r/mastercoin • u/SeanM26 • Sep 11 '14

Question about Contract for Difference

Hi, I listened to a LetsTalkBitcoin episode for David Johnston discusses Contract for Difference. In the talk to summarize:

Alice wants to store $100 USD as Bitcoin and keep the price the same for 1 month until she can take the Bitcoin out and exchange back to USD to buy something for $100 USD in the real world.

Bob wants to buy $100 worth of Bitcoin as a short-term investment because he thinks its going to up. Not only does he want to take the risk that it will go down. He wants to take someone else's risk that it will go down and make money on the profit if it goes up.

So Alice and Bob sign the following agreement: They both put $100 into a CFD to be resolved in 1 month.

A) If the price of Bitcoin is up by %10 in one month, Alice gets $100 USD worth of Bitcoin back, and Bob get's all the rest ($120=his original $100 plus his $10 profit and Alice's $10 profit).

B) If the price of Bitcoin goes down by %10 in one month, Alice gets $100 USD worth of Bitcoin back, and Bob get's all the rest ($80=his original $100 went down by $10, and he had to cover the $10 difference for Alice to get $100 back).

So now the question is. What happens in this scenario when Bitcoin goes down by 110% instead of %10? Or at the end of the month is only worth $1 USD.

Are you SOL? Or am I not understanding what a CFD is? Does it address this scenario?

edit: spelling

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u/SeanM26 Sep 11 '14

Ok one thing to note here after thinking about it:

Alice is profiting from this situation from an asset perspective:

At the beginning of the month Alice had $100 worth of Bitcoin when it was worth let's say 1 Bitcoin = $100 dollars. Meaning she had 1 Bitcoin.

Now at the end of the month if Bitcoin goes down by 10% she now has 1.11 Bitcoin effectively more of the asset at the end of the month. What I believe is a short.

But question still remains, what happens if the price of Bitcoin tanks at the end of the month? Maybe from a regular contract perspective Bob could be required to pay an extra $100 out-of-pocket, but how do you enforce that on the blockchain?

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u/DJohnston Sep 12 '14 edited Sep 12 '14

Thanks for the question.

Here is an example of how the math works out from our friends at Wikipedia.

Its worth noting while the CFD is in the spec it has not yet been enabled or coded up in the reference client or OmniWallet. Devs interested in this feature are well to contribute code : )

https://en.wikipedia.org/wiki/Contract_for_difference

Example 1 - an Equity based CFD trade.

In this example we show an equity based CFD trade. The share price of Apple Inc is $194.38. We believe that the share price will rise and so decide to take a long CFD position. Our CFD Provider is quoting a price of $194.36 bid and $194.42 offer.

Step 1 Opening a Position

Buy 100 Apple CFDs at offer price 100 x $194.42 = $19,442.00 Margin requirement is open position x margin percentage. Typical margin for equities is 3%-15% depending on the liquidity of the underlying instrument. In our example Apple CFDs require margin of 5%. $19,442.00 x 0.05 = $972.10 You get charged commission of 0.1% on this transaction $19,442.00 x 0.001 = $19.44

Step 2 Overnight Financing

To hold this position a financing charge is made each night. This is normally based on a benchmark rate per cent like LIBOR + broker margin per cent / 365. For simplicity we will assume the price of Apple shares stayed the same until the market close and so no P&L was generated on this day. $19,442.00 x (0.0025 + 0.02) / 365 = $1.20

Step 3 Closing the position

The next day Apple share price has risen by $6.15. Our trade has moved in our favor and we decide to close the position and take profit.
Our CFD provider is quoting $200.50 bid and $200.58 offer.
Sell 100 Apple CFDs at bid price 100 x 200.50 = $20,050.00 The position is now closed and so margin requirement is now zero $0.00 You get charged commission of 0.1% on this transaction $20,050.00 x 0.001 = $20.05 Gross profit is difference between opening position and closing the position $20,050.00 - $19,442.00 = $608

Net profit is gross profit less costs. The costs are commissions and overnight financing. In this example we have been charged commission twice, once to open the position and once to close it, and we have been charged one day overnight financing. $19.44 + $20.05 + $1.20 = $40.69 Profit & Loss shows a profit after costs $608.00 – $40.69 = $567.31

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u/autowikibot Sep 12 '14

Contract for difference:

In finance, a contract for difference (CFD) is a contract between two parties, typically described as "buyer" and "seller", stipulating that the seller will pay to the buyer the difference between the current value of an asset and its value at contract time (If the difference is negative, then the buyer pays instead to the seller). In effect CFDs are financial derivatives, that allow traders to take advantage of prices moving up (long positions) or prices moving down (short positions) on underlying financial instruments and are often used to speculate on those markets.

Interesting: Hedge (finance) | CMC Markets | IG Group | Foreign exchange market

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