It is frequently claimed that 'paper' bitcoin (like the cash settled CME bitcoin futures) suppress the price of bitcoin, because they create additional supply beyond the 21m 'actual' on-chain bitcoin. It seems to me that CME bitcoin futures are no worse in this regard than crypto exchanges that allow short selling (or margin trading). Why?Suppose I have 1 btc in my wallet. I create an account with kraken and deposit my 1 btc there. You go short 1 btc on kraken. This is like you borrowing 1 btc from me (with the promise to return it later), and then you selling this 1 btc on the market to JoeHodl (say), who withdraws it to his wallet. What happened?The one 'actual' on-chain bitcoin went from me to JoeHodl, but in addition we created one 'paper' bitcoin on kraken: I have the long side and you have the short side of it. (I have an IOU from kraken for 1 btc; kraken has an IOU from you for 1 btc plus interest.) This is exactly the same as CME bitcoin futures (up to the fixed future expiration date). One person is long, the other is short. It's all based on credit, with no 'actual' on-chain bitcoin involved (except the one that went from me to JoeHodl).When you close your short position, this credit based 'paper' bitcoin is destroyed again: To close the short, you effectively buy 1 btc on the market, eg from JoeHodl, and then deliver it to me; I withdraw it to my wallet. What happened?The one actual on-chain bitcoin went back from JoeHodl to me, and the 'paper' bitcoin disappeared (both IOUs are torn up). The credit based 'paper' bitcoin behaves just like CME bitcoin futures in that respect; and just like fiat bank money (M1): it gets created when you take out a loan from a bank, and it gets destroyed when you pay back the loan.The crucial distinction is that 'actual' on-chain bitcoin are real assets, in the sense that they are nobody else's liability (like a house with no mortgage on it). In contrast, 'paper' bitcoin are credit based assets, in the sense that one person's asset is always somebody else's liability. So you cannot create 'paper' bitcoin out of thin air all by yourself; you always need two people who want to take opposite sides of the deal (long and short). These two enter into a contract with each other, the value of which depends on the bitcoin price. Disallowing people to enter into such contracts seems to be in opposition to free market principles.Short selling can also help with price discovery, since it allows bears with no bitcoin position to express their views in the market; so to get more efficient markets, we should allow short selling, I think.This also suggests that exchanges that don't allow short selling (or margin trading), like bitstamp, might have less counter party credit risk, than margin exchanges that do allow it, like kraken, due to the many more IOUs involved.Tl;dr: We should allow crypto short selling for price discovery, and to adhere to free market principles; but then we shouldn't complain about 'paper' bitcoin being created by CME futures, because it is essentially the same thing.Am I missing something?
Submitted November 16, 2019 at 07:32AM
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