect to the yahoo feed. We could probably take advantage of this to hold a good bit of CNY on exchange.

So someone could put up a bunch of PPC, for instance, and be given NBT to go buy CNY with and hold it on exchange. At any point in the 3 months or whatever Nu can ask that person to buy NBT with CNY and burn it, or promote to Tier 1, or whatever the deal that’s been worked out is (flexibility is good here). At the end of 3 months, the person has the opportunity to request the PPC back via motion. If it passes, the person buys NBT or BTC with the CNY and gives it to T4, who will give back the PPC. Alternatively, the person can just continue the contract without much difficulty.

The issue:
What happens if the CNY cannot be liquidated on-exchange at the end of the contract? For example, what if there were no CNY markets and the peg is already breaking upward on the NBT/CNY pair? If we require the custodian to return the same number of NBT as they were given, suddenly they are taking on a much bigger risk. That’s fine, but it will need to entail a lucrative reward scheme.

1 Like

@Nagalim your proposal could be a nice addition to mine for minimizing T4 funds to BTC volatility.

If there are no other objections/questions I will put up a draft tomorrow. Still hoping for a reaction of @JordanLee, but holding the collateral in a FLOT multisig will suffice at first.

1 Like

how about extend to next 3 month?