This is actually pretty interesting -- let's say this market does exist. What discount should we be applying to capital that's locked on OKEx? https://twitter.com/cmsholdings/status/1317973201654288395

I’ll preface the rest of this by saying that I really have no idea (and an obligatory NOT INVESTMENT ADVICE) -- there’s a ton of moving parts, and I’m definitely not an expert on all fo them. I imagine there exist few such experts, in this case! But anyway:

In determining a “fair price” for the locked capital, there are two main considerations -- what’s the probability that the money is gone forever, and, if it isn’t, what’s the cost of the capital being stuck on OKEx for however long it is stuck there.

To determine what the cost of the capital is short-term, you first need to determine what the marginal return on capital you could move freely is vs. capital that you can only use on OKEx. Honestly, for the capital you were *already holding* on OKEx, this shouldn’t be HUGE.

At least not on average -- presumably the capital being there implies you’d usually keep some capital there, which means that you’re getting some utility from having it there. So, assuming that OKEx maintains trading at close to typical volume, call this 5bp/day.

Next, you need to build a probability distribution for when the funds get unlocked (let’s pretend that all the funds get unlocked all at once, for simplicity). Tons of assumptions and different sets of info come into play in divining this, and everyone’s answer will vary.

(That’s true for pricing almost any asset over any time period, though, which is the basis of the existence of trading :D)

Let’s just pick a distribution for the sake of continuing -- maybe I believe that there’s a 2% chance that the funds unlock each day for the next month, and then a 10% chance that they unlock at the end of each of the following four months.

That’d mean I expect my funds to be locked up for, on average, .02 * 1 + .02 * 2 + … + .02 * 30 + .1 * 60 + .1 * 90 + .1 * 120 + .1 * 150 = 51.3 days. Since the marginal capital cost is 5bp/day, that should cost me about 2.5%.

Cool -- so if we know ~the funds are safe~ then maybe about a 2.5% discount is fair, assuming some things about timeline and my marginal returns. What are the chances that the funds are actually safe?

OKEx, of course, claims 100%. Again, everyone has their own opinion here about what sorts of factors that might render the funds impossible to salvage could be at play and how likely they are -- China clamping down, CEO being MIA forever, etc. And this probability is critical.

Is it really plausible that this probability is as high as 20%? Maybe! I don’t claim to be an expert on any of the relevant factors. So let’s call it 20%, again for the sake of continuing (I’m not claiming to believe that’s the real probability, could be way less or way more).

It does strike me as not especially likely that cases where funds cannot be recovered, on average, lead to 100% of funds not being able to be recovered -- let’s call it an average of 75% of funds that never get recovered whenever this occurs.

This would lead to a discount of .2 * .75 = 15% from this factor, plus .8 * 2.5% = 2% for capital cost the rest of the time. That leads to an overall fair discount of 17% -- using a TON of assumptions that could be really off.

Maybe I have some (perceived) information about what’s actually going on with the CEO, and I therefore think that it’s HIGHLY unlikely that the funds actually not get recovered -- my fair discount should then start a LOT lower (much closer to 2.5%). I’m not sure which is better!

And that’s just one part of the story, anyway -- I think various market conditions should have WAY outsized impact in a situation like this one, and fairs should be fairly quickly abandoned / updated as new information arises.

In particular, I think there’s REALLY intense selection bias in a market like this one -- if my starting fair discount is 5% and someone offers me their entire $50m holdings for a 20% discount, I HAVE to wonder why they’re willing to do that.

Do they actually have marginal return on capital -- for any exchange vs. just for OKEx -- high enough to justify that? Probably impossible, even if trading on OKEx totally dries up. That HAS to imply they’re pricing risk of ruin very, very high.

And if they have that much money on OKEx, should I be updating toward their opinion? It might imply some probability of them having ties to OKEx in a way where I should maybe assume they know something I don’t, sometimes. Or even that they learned public info faster than I did.

Either way, I definitely have to consider that this other party has information I don’t of some nature -- and that’s terrifying, so I’m going to have to strongly think about my own information, and likely update my fair -- maybe by a lot! And that might kill the trade.

(Or, it can also imply that they’re SUPER risk-averse, for some reason, and are willing to pay for insurance -- if I can become convinced of this, or just that they’re wrong, a trade COULD happen in this case, and I think buying insurance is the main way this market will exist.)

On some level, these are the kinds of considerations I have all the time when thinking about all kinds of trades -- after all, someone’s always on the other side of all my trades, and each time I make a trade I’m choosing to trust my info over theirs. What’s different here?

Mainly how drastically fairs change when you make small perturbations about starting assumptions, and just how uncertain those assumptions are for the whole world right now. Information is power here, and a big order implies information.

We’ve found that rarely to be the case for, e.g., BTC -- but sometimes to be the case for big shitcoin trades. Selection bias will tend to be a bigger factor the more idiosyncratic the trade is, and the more sorts of things your counterparty could know that you don’t.

So, if this market does end up existing, I think it will be more important than almost ever to questions our own assumptions really aggressively -- selection bias can be a killer. (And note: I really *don’t* have a clue what my fair is for this right how, need to think on it.)