What is Provably Fair Gaming?

In the “olden days” before the internet, casinos had to demonstrate their trustworthiness to players in order for players to have confidence they were being dealt a fair game. In places such as Nevada, the state also took on this responsibility by providing a regulatory system that ensured casino games are being dealt fairly, and extended the system to various electronic games and slot machines. Bucket shops online and in back rooms still pray on the uninformed and careless, but with greater access to online information, it has become easier for gamblers to find fair games by using an innovative cryptological process called Provably Fair.

What is Provably Fair and how can it be used to prove a game is fair? Provably Fair is a cryptological process that allows players to verify the randomness out an outcome. This is done by using an open source algorithm for random seed generation, hashing, and for the random number generator. Players can use such algorithms to test a game’s response to in-game decisions and evaluate the outcome by only using the published algorithms, seeds, hashes, and the events which transpired during the game. A provably fair game provides players with the tools to have confidence that a game is fair without requiring third-party verification.

The concept of Provably Fair was first implemented by BitZino back in 2012. Bitzino is a bitcoin casino that wanted to prove that its games were fair without having to register with a state based authority. Provably Fair methods do not require bitcoins or other digital currency, but the concept of provably fair matched well with a bitcoin based casino since the digital currency is extra-territorial.

Basically, bitZino deployed a cryptographic hash function (SHA256 algorithm) to create a digital fingerprint of an already shuffled deck. Since the SHA256 hashing algorithm is one-way and there’s no way a player can use that hash to figure out what the shuffle of the deck actually is, the casino can let players look at the hash before the game starts. Two “seeds” of data are needed, one provided by the casino called the server seed and another provided by the player called the client seed. The client seed is typically provided by the player’s browser.

Then, the vitural deck is reshuffled using the Fisher-Yates shuffle algorithm with the random numbers generated from the Mersenne twister algorithm that was seeded with a hash of the combined server seed and client seed. According to bitZino, “The second round of shuffling only serves to ensure that neither the server nor client could possibly know the final deck before the game starts.” Finally, the initial shuffle and the server seed are provided to the player for verification.

The provably fair method used by Bitzino set off a flurry of developments within the bitcoin gambling community. With provably fair technology, it is now a lot cheaper for online casinos to operate fair games since 3rd party verification of game fairness is not required and provably fair gaming also makes it safer for players since we now have the tools to test whether a casino is provably fair, thereby reducing the risk of being cheated. In the wake of provably fair, a group of “provably fair verification” services emerged to make it easier for players with less technical knowledge to test provably fair games.

Comparing Crypto Margin Lending Sites

As the digital currency financial system develops, a new type of investment is emerging: margin lending. Currency exchanges have created platforms for their users to take out margin loans in order to make leveraged currency trades and the margin funding itself is also provided by users. This goes against the traditional system of brokers providing margin. This development makes sense because it takes the exchanges out of the credit side of the transaction, and focuses their role on maintaining a market and processing transactions. The exchange still needs to work on providing users with a margin exchange that promotes liquidity by offering participants a fair marketplace. The relative success of each exchange will depend on the rules accompanying their own system.

The table below shows the simple APR for various margin lending platforms for various currencies. The way I calculated the rates in the table was to take the midpoint of the bid/ask in the current market at the time of writing then multiply this midpoint price by 365 to arrive at an annual rate.  I understand this calculation doesn’t take into consideration such factors as compounding, but the table below still gives us an idea of relative rates of return.

  USD BTC ETH
Bitfinex 17.53% 1.57% 7.14%
Poloniex N/A 6.28% 1.99%
OKCoin 31.02% 27.37% N/A
BitVC N/A 0.37% N/A

The first thing I noticed from this table is the widely divergent rates between each platform and between currencies. Each of the markets listed in the table provides bitcoin margin lending markets and the rates that can be obtained from each site are widely different. The rate on Bitfinex for BTC is so low as to compare with the rates offered by regulated banks in the fiat economies of North America, whereas the rate for BTC at OKCoin is at a massive 27.37%.

The best rate for both USD & BTC can be found at OKCoin, and OKCoin also offers CNY margin lending markets as well. So let’s look at the mechanics, liquidity, and rules of OKCoin in particular to see why this might be the case. OKCoin is based in mainland China and does not allow US based customers. This might partially explain the high rates for USD as there might be a lack of supply for these types of margin loans, but not the high rates for BTC. The mechanics at OKCoin for the margin lending market are pretty straight forward, with an open market of bids and offers and an auto-renew feature. The exchange states the margin rules call for forced liquidation in the event a trader’s margin falls below 10%. Without much experience on this platform or data at my fingertips, its impossible for me to say whether the risk of default is large. Judging by the high rates at OKCoin, default sounds like a real possibility. The exchange offers a service called “insurance” which costs 10% of the value of the interest earned. Whether this is a good or bad deal, or the details of coverage don’t seem to be disclosed. The fact that insurance costs a nice round number like 10% makes me think the exchange is up-selling coke & fries with margin orders.

Bitfinex is the largest crypto currency exchange and provides the platform with the most usability and an ecosystem of data from BFXData that publishes useful information from the exchange. Although Poloniex trades the most currency pairs and also has the most currencies listed for margin lending, Bitfinex is the most liquid and the market at Bitfinex is currently offering higher rates on Ether.

I wonder how these markets will develop? In terms of regulation, these exchanges will be in a constant negotiation/battle with regulators, particularly in the US & China. It might be beneficial to be located in a 3rd party country in order to fly under the radar of the shifting regulatory landscape. Another factor to keep in mind as these platforms develop is liquidity. A lack of liquidity might be a bad thing in terms of getting orders filled and keeping money invested, but a lack of liquidity could also offer opportunities for higher rates (being compensated for the lack of liquidity) and also arbitrage and hedging between platforms. I think as more margin lending groups start using APIs to move faster between platoforms, the rates of returns between platforms should converge. But maybe not, if the margin rules between exchanges are different, those different rules will mean different risks, which means different rates.

How Volatile is Bitcoin?

A frequent criticism of bitcoins from the lay person revolves around the perceived bitcoin price volatility compared to fiat currencies such as the US dollar.  But although this type of commentary is common, its often not backed up with any type of data.  The assumption that the price of something is volatile is not itself proof of the fact.

I thought it might be helpful to publicize a website that tracks the volatility of bitcoin prices as measured by standard deviation. Standard deviation is a backward looking measurement of historical volatility. At present, there is no reliable source of implied volatility data about bitcoin due to the lack of an open derivatives market, so historical volatility is the best we can do right now. Here is a link to The Bitcoin Volatility Index, which is a website that tracks the standard deviation of various bitcoin prices.

Its important to keep in mind when discussion the bitcoin price (or any price for that matter) that the price of something is simply a expressed ratio between the value of two things. So to say there is one price for something assumes a standard base currency. We take this for granted since in North America at least, most of us use either the Canadian dollar or US dollar to buy and sell things during our daily lives at the retail level. But theoretically we could also value goods and services by any other price ratio too.

How does the volatility of the bitcoin/US dollar price compare to other currency pairs or other assets?  The price of bitcoin is indeed more volatile than CAD/USD, CNY/USD or any other major fiat currency pair. This may be because most central banks around the world have similar monetary systems and policies, therefore, they all tend to move in the same direction (whether you think these directions are “right” or “wrong” is beside the point). But what about the volatility of Gold/USD or other assets? It turns out the bitcoin price has also been much more volatile.

At this point in bitcoin’s history, its price has a similar level of volatility as stocks.  The historical 30 day standard deviation of the price of bitcoins/USD is currently 1.39 according the btcvol.  I used the standev excel function and data on the SPY from Google Finance to calculate the standard deviation of the SPY and got 2.09. So right now, over the past month, stocks/USD is more volatile than btc/usd. But they are close.

Zimbabwe is starving itself

The government of Zimbabwe is declaring a state of emergency because of food shortages within the country.  This is a very sad situation, made even worse because the ways to ensure food is available are well known and easy for policy makers to implement.  The problem for Zimbabweans is their government is unwilling to allow a free market in food. Instead, the government blames a poor crop for causing starvation, but if free markets were allowed, bad weather wouldn’t impact the availability of food.  If free markets were allowed, farmers would simply purchase insurance against bad weather and consumers would be free to purchase imported food. Part of the reason behind the current food shortage is the government has increased the taxes on imported food in an effort to raise money for itself, but at a drastic cause to its citizens.

Being in Debt

It’s common wisdom in North America that debt is bad. Most of us think its best to avoid debt and save rather than borrow. But if you’re a part of the working class, saving the old fashioned way will simply handcuff you to your job. Working and saving is what those in power want you to do. They want you to compliantly sell your labour and slowly save for your retirement. Its a low risk strategy that keeps you in your place.

When you work and save, you’ll never be rich and you’ll always be forced to sell your labour.  The only hope you have of a materially better life is when the the standard of living generally rises. When you work and save, your station in society will always be the same. When you work and save, your life will go by, and you will always be stuck in the working class. Sure, you will retire, and pay for your kids education, and consume all the products being offered by the capitalists. Common wisdom tells us that those who work hard and save their money are admirable. But when you borrow to invest, you give yourself the potential of lifting yourself out of your class and making yourself a capitalist too.

When I talk of debtors, I’m not referring to those who borrow to consume. I’m referring to those who borrow to invest, whether its in real estate, the stock market, or their own business.

What’s the risk of debt?  If you are born rich, getting into debt risks your capital. A rich person who borrows could slide down the ladder of society back into the working class. Rich people would rather lend their capital to others, rather than borrow to gain more if they already have enough capital to provide for their lifestyle. The working class should do the opposite. We should borrow as much as we can for the lowest rates possible and find good ways to profit from this borrowed capital.

For someone who starts with nothing, what’s the worst that can happen after they are highly indebted? Bankruptcy? So now the poor person who started at zero is bankrupt and they are right back to zero; right back to where they started. Nothing lost, nothing gained. Doesn’t sound so bad. At least they tried. At least they didn’t just follow instructions. At least those who borrow to invest tried to claw their way out of their station.

 

I can see why the rich are so worried about debt. All those working class people who are in debt might one day default, and this hurts the capitalists. At the same time, the working class have promoted government policies that benefit themselves. A generous social safety net helps the poor who lack their own resources. If you borrow to invest and it all goes wrong, the government will still provide you with a basic pension and health care. The welfare state helps debtors.

Artificially low interest rates also benefit the working class at the expense of the capitalists. Low interest rates benefits borrowers, while lenders receive less interest income from the capital they lend out.

Gender and Risk

I recently reviewed the latest research related to the issue of Gender and Risk. Based on what I’ve read, males are riskier than females, although the differences may be overstated in some situations.  Whether the differences are large or meaningful seems to be the current subject of debate in academia, but from my perspective, there is no doubt that men take more risks compared to women. This is observable in the number of men and women playing poker, or the number of men and women as race-car drivers. In both cases, there are many men and very few women taking part. These are only two examples, and there are many more.

How does the different risk appetites of each gender impact social outcomes? If men are more likely to take risks, they are also more likely to have a greater variability of outcomes. Are men more likely to be entrepreneurs? Does this mean there are more men who will become bankrupt entrepreneurs and oppositely does this mean there are more men who will also be successful entrepreneurs? When we rank the highest income earners, does the basic statistics of risk cause most of the extreme high income earners to be men?  Intuitively, if men are taking more risk, their outcomes will be more variable and extreme (both negative and positive).

Since I’m particularly interested in the study of financial risks, it was interesting to read about evidence showing women are better portfolio investors compared to men. Women suffer less from the drag of investing’s psychological biases such as overconfidence. Women are less likely to tinker with their portfolio, because they are less confident they can “beat the market”. Women are more likely to formulate a portfolio and stick with their plan. The greater propensity of men to tinker with their portfolio causes them to under-perform because of transaction costs.

Some studies point to physical or genetic causes behind the different risk perceptions that men and women have. These explanations are less convincing to me since more testosterone or other measurable aspects of chemical activity in the brain may be the result of the risky activity itself and not the cause of it.

Regardless of why men and women have different views of risk, I think it would be helpful to teach our children to have a greater appreciation of risk. A greater understanding of risk will help future generations manage the risky choices they will face and hopefully this education will narrow (or eliminate) the gap between the ways different genders perceive risk.

What is Fracklog?

Fracklog is a new term in the energy market that describes the amount of energy being stored in drilled but untapped wells. Instead of pumping out oil or natural gas at current prices, some energy producers are drilling wells but not pumping the energy. They are waiting for higher prices and possibly hedging forward prices, which are in contango.

I think this strategy is very interesting and highlights another innovation in today’s energy markets. Many commentators attribute the current increase in North American energy to technological factors.  There’s more oil and natural gas being extracted today because producers have developed more effective ways of finding and getting it out of the ground.  But financial innovation has also played a part. Low interest rates make it cheaper for producers to raise capital and undertake new projects. Financial engineering has also played a role as energy companies are more financially sophisticated today than in the past. Energy companies better understand how financial factors impact their operations, and they are increasingly using more sophisticated strategies to mitigate risk and maximize returns. Fracklog is an example of this.

George Weston Ltd wins $317-million tax dispute

One of the main tax issues associated with derivatives is whether the gains/losses from hedging should be treated as capital gains or income (when they are recognized for tax purposes).  The tax treatment makes a dramatic impact on the overall outcome since only 50% of capital gains/losses are treated as income for tax purposes.  For those who have booked gains from hedging, especially if there is no associated capital losses to offset, there is a strong preference to treat these hedging gains as capital gains for tax purposes.  Treating the gains from hedging as capital gains reduces their tax impact.

As a long-time George Weston shareholder, I’m happy to hear they were able to win their case to classify the gains from a hedge of a US based holding as capital gains income.  This should also set a precedent for other Canadian businesses who are hedging the value of their US holdings. I agree with the outcome of this tax case since it shouldn’t matter if the risk being hedged was also traded during the period of the hedge. There are lots of situations where a hedge is desirable even when the underlyingrisk may not have a taxable consequence during the same time-frame as the hedge itself.