How does rebalancing work?

How does rebalancing for BTCSHORT work? This short article breaks it down for you.

What is rebalancing?

As mentioned in previous educational posts, BTCSHORT is an Ethereum-based inverse token that seeks to provide a notional exposure to the inverse or -1x the daily performance of Bitcoin on any given day. This means that if the price of Bitcoin increases by 5% in a day, BTCSHORT’s price will decrease by 5% in a day (before any fees or expenses are applied). One key aspect of BTCSHORT’s operations is its daily rebalancing where the exposure of BTCSHORT is reset daily at 5 PM Central European Time (CET) to achieve the appropriate asset levels to maintain the implied notional exposure of -1x of Bitcoin’s daily returns. This is called rebalancing.

How does it work?

At 5 PM CET everyday, we will capture the current token value — how much in USDC the total outstanding amount of tokens are worth — of BTCSHORT in the smart contract and compare that with the current USD price of the reference crypto asset to determine the new appropriate exposure levels. The leveraged factor for BTCSHORT is -1x due to the fact that it aims to maintain notional exposure to -1x of Bitcoin’s daily performance. The exposure can change due to price action — for example, if BTCSHORT were to double in value in a single day due to Bitcoin’s price falling by half. The reset or rebalance will help correct BTCSHORT’s exposure. This periodic resetting means that a constant -1x leverage factor is maintained for every holder over that one-day period.

The equations below explain this point in more detail:

USDC in Smart Contract: 20,000 USDC
Bitcoin Borrowed in Token: 1 BTC
Current Bitcoin Price: 10,000 USDC
Total Token Supply: 100
Net Token Value 20,000 - 10,000*1 = 10,000

For BTCSHORT, there will always be a 2:1 ratio between the amount of USDC in its smart contract and the USDC amount of BTC that is being borrowed in order to short sell to provide -1x exposure to Bitcoin.

Let’s look at what happens when Bitcoin falls from $10,000 to $9,900:

USDC in Smart Contract: 20,000 USDC Bitcoin Borrowed in Token: 1 BTC
Current Bitcoin Price: 9,900 USDC
Total Token Supply: 100
Net Token Value: 20,000 - 9,900*1 = 10100
Ratio of USDC in the contract to the amount of Bitcoin Borrowed: 2.020202

To get the ratio back to 2:1, we would need to increase the Bitcoin borrowed to 1.020202. Our trading engine would then submit an order to a lending desk to borrow 0.020202 to then sell on a trading venue at a price of 9,900 to bring us with the below amounts.

USDC Amount: 20,200 USDC
Bitcoin Borrowed: 1.020202 BTC
Current Bitcoin Price: 9,900 USDC
Total Supply: 100
Ratio of USDC in the contract to the amount of Bitcoin Borrowed: 20,200 / (9,900*1.020202) = 2

The table summarizes the changes in the price of Bitcoin as well as the different holdings of BTCSHORT in the three different periods outlined above.

Conclusion

Understanding how BTCSHORT’s rebalancing works is key to being able to use the token sensibly. As we have shown in this short article, BTCSHORT rebalances on a daily basis in order to ensure that the ratio of USDC in the BTCSHORT smart contracts maintains its 2:1 ratio with the amount of Bitcoin borrowed. This mechanism works the same in cases where Bitcoin’s performance hits the performance threshold of ±33% and is important to understand as it explains how BTCSHORT is able to maintain its notional exposure to Bitcoin’s -1x daily performance. BTCSHORT is a useful tool to allow token holders to get notional exposure to the inverse (-1x) of Bitcoin’s daily performance.

Disclaimer

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