Market Discussions

Yeah...the title is long. Sorry.

For current Use Cases references this thread: Use Cases: Debt focused Exchange with Automated Credit Rating Mechanic

So here's what I'm giving you; a proposal for a debt focused exchange with an automated credit rating mechanic.

Here's what I'm asking for; feedback on what it should include or control for in order to be adopted and/or "work". If there's low participation this just won't work. I'm more then half way through creating my use cases for the software and figured now would be a good time to get commentary from potential stakeholders to ensure my requirements design has all the use cases it needs before I decide to keep going and produce a technical design. I'll publish use cases later if I decide to keep pursuing this.

The Exchange – Design Document

Disclaimers:
• I’m not committing to building this – I’m simply considering it
• The purpose of this is to gather feedback on the design
• This document can and will change, nothing here represents the final design nor serves as a commitment to future financial policies.

Overview:

The Exchange is a place where corporation and alliances can raise capital via Bond sales and investors can have ready access to that debt as a means for investment. Complimenting this will be a derivatives market in the form of simplified Credit Default Swap (CDS) contracts. These CDS contracts will be allowed to be traded “synthetically” which means it isn’t necessary to hold the underlying Bond shares in order to write, buy, and sell CDS contracts. This active speculation-based market will serve as a real-time proxy to the credit worthiness of the Bonds that the CDS contracts are derived from.

Objectives
• To create a better capital market for large Corporation/Alliance debt financing.
• To create a market that self-regulates the “credit” of debt sellers.
• To create an active speculative market based on debt derivatives that provides visibility into market sentiment on the “credit” of debtors.

Self-Regulations of the Exchange
• The Exchange will not use any amount of moneys in escrow accounts for any purpose. Period. Full stop.
• Three Auditors will be selected and given the full API Key Character of the Exchange. Total funds held by the Exchange should be equal to the amount in the in-game wallet of the Exchange. Auditors are chosen based on the judgment of the Exchange but public opinion and comment is desired in order to provide a reasonable assurance to the public on the Exchange’s compliance with its own Financial Policies.

Things Worth Pointing Out
• Definition of CDS: Credit Default Swap - A derivatives contract, the spread of price and recovery is a reliable measure of market perception of risk, hence the "automated credit rating mechanic". Since people can make money off of these, it encourages their use and ultimately determines their utility to Bond investors.
• Customers are not permitted to make use of “margin” trades. All trades must be “covered” through existing funds placed in escrow. This applies to Bond shares and CDS contracts.
• The holder of a CDS does not need to be an owner of the underlying debt security from which it is derived. In real world markets there are critics that assert that "naked" or synthetic CDSs should be banned, comparing them to buying fire insurance on your neighbor’s house, which they claim creates an incentive for arson.
• Each “Day” is defined by its beginning and end – Midnight GMT, aligned with 00:00 EVE Time.
• Hopefully obvious but this will be a web application with links to EVE via the standard methods used by my previous work, EBANK and EVE Insurance. I also made an EVE Audit application but killed it before I launched it - flat out too complicated to be usable.
• It is neither my plan nor my intention to make in-game money off of this. This is just how I play EVE - 100% meta.

Notes on Contracts:
• Sell Contract Orders (Contract writer, Payout for contracts placed in Escrow)
• Buy Contract Orders (Contract buy order value placed in Escrow)
• Buy to Close Contracts (Once order is completed payout value in escrow for corresponding contracts sold are removed from Escrow)

Just dropping in to say "Hi!" as it's nice to see you're still around.

I can't really offer you much in the way of feedback on your scheme, since I don't really understand any of it. Maybe that indicates that you need a more idiot friendly description of what you are doing?

I wish you the best of luck!

A good point - while credit in real world scenarios often deals with inferring credit worthiness based on historic events this model does not. The way that "credit" is determined is by real-time trading of CDS contracts and their respective spreads. If the "cost" of the contract is relatively far away from the "payout" then the credit risk of the underlying debt instrument is low per market sentiment. Likewise, a "cost" that is close to the "payout" can be interpreted as a high credit risk. A simple ratio between these two can provide a simplistic, automated, real time credit rating mechanism.

I'm actually working on a few different models of CDS contract and may throw it all out in favor of a simpler contract mechanism - that said, the idea of the cost of contract and the payout in the event of a default will remain. Think of it as a miniature, trade-able, insurance contract (somewhat of an over simplification, but there it is).

An interesting proposal. I've got a couple of questions:

1) Regarding the use of a single character as the executor of the exchange: I'd imagine there would be advantages and disadvantages of using a corporation instead, allowing multiple individuals to execute orders on the market. Can you see any definitive reason(s) to use one over the other?

2) Risk assessment: you mentioned that your current idea of a credit score is rather fluid and based on the CDS contracts themselves. Would it be beneficial to include a score based on the individual(s) requesting said CDS contracts?

All-in-all, an interesting idea.

I think that puts you back into the "past performance is no guarantee of future performance" trap. I understand the attractiveness of some "safety" indication. But Eve being Eve, we've got to be very careful with any such rating.

A perhaps better metric would be a measure of how "at risk" the debtor's assets are (e.g. held by known independents for other purposes). For example (this is an off-the-cuff example): If a debtor has BPOs locked down by Chribba/flakeys/RAW32 (I'm not meaning to slight anyone by omission) then they might be more inclined to keep their trustworthy reputation.

MDD

Yes, I see that. What Xinryu seemed to be asking for was some indication of the creditworthiness of the issuer other than past and current "CDS rating" (as represented by the spread). Such a metric would be useful to seed the crowd sourced CDS rating for those common situations where the issuer has no prior CDS rating.

Are you contemplating providing any assistance for the crowd to evaluate the issuer prior to the crowd pricing the issue?

MDD

Yeah, this is what I was referring to. While the securities themselves would do well with a risk profile of some kind, it would also be rather beneficial to have a risk profile of the individual who is issuing the CDS contracts. It could be based off of a variety of metrics, including, but not limited to, character age, and the risk profiles of past CDS contracts.


On the note of the automation via a web application (and as someone who's building one), WTB a CREST endpoint for transferring ISK.

Honestly I'm not planning to do anything in addition to what I've laid out for identifying risk - I'd rather leave speculation to investors and traders and not the Exchange itself.

I didn't mention it before, but even if I do this it will take months before the software is even ready for testing. The minimal use cases I've identified already are fairly complex to code for. Not terribly concerned about usability for the customer however.

Historically there has always been a large market for investment with a relatively low supply of actual investments. I'm estimating about 20 to 30 borrowing organizations and bond buyers and CDS speculators numbering between 500 and 1,000. I don't think I'll hit those numbers until after a few months of operation however.

To my knowledge the only one who has ever run an insurance business on MD was cosmoray, and he insured the offerings made by his own scam alts. Insurance of offerings is one of the holy grails of MD (to borrow some of Hexxx's terminology) and yet it has never been attempted. Why? because the brightest minds of MD have concluded it to be unfeasible.

Enter the *cough* wisdom *cough* of crowds!

The MD elite deems bond insurance to be unfeasible? John Doe doesn't care. The MD elite thinks that past performance is no indicator of future profits? John Doe doesn't know. The MD elite talks about 'adverse selection' and 'moral hazard'? John Doe is an hasardeur extraordinaire and proud of it!
In fact John Doe has no idea he is selling insurance. He is trading in 'CDS' which are just like stocks.

And thanks to all the John Does in EVE, the MD elite is now able to purchase affordable insurance for their investment vehicles. What the brightest minds could not have accomplished the wisdom of crowds has achieved!