I've been experimenting with collateralizing Bitshares (BTS) and creating HERO. The mechanics are easy, but like anything else, it's important to understand why you'd want to do it in the first place. While I'm sure people have various motives, mine is one of profit. To be clear, I'm not trying to make a lot of money in the process, at least not right now. It's more of an experiment to understand how to make money during all phases of the market.
Setting the Stage
It's easy to make money during a bull market right? You invest in something that you expect to go up. Let's say Bitshares (BTS) for the point of this article. If I buy 3000 BTS at 20 cents and it rises to 30 cents, I made $300 ($900 - $600). But what if BTS decreases? The typical knee-jerk reaction is to sell your shares. While that is certainly an option, it's a drastic move if you hold a fundamental belief that BTS is good and that it will thrive in the future. The odds of you selling at the top of the bull run and buying back in at the bottom of the bear run are horrible. Human nature has a way of making impulse decisions that follow a herd mentality. Guess what happens to you when you are stuck in the herd. Absolutely nothing in some cases, and often you end up buying at the high points and selling at the lows.
Stay in the Game
But how do you stay in the game when things are working against your original assumptions? That's what this article will cover, in detail. I'll provide a real-world example with screenshots and do my best to explain where the profit lies so you can try it for yourself. Don't feel bad if you have to re-read it a few times. It's take me a bit to wrap my mind around it as well.
This word is so simple but can be so cryptic. Collateral is anything of value that you own that is pledged to someone other than yourself in exchange for some form of value. if your house is worth $200,000 and you need money, most banks will hold the deed to your house and hand over cash, say $20,000 that you can use however you see fit. You still owe the bank $20,000 and if you fail to pay it, they can take your house from you, sell it for $200,000 and give you $180,000 thereby forcing you to pay back the $20k loan. So, for the rest of this discussion, BTS = COLLATERAL. Got it?
Awesome, no banks. But.... We have a blockchain. And it has rules. One of the amazing rules @dantheman built into it is the idea of setting aside BTS as collateral in exchange for certain other forms of value. We will get into the mechanics shortly, but I want to marry the terms in Bitshares to the House example above. Your BTS is the same thing as your home and to keep it simple, we are going to pretend that your home is paid off just like your BTS is "paid off", meaning that you own it free and clear.
The Hero is an asset on the Bitshares Dex. It was created with the mission of being a value that tracks what a dollar would be worth if there had not been any monetary inflation since 1913. So, if you owned a dollar in 1913, it would have much higher purchasing power today. You've heard this many times in stories where your parent bought a house for $25,000 in 1970. Homes were less expensive because money was actually worth more. You could buy a nicer home with less money. Governments print money for various reasons and when they do, it increases the supply of that money. If money is printed faster than demand keeps up, it gets devalued. NEWS FLASH: Printing money will continue. It's a drug for the fiat world.
The HERO takes us to a somewhat magical place where the printing presses stopped in 1913 and we can now see what that dollar will buy us today. It's around $160 and the formula used will keep it on a steady ~5% rise. You must trust the peg on this in order to follow the rest of the discussion. I'll try my best to explain why the peg will work later, but for now all I can say is that it works because there is real skin in the game. People buying and selling the HERO are both operating under the same set of assumptions. When this happens, a market can be made.
The Good Stuff
I think we have enough background to dive in. I'm going to buy 3000 BTS. You can use any amount you like, even 300 BTS. Remember, in this world we can buy fractions of everything too so you can learn with much smaller values. I think 3000 BTS, which represents around $1000 USD is a reasonable amount of money to demonstrate and drive home the concept.
Setup an account at Openledger
You can transfer BTC from any account you may have elsewhere into the Openledger wallet under the Deposit/Withdraw menu
Navigate to the HERO / BTS Market
Here, you can see the market representing trades between BTS and HERO. You could easily trade BTS for HERO right? The scenario is that you bought BTS and rode it up, but now BTS is in a downtrend and you are beginning to fidget. "I don't want to lose value." "Will it keep going down?" "I believe in BTS long term and don't want to miss the boat if there is a sudden reversal."
Believe me, those questions go through all our heads and this strategy will allow you (a) keep all your BTS (b) benefit from the reduced price once the market reverses.
Here is where most guides glaze over the mechanics. Not gonna do it.... This is where you have the opportunity to gain a real understanding. Remember the house (BTS). Remember the cash you borrowed from the house (HERO). We are going to borrow some HERO by putting our BTS up as collateral! I'll get to the question of why we want to borrow HERO later. For now, let's just say we have an opportunity and need HERO to take advantage of it.
- Click borrow bitHERO / HERO
- Type in the value 1 into the DEBT field
- Set the slider to the highest collateral ratio allowed (I like to set it to 5:1 but 4:1 is probably safe in a non-volatile market as well) I will discuss this later as well
- The form will show how much BTS will be locked up (collateralized). That BTS qty is your house. That represents the 200,000 house and you just borrowed on 1/5th of it's value by setting your collateral to 5:1.
- Lastly, click Update Position That inks the deal.
If you choose to do nothing else, you can exit the position by clicking the borrow link again and typing a 0 into the field. Since you still have 1 HERO in your possession, it'll just close it out and you will be right back where you were before. Cool.
You pay no interest from borrowing off your own collateral. There is only a very small fee for the operation.
This is where my mind explodes. Or at least it used to. All of a sudden I have this HERO in my possession. I created it out of thin air. Not really... I borrowed it by pledging BTS, BTS that I can't get back unless I pay back the HERO. So, I've got skin in the game. This is why it works, because everyone has skin in the game.
But how is selling a HERO going to help me? I mean, I'll sell it to someone and then what?
I love analogies and I'm about to drop another one on you to illustrate this concept. Let's say you own a computer and you sell it to Joe for $1000. But two weeks later, Joe is finacially strapped and wants to sell it back to you for $600. You'd gladly take that deal right? I mean, the end result is that you'd have the computer back and $400 in your pocket. You are clearly better off than you were before. If you sold the computer at a later date at market value, you'd have your $1000 plus the $400. Score!
This is what we are doing with HERO. We are going to sell our HERO at market rate and then buy it back when BTS goes back up in value. There is one glowing assumption here and it's that you ultimately believe in the long term potential of BTS. If you don't believe in BTS, then your choice is really easy. Just stop reading this article and sell your BTS. Otherwise, continue reading.
Since you are still in the market view, you can see a red line on the chart. This line represents the calculated value of what a HERO is actually worth relative to BTS. It's also listed above under the Settlement box.
Looks like it's $511 BTS. This is the price you will sell your HERO for, so do it!
You'll show an open order now until someone buys it
Once it's sold, I like to place an order to repurchase it while I'm thinking about it. Just like you bought your computer back for less than you sold it for, it's important to put in a buy order for a lower price. I've chosen to buy it back for 350 BTS. I don't know exactly what day that will happen on, but when it does, the order will execute all by itself.
The end result after you buy it back will be just like the computer analogy. You will have 1 HERO plus 161 BTS (511 - 350). So, you made 161 BTS. Once that cycle is complete, you can either pay back the loan by clicking on borrow bitHero and setting the value to 0 or you can repeat the cycle assuming your faith in BTS is strong. Another awesome part of this strategy is that you never sold your underlying BTS. You were able to make 161 BTS leveraging your existing BTS.
I like to treat this as a downward price strategy and limit my exposure by setting limits. Borrow and sell HERO on BTS price dips. Buy the HERO back when the BTS price recovers and payback the loan. Repeat.
Sometimes your sale might not go through at the Settlement price. You might need to entice users by offering slightly below the Settlement price. Maybe 505 or 500. This may result in 5-10 BTS of sacrificed profits, but you'll never even have the opportunity to profit if you don't find someone to buy it.
I'm a peerplays witness too, please vote for me: