> But if I had some sort of insurance that I'll get my bitcoins back
That's the problem. That insurance is not possible within Bitcoin. In equities markets, shorting is possible because the broker can force the borrower to cover and return the borrowed security. The broker can in turn resort to another layer of force in legal recourse if the borrower doesn't have sufficient cash deposited with the broker.
In Bitcoin, no entity can ever compel another to spend bitcoins (to the protocol, anything like asset seizure or any other method of surrendering a bitcoin is spending.) So the short-seller can walk away and never cover a short position that went badly, and the lender never receives back his bitcoins. For Bitcoin shorting to exist requires a broker with some way of enforcing non-Bitcoin power over the short-seller, perhaps a deposit in a fiat currency or some other kind of collateral. It is possible for this to exist but not at all simple.
> That's the problem. That insurance is not possible within Bitcoin.
Sure it is. Berkshire Hathaway and others insure satellite launches. If the launch vehicle explodes on takeoff there is zero recourse because, much like a Bitcoin trade gone bad, everything is lost and the insurance payout covers a rebuild plus an entirely new launch.
The solution involves the insurance companies understanding the risks involved, forcing Bitcoin companies to implement specific security measures designed to mitigate risk, and accepting the fact that they will have to pay out a certain percentage of trades. The premium charged for the insurance plus the deductible cost to make a claim reflects the risk of fraud + expected profit. This is a solved problem in the insurance industry already.
The only remaining question is which insurance company will put sufficient effort into understanding the risks so that they can issue a product to meet whatever market demand exists?
It's not possible within Bitcoin. An insurer as you describe is certainly possible -- but relies on a level of trust or force outside the Bitcoin protocol. A Bitcoin insurer can never be compelled to pay out its promise. Insurance in fiat currency works because there is a level of legal recourse that can apply force if necessary: you sue the insurer and the court seizes funds from their bank account. Insurance in Bitcoin alone can't work because the insurer's promise can't be enforced. A bitcoin cannot be seized except by gaining control of its wallet.
Hypothetically, the legal system could enforce Bitcoin contracts in this way, with legislation that a Bitcoin wallet can be seized under the threat of other penalties such as imprisonment. But until that happens, Bitcoin insurance and shorting can only exist as far as you trust the insurer or the lender trusts the shorter, because there is no ultimate avenue of forcible recourse.
That's the problem. That insurance is not possible within Bitcoin. In equities markets, shorting is possible because the broker can force the borrower to cover and return the borrowed security. The broker can in turn resort to another layer of force in legal recourse if the borrower doesn't have sufficient cash deposited with the broker.
In Bitcoin, no entity can ever compel another to spend bitcoins (to the protocol, anything like asset seizure or any other method of surrendering a bitcoin is spending.) So the short-seller can walk away and never cover a short position that went badly, and the lender never receives back his bitcoins. For Bitcoin shorting to exist requires a broker with some way of enforcing non-Bitcoin power over the short-seller, perhaps a deposit in a fiat currency or some other kind of collateral. It is possible for this to exist but not at all simple.