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). BTCSHORT is strictly not a security, carries many risks, and is not suitable for risk-averse token holders and traders. This type of token is best suited for sophisticated, highly risk-tolerant token holders who understand and are comfortable with taking on the risks inherent to inverse tokens like BTCSHORT and understand the risks associated in holding tokens generally and inverse products in particular. In this post, we exclude all fees and expenses associated with BTCSHORT and holding Bitcoin for simplicity.
The main objective of BTCSHORT is to track -1x the daily performance of Bitcoin. The table below shows an example of how the price of BTCSHORT changes with changes in Bitcoin’s price over multiple days. We show three days of price returns and assume both BTC and BTCSHORT are indexed at $100.
As you can see, BTCSHORT does not track the performance of Bitcoin over the total 3 day period but instead its notional exposure to Bitcoin is reset at the end of each day (5 PM CET) which, in this example, gives a variance of 0.6% from a simple -1 x track of BTC over the 3 days.
This compounding effect can also lead to reduced performance in volatile periods as we show below.
High Volatility, Flat Market
BTCSHORT will underperform in a volatile market. BTCSHORT provides exposure to -1x the daily performance of Bitcoin. If the token’s value rises on day one and then is followed by a loss of the same percentage amount on day two, the loss is applied to a larger amount than the gain. This means the token will lose more than it gained even if the price of Bitcoin ends up being the same after two days.
In a similar fashion, if the token’s value falls on the first day, then rises by the same percentage amount on day two. The token’s rise is applied to a smaller amount than the fall. This means that the token will again lose more compared to traditional shorting than it gained even if the price of Bitcoin ends up being the same after two days.
Volatility has a negative effect on token holders who hold the token for longer than a day as the table below shows.
Low Volatility, Markets Trending Downwards
If the Bitcoin price is stable but trending in a negative direction, then BTCSHORT’s multi-day performance will benefit. This is because daily returns of the token are compounded (i.e. daily profits are automatically rebalanced at 5 PM daily) and gains made on one day will benefit from gains made on previous days.
Low Volatility, Markets Trending Upwards
If the Bitcoin price is stable but trending in a positive direction, then the BTCSHORT performance will falter but less than it would’ve had there been no compounding. Losses made on one day will be, because of previous losses, applied to a smaller amount. This means that compounding will lead to slightly reduced losses than if there were no compounding.
BTCSHORT offers a notional exposure to -1x the daily performance of Bitcoin. It is crucial that all token holders understand how compounding and the daily rebalancing of the token affects performance, especially in volatile markets. The tokens are designed for holding periods of equal or less than one day and holders need to consider their holdings each day.