Oddbean

Suppose a bitcoin bear thinks bitcoin will fall in price from $40k to $10k at some point during the coming year, and then bounce back up a little to $15k. He can use loan shark to profit from his prediction. First, he must find a loan offer with a 1 year term, a low collateral requirement, and a low interest rate. For this example, I will assume the collateral requirement is 102% and the interest rate is 1%. I will also assume the bear wants to put $1000 into his short position. For this to work, the shorter needs to get 0.025 BTC from the lender in a contract with terms similar to the above, so he must deposit 0.025 * 1.02 as collateral, i.e. 0.0255 BTC, worth $1,020. He should therefore buy 0.0255 BTC for $1,020 and deposit it into loan shark for use in the above-mentioned contract. He will "get" 0.025 BTC from the lender, which is worth $1,000, and he will owe the lender 0.02525 BTC in 1 year (0.025 * 1.01 = 0.02525). Next, the shorter should sell his 0.025 BTC for $1,000 and wait for bitcoin's price to drop. When its price hits $10k, he should buy 0.0275 BTC. This should cost him $275, leaving him with $725 so far. Next, he should use the 0.0275 BTC to pay off his loan. He will immediately get his collateral (0.0255 BTC) back. Next, he should wait for bitcoin's price to rise to $15k and sell his 0.0255 BTC for $382.50. When added to his $725, this means he has a total of $1,107.50 at the end of this procedure. He started off with $1,020 and now he has $1,107.50, a profit of $87.50 or 8.6% on his initial investment.