This is an editorial review by Max Keidun, CEO of peer-to-peer bitcoin exchange Hodl Hodl.
The Bitcoin lending space has suffered from several major issues in recent months and years: the fallout from the Terra/Luna crash, affecting Celsi and BlockFi and now FTX, to continuous price declines, to liquidity crises given the market’s various accusations. manipulation etc.
All this led to significant losses, bankruptcies and a complete restructuring of the credit market. Many users have lost faith in bitcoin-based loan products, and the market appears to be at historic lows, both in terms of volume and public trust.
As usual, the mainstream media blamed these crises on Bitcoin itself. But is it Bitcoin’s fault? Does this make Bitcoin less attractive? Does this mean we shouldn’t accept bitcoin as collateral? No!
Bitcoin Is Super Collateral, Failed Lenders
While the Bitcoin code is the law, custodial loan platforms are trusted third parties, owned and operated by private entities. Trusted third parties are security holes. This was true before Bitcoin and it is still true today.
Furthermore, most bitcoin lending platforms are poorly conceived, poorly developed, and poorly managed. This does not necessarily mean bad code. The code may be well written, properly audited and verified, but there may still be poor incentives from the design of the lending platforms. If the focus is on treating bitcoin as an income generating asset, we are likely to be in trouble.
The longer the “Bitcoin lending” industry has been around, the more it’s become clear that most participants don’t really understand how the income is generated. And as they say, if you don’t know where the product comes from, then you is productivity. What this really means is that your bitcoin is being used as the basis for risky investments, and it’s likely only a matter of time before the house of cards starts to crumble.
I believe that the right focus for integrating bitcoin into intermediary lending is to appreciate how valuable and unique bitcoin is and treat it as something to borrow: understanding that bitcoin is super-collateral. But what makes it so unique?
We can identify twelve characteristics that do this:
Bitcoin is liquid
Bitcoin is an extremely liquid asset. It trades 24/7 with no weekend breaks or bank holidays. Massive liquidity pools exist globally for various fiat currencies. For lenders, this means that if you want to convert your collateral to fiat, you can do so immediately—either because the borrower is liquidated or because the loan is paid off from the collateral.
It also allows you to hedge against risks. Bitcoin may be the only loan collateral that can be instantly and dynamically hedged: a serious competitive advantage.
Bitcoin is programmable
Bitcoin enables the creation of programmable credit products and proprietary mechanisms. Among other advantages, this feature allows us to solve the problem of trusted third parties by building non-recourse credit mechanisms and storage systems. For example, we can distribute collateral claims or create conditional logic for payment to be automatically executed by the Bitcoin network rather than the whims of a centralized financial institution.
Bitcoin is scarce
There will be a total of 21 million bitcoins. Your collateral becomes more valuable over time, which means you have less incentive to sell and likely more lenders willing to accept it.
Bitcoin is Flexible and Transparent
Bitcoin allows for selective transparency of your assets when useful, but also full anonymity when desired. For example, in a lending scenario, you can easily prove to the lender that you own and control the collateral in question.
Bitcoin is Sovereign
Bitcoin is yours. Just like the keys to your house and car, you have keys to your bitcoin. Bitcoin is your personal property. If you use a house or car as collateral, you won’t own it – your lender will. With Bitcoin, you can still hold it contingently during your loan agreement. In fact, with the right tools, you can not only use this collateral, but continue to use it for the duration of the loan agreement.
Bitcoin is Safe
Bitcoin is cryptographically, economically and socially secure. It makes sense to think that Bitcoin’s lowest-level network security extends to the toolset it’s built on top of. For example, you can share ownership of collateral between multiple independent parties, use offline wallets, and use more security methods.
Bitcoin governs the market
Bitcoin is the essence of a market-based asset. The price of Bitcoin reflects the market almost instantaneously and is not determined by one or a few individuals. It is extremely difficult to manipulate the price of Bitcoin. Bitcoin costs almost the same as fiat anywhere in the world and is determined by the global market.
Bitcoin is a Real Time Asset
Not only can we track the price of bitcoin collateral in real time, but Bitcoin’s blockchain allows you to track your collateral address in real time. Any price changes can be reacted accordingly. As mentioned, there are no weekends or holidays and the market is always open to everyone, so no one will close the market on Friday and open on Monday with different prices.
Bitcoin is Objective
Bitcoin is honest. Bitcoin costs the same fiat price in Miami as it does in Lugano or Riga. Bitcoin doesn’t care if you like it or not. The price of Bitcoin cannot be determined by your personal views or forecasting abilities. To borrow against bitcoin, you just need to own bitcoin. Your credit history, social score, or anything else doesn’t matter to the lender because you have collateral to back the loan.
Take real estate for example. The same amount of money can buy you different properties in different countries with the same level of economic and social development. So what’s the difference? Why can you buy a mansion on the Mediterranean coast in Spain or Italy and not a suitable house in the Bay Area in the US for the same amount of money?
This is due to people’s ability to judge irrationally. Since real estate valuation is primarily based on human factors, banks value your property as either too expensive or too cheap, depending on market conditions and plans.
Or take stocks for example. Your shares in a particular company may have good fundamentals and great potential growth, but suddenly the CEO of that company tweets something stupid and you lose money or get liquidated. Meanwhile, Bitcoin is fair.
Bitcoin is Global
Bitcoin is globally accessible and globally distributed. For lending, this means you can borrow remotely from anywhere in the world, and you can lend money to anyone in the world as collateral using bitcoin. Bitcoin is neither limited to nor exclusively exposed to specific local markets.
Bitcoin is Digital
In the digital age, with digital commerce, we need digital collateral. Bitcoin is now online. It’s here, in your car, on your phone, in your cold wallet. Bitcoin enables remote and instant borrowing. There is no need to digitize bitcoin because you are dealing with real estate, land, cars or any other assets. It’s now digital.
Bitcoin is Decentralized
Bitcoin has no single point of failure. Bitcoin has been attacked many times, but it is growing and expanding globally. No single committee or individual is responsible for Bitcoin. Having decentralized collateral significantly reduces your dependence on single events and failures of companies or people. You are protected by a distributed network.
Will lending ever match Bitcoin’s potential?
Strong collateral requires strong tools. Is it possible to create credit instruments that match the value of bitcoins? To do this, we all need to take a step back and examine Bitcoin’s white paper.
After reading Bitcoin’s white paper, you will understand that in order to create a successful credit product (in fact, any Bitcoin product!), you need to meet three main criteria. If your product has all three, you’ve passed the test, congratulations. Let’s call it the “Satoshi Test”.
- Your service must be non-custodial. Remember: not your keys, not your coins. When using custodial loan platforms, you run the risk of losing your collateral entirely. Because once bitcoin hits the platform wallets, they are no longer yours. This is exactly what happened to the clients of many credit and trading platforms that failed in 2022.
- Bitcoin is a peer-to-peer, electronic money system. Again: peer. Instead of acting as an intermediary, you should provide the technical means for individuals or businesses to work with each other. Or you can have a business that will allow customers to interact directly with your platform. A good example is a platform that allows customers to buy bitcoin directly in their cold storage.
- Your platform must be Bitcoin only, meaning the only collateral you have to work with must be bitcoin. Shitcoins are risky and the code of shitcoins is a ticking time bomb. By integrating multiple blockchains into your product, you deliver the most valuable to the most vulnerable.
There is an additional criterion that can be met: anonymity. If you are building non-secure, Bitcoin-only, peer-to-peer products, this can and will allow you to offer your customers anonymity and better privacy, because without anonymity, security is incomplete and your customers’ data must be protected. , as well as their funds.
A good way to pass the Satoshi Test is to use multisig. Multisig is a simple and safe yet powerful tool. It allows users to offer peer-to-peer interactions, use custody-free deposits, and use only Bitcoin. It also allows you to offer better privacy for your users.
For example, take a three-key multisig setup where a consensus mechanism is achieved by including at least two keys. This is called “two out of three Bitcoin multisig”. In this type of setup, you – as the technical tool provider – can become one of the key owners, but you won’t have full control over the customer funds (because you only have one key!), so you will ensure that those funds are earned. t must be carried and not re-hypothecated. For example, the lender will have one key, the borrower will have another key, and the provider will have the third key. Such a setup will allow users to verify that the funds are used only by them and that all parties must act according to the rules to reach a consensus and no party can act in a suspicious and shady way.
In fact, there are already powerful platforms that use Bitcoin multisig and offer peer-to-peer interaction. These platforms can provide lenders and borrowers around the world with easy two-to-three multisig setups with one switch on each side (including the platform itself). Multisig is built on Bitcoin’s public blockchain, meaning you can verify your pledge through any block explorer at any time. And the best part is that no funds can be rehypothecated, because the platform itself has only one key, which ensures that each involved counterparty acts well and professionally.
The Right Lending Platforms Can Benefit HODLers
While the credit market is currently facing turbulence and contagion, now is a good time to educate yourself about the right lending platforms that could be beneficial for any genuine HODLers in the future. As we enter the next bull period, there will be less incentive to sell bitcoin and more interest in holding it long and borrowing against it. Get ready because bear markets don’t last forever. HODL and learn!
This is a guest post by Max Keidun. The views expressed are entirely their own and do not necessarily reflect the views of BTC Inc or Bitcoin Magazine.