Needs of a distributed exchange

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TLDR/abstract: merchants need a way to hedge bitcoin inventory to avoid having to endlessly transact tiny amounts sent by customers to avoid the volatile exchange rate. This solution already exists, it’s called a futures contract. I think this is just as important as all the concerns over the quality of the currency exchange we now have.

OK here’s a quick overview of the idea of a futures market for those not in the know; if you are, just skip down a couple of paragraphs.

Futures markets originated as a solution for sellers of agricultural produce, e.g. corn. First, what problem are futures designed to solve: if you are a producer of corn (farmer), you can encounter the following scenario. In year 1, you plant X acres and find that the market price is very high, $Y, when you go to sell your corn at the market (due to some unexpected bad weather). You’re happy because you make a good profit that year. Next year, you plant more crops, requiring more investment, but that’s fine, because the profits will be good. Unfortunately due to unexpectedly huge supply and surprisingly little bad weather (weather is always a total wildcard, even today we can’t predict it more than a few days out), the price is now $Y/2 and we already spent, say, an extra $Y/4 this year on extra planting 2X crops(OK, I don’t know about farming, so sue me). You lose a ton of money. Maybe if you were very careful, you can anticipate this kind of swing in fortunes, but that’s really tough to do.

 




 

So there’s the problem. What’s the idea of futures? It’s simply this: at the very time you decide how much crop to plant, LOCK IN the CURRENT BEST GUESS of the what the price of the corn will be when you deliver it to market. If the price then soars, it’s true you’ve lost out on an opportunity to make a bundle, but equally if the price plummets, you still got a decent price, so you have avoided trouble. Notice how in this way it feels a bit similar to insurance, but also notice that it absolutely is not the same structure as an insurance contract, which has a completely asymmetric payoff. Futures are more like direct buying and selling, with a time offset, but insurance (and lotteries, and options) have an additional component of asymmetry (big potential reward and low potential loss or vice versa, with compensating probabilities).

Bitcoin needs a futures market just as much as it needs a distributed exchange

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