Why I am converting SBD into Steem now

Hi everyone,

this is a rather technical post and I am not 100% sure if I have understood everything correctly. So please do not take this as financial advice - and correct me if I made a mistake. I have been helped to better understand the technicalities by discussions with @reggaemuffin and @therealwolf as well as a post by @themarkymark ( link) and some comments made to this post by @smooth. Also, I did use the official Steem Whitepaper.

So lets start:

May first idea was plain and simple - the value of 1 SBD is currently around 0.80 USD on the exchanged - but via the convert function I am able to convert 1 SBD into 1 USD worth of Steem. It will take 3.5 days for the conversion to be done and I will not get the current price of Steem but the average price over this period, but hey, there is a 20% margin of safety for this trade to work out as I have to pay only 0.8 USD to get one 1 SBD. Sounds like a simple and highly profitable deal - and the best is, I would even help to save the peg of the SBD to the USD by reducing its supply (my SBD will be burned).

Saving the peg?

But wait a minute - when I am helping to save the peg - is the peg in danger and how does it affect my trade? After some more research I realized that conversions for 1 USD will only be possible if the debt ratio does not surpass 10%. But what is this debt ratio and how is it calculated?

The debt ratio

The debt ratio is calculated by (virtually) converting all SBD into Steem and then calculating the ratio of this amount to the full virtual supply of Steem, which includes the current supply as well as the virtually converted SBD. This current ratio can be found for example at steemworld.org. Looking it up shows that the current ratio is still well below 10% - so I should at first glance be safe as I would suspect many others to to the same operation, which would result in a reduction of the amount of SBD.

Looking backwards...

However, the current ratio is not what is relevant for my conversion. It is calculated by using the 3.5day average price of Steem, which is currently around 0.575 USD. Unfortunately, the huge decrease in the Steem price over the last days has resulted in a current Steem price of only 0.40 USD. Not so pretty...

… into the future

If we assume that the Steem price remains at 0.40 USD for the next 3.5 days, the relevant price for my conversion would be 0.40 USD. Doing the math based on this price would result in a SBD Debt ratio of 11% - something which is ruled out by the creators of the Steem blockchain. This means that if the total supply of SBD and Steem as well as the price of Steem remain unchanged, I would not get my SBD converted into Steem for the price of 1 USD worth of Steem for 1 SBD.

But what does this mean?

The blockchain will automatically reduce the conversion ratio downwards. This is necessary in order to make sure that in case of a black swan event Steem does not become inflated to an infinite amount. This could happen if the total market cap of Steem would fall below the theoretical market cap of the SBD, which is currently around 14 million USD. In this case, there would not be enough Steem available to convert all SBD into Steem for a thoretcial value of 1 USD per SBD.

If my understanding of the whitepaper is right, the conversion price would be brought down to the price, at which the 10% limit would not be exceeded. In our example and assuming supply and price to remain unchanged, this would mean that Steem has a total market cap in USD of USD 113m. Given that the debt ratio is allowed to amount to up to 10%, this would represent 90% of the virtual market cap of the whole Steem universe, which would thus amount to 125.7m USD. This leaves a market cap of 12.6m USD for the SBD part. From this we can calculate the conversion price, which amounts to 0.90 USD.

Here is the deal

So in case nothing changes, I would not be able to convert 0.8 USD worth of SBD into 1 USD worth of Steem - but I would still be able to convert it into 0.90 USD worth of Steem - which remains a great deal.

Is this a safe profit?

No, it is not possible to game the system and make a sure profit. E.g. the Steem price could go down a lot more - lets assume it goes to 0.20 USD over the next 3.5 days, with the average amounting to 0.30 USD. This would lower my conversion price to 0.67 USD - a loss of 16% versus the alternative to hold fiat. But it is still the far better deal than to own Steem directly.

What might also happen is that the Steem price recovers - lets say to 0.8 USD over the next 3.5 days - an increase of 100%. Assuming that the average price would then by about 0.60 USD we would be able to convert at a value of 1 USD - but not based on the current price but on the average price over the last 3.5 days. We would thus get 1.67 USD worth of Steem based on the last price - while we would have gotten 2 USD in case we would have invested in Steem in the first place. This would be a nice profit - but only if we have not sold Steem in order to buy SBD in the first place.

Is there something that could also work in our favour?

One thing that could work in our favour is the fact that the supply of SBD might shrink as user convert their SBD into Steem. However, this is a double edged sword as this is also putting pressure on the Steem price, which is working against our odds in this trade.

Conclusion

To be honest, I did already start to convert before I even completely understood what I was doing. Not very wise and clearly not something which is advisable. With what I know now, however, I continue to believe that this remains a smart trade. I like the idea that I have a bit of downward protection, while at the same time being able to benefit from a possible rebound of the price. This is why I continue to buy additional Steem for Fiat, convert it to SBD on the market and then use the convert fuction to convert it into Steem again.

As mentioned above, this is no financial advice and I would also not rule out that there might be a mistake in my thinking. The whole stuff is extremely complicated to understand and not straight forward. If you see any mistakes in my thinking, please let me know.

Best regards,
Tim