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The article discusses the evolution of Bitcoin and its financialization process while retaining its local characteristics. With the emergence of various income products, people are now thinking about how to promote Bitcoin’s financialization process while maintaining its local characteristics. The article discusses different categories of Bitcoin income products, from local consensus and assets to income, and emphasizes the importance of localized design in reducing trust dependence and counterparty risk.
The article analyzes existing solutions and uses the Brick Towers project as an example to show how Bitcoin’s local consensus, assets, and income can be combined to achieve near-perfect Bitcoin compatibility. The article emphasizes the importance of balancing innovation and risk management in the process of digital currency financialization. Despite facing many challenges and unknown factors, Bitcoin, as an open and decentralized protocol, will continue to lead the development direction of financial technology with its localized design and basic characteristics.
Bitcoin is undergoing a remarkable evolution, and there are multiple views on its essence. Some people believe that it is a currency for daily transactions, while others believe that it is a modern gold used for storing value. Some people also see it as a decentralized global platform for protecting and verifying off-chain transactions. Although these views have their merits, Bitcoin is increasingly being viewed as a digital basic currency.
Bitcoin’s function is similar to physical gold, serving as an asset holder, inflation hedging tool, and providing currency denominations similar to the US dollar. It is reshaping the concept of currency basic assets. Its transparent algorithm and fixed supply of 21 million units ensure a non-discretionary monetary policy. In contrast, traditional fiat currencies such as the US dollar rely on central authorities to manage their supply, which raises questions about their predictability and effectiveness in the volatile, uncertain, complex, and ambiguous (VUCA) era.
This comparison is particularly prominent in the criticism of centralized currency decisions by Nobel laureate Friedrich August von Hayek in his book “The Pretense of Knowledge.” Bitcoin’s transparent and predictable monetary policy contrasts sharply with the opaque and potentially unpredictable nature of traditional fiat currency management.
For staunch Bitcoin supporters, the 21 million supply cap is sacred and inviolable. Changing this limit would fundamentally change the nature of Bitcoin and make it completely different. Therefore, the Bitcoin community is generally skeptical of leveraged Bitcoin. Many people believe that any form of leverage is similar to fiat currency practices and undermines the core principles of Bitcoin.
This skepticism about leveraged Bitcoin is rooted in the distinction between commodity credit and circulation credit outlined by Ludwig von Mises. Commodity credit is based on real savings, while circulation credit has no such support and is similar to unsecured promissory notes. Bitcoin supporters believe that leveraged operations create “paper bitcoins” that are economically risky and unstable.
Even some of the more nuanced views within the community remain cautious about leveraged Bitcoin, consistent with the position of Caitlin Long and others. Caitlin Long has been warning about the dangers of leveraged Bitcoin. The collapse of some leveraged Bitcoin lending companies such as Celsius and BlockFi in 2022 further reinforced Long’s and others’ concerns about the risks of leveraged Bitcoin.
The cryptocurrency market experienced a significant upheaval similar to the collapse of Lehman Brothers in 2022, triggering widespread credit tightening and affecting multiple participants in the cryptocurrency lending field. Contrary to assumptions, most cryptocurrency lending activities are not peer-to-peer and carry significant counterparty risk, as customers lend funds directly to platforms that then invest these funds in speculative strategies without adequate risk management.
During the DeFi summer of 2020, the rise of major DeFi protocols provided promising avenues for generating income. However, many of these protocols lack sustainable business models and token economics. They rely heavily on the inflation of protocol tokens to maintain attractive returns, resulting in an unsustainable ecosystem that departs from basic economic principles.
The cryptocurrency credit tightening in 2022 exposed various problems with centralized income tools, highlighting concerns about transparency, trust, and counterparty risk, as well as liquidity, market, and off-chain risk management. It also highlighted the flaws in centralized and off-chain risk management processes, which mimic the flaws of traditional banks when applied to blockchain-based “banking services.”
Although the bull market of 2020 and 2021 brought optimism, the lack of these necessary processes led to the collapse of many institutions such as Voyager, Three Arrows Capital, Celsius, BlockFi, and FTX. The inability to transparently and independently implement necessary checks and balances often leads to overregulation and constant failures and fraud, reflecting the historical challenges of the traditional banking system. However, the lack of regulation is not a solution either.
Given the events of 2022, more and more Bitcoin supporters are asking whether we should accept Bitcoin income products or whether they pose too much risk, similar to the fiat currency system. Although these concerns are valid, it is unrealistic to expect Bitcoin income products to disappear completely.
With the development of the emerging Bitcoin ecosystem, this issue is becoming increasingly prominent. More and more projects are building or claiming to develop financial infrastructure and applications directly on Bitcoin. Will this once again lead to the problems we have seen in the broader cryptocurrency field?
It is likely because this is the nature of the game. Since Bitcoin is a permissionless protocol, anyone can build on it, including those who want to establish a Bitcoin-driven financial system. And financial systems inevitably require credit and leverage.
This is a historical fact: in any prosperous society, the demand for credit and income naturally arises and becomes a catalyst for economic growth. Without credit, underdeveloped economies struggle to escape survival mode. Only by obtaining credit can more complex and efficient economic structures be formed.
To realize the Bitcoin-based economic vision, supporters recognize the need to develop credit and income mechanisms on top of the Bitcoin protocol. Although Bitcoin is often praised for its role as a currency, the reality is that it needs a local economy to support it in order to operate effectively as a currency.
This highlights the importance of Bitcoin-based income products in promoting Bitcoin-centered economic growth. Such an ecosystem will use Bitcoin as its digital basic currency while using income products to promote its adoption and use.
This is all a matter of trust, anonymity, and scope. A Bitcoin-driven financial system will inevitably be built in layers. From a system perspective, this is not much different from the current financial system, which also has inherent layers in similar currency-like assets. To understand these necessary trade-offs correctly,We need a high-level framework to distinguish the implementation of Bitcoin at different levels.
When providing Bitcoin returns, it is essential to understand that these options can be built within a triple trust framework. The main points to focus on are:
– Consensus
– Assets
– Returns
Assessing Bitcoin-based assets and investment products based on the degree of Bitcoin nativeness provides a valuable framework for evaluating their consistency with the spirit of Bitcoin. Assets and products that score higher on this spectrum usually minimize trust, reducing reliance on intermediaries and instead depending on transparent and flexible code.
This shift reduces counterparty risk, as reliance shifts from off-chain intermediaries to code. The transparency of the code enhances flexibility compared to the need to trust intermediaries.
This is a development direction worth exploring, and creating native income options for Bitcoin should be the gold standard and ultimate goal of the Bitcoin community.
Consensus Perspective
Based on the consensus consistency of the Bitcoin blockchain, Bitcoin income products can be divided into four categories.
No consensus: This category refers to infrastructure that is still centralized off-chain platforms. For example, centralized platforms like Celsius or BlockFi, which fully control user assets, exposing users to counterparty risk and reliance on intermediaries. Although these platforms use Bitcoin, their income strategies are mainly executed off-chain through traditional financial mechanisms. While these platforms are a step towards Bitcoin adoption, they are still highly centralized, similar to traditional financial institutions, but often lack regulation.
Independent consensus: In this category, the infrastructure is decentralized, represented by public blockchains such as Ethereum, BNB Chain, Solana, and other blockchains. These blockchains have their independent consensus mechanisms and are not explicitly linked to Bitcoin’s consensus.
Inherited consensus: In this category, the infrastructure is decentralized, represented by distributed consensus representatives of Bitcoin sidechains or Layer-2 solutions. Although these sidechains have their own consensus mechanisms, they are designed to align more closely with the Bitcoin blockchain. Examples include federated sidechains such as Rootstock, Liquid Network, or Stacks.
Native consensus: This category relies on Bitcoin’s own consensus mechanism as the basis for the security model. It does not use independent blockchains or sidechains but utilizes off-chain state channels linked to the Bitcoin blockchain using cryptographic methods. The Lightning Network is a significant example of this approach, providing a high level of trust minimization through full reliance on Bitcoin’s consensus.
The closer Bitcoin income products are to the native consensus of Bitcoin, the higher their alignment with Bitcoin, and they are generally considered to have a higher degree of trust minimization. However, in the independent consensus and inherited consensus categories, there are subtle differences in the degree of decentralization and security of the infrastructure.
Overall, the level of decentralization and trust minimization is lowest in the no consensus category, while native consensus is considered to provide the highest level of trust minimization, although considerations for consensus security and decentralization still require further analysis.
Asset Perspective
When considering the assets used in Bitcoin income products, their alignment with Bitcoin can be divided into three categories.
Non-BTC: This category includes solutions using assets other than BTC, resulting in lower alignment with Bitcoin. An example is Stack’s stacking options, where Stack’s native token STX is used to generate BTC returns.
Tokenized BTC: In this category, the assets used are tokenized versions of BTC, which improve alignment with Bitcoin compared to non-BTC assets. Tokenized BTC can be found on public blockchains such as Ethereum (WBTC, renBTC, tBTC), BNB Chain (wBTC), Solana (tBTC), and are also custodied on Bitcoin sidechains with inherited consensus mechanisms, such as sBTC, XBTC, aBTC, L-BTC, and RBTC.
Native BTC: The assets in this category are on-chain Bitcoin (BTC), without any tokenized versions, providing the highest level of Bitcoin alignment. Various CEX solutions and Babylon’s Bitcoin staking protocol directly utilize BTC. Babylon aims to enhance Bitcoin’s security by adapting proof of stake mechanisms for Bitcoin staking. Additionally, projects like Stroom Network utilize the Lightning Network to implement liquid staking, where users can earn Lightning Network income by depositing BTC and minting wrapped tokens like stBTC and bstBTC on EVM-based blockchains for a wider DeFi ecosystem.
Return Perspective
When examining the returns of Bitcoin income products, the issue of alignment with Bitcoin arises, leading to a similar classification as in the asset perspective: non-BTC, tokenized BTC, and native BTC.
Non-BTC returns: Babylon provides returns through its proof of stake (PoS) blockchain’s native assets, enhancing the security of the blockchain through Babylon’s staking mechanism.
Tokenized BTC returns: Stroom Network offers returns in the form of lnBTC tokens. Sovryn, running on Rootstock, facilitates Bitcoin lending using tokenized BTC (RBTC) as returns. On the Liquid Network, Blockstream Mining Note (BMN) provides BTC or L-BTC returns upon maturity, offering a way for eligible investors to obtain Bitcoin hashpower through secure tokens that comply with EU standards.
Native BTC returns: Stacks offers various options, including returns paid in tokenized BTC in certain income applications, utilizing sBTC. However, for Stack’s stacking options, returns accumulate in native BTC. Similarly, some CEX-provided centralized income products distribute native BTC as returns to users.
Bitcoin’s Gold Standard: Full Nativeness
Considering the ideal Bitcoin-based income products, the gold standard product would combine the following three characteristics: native Bitcoin consensus, native Bitcoin assets, and native Bitcoin returns. Such a product would closely mimic a perfect alignment with Bitcoin.
Currently, such solutions are just beginning to be developed. One actively developing project is Brick Towers. Their vision for the ideal Bitcoin-based income product encompasses achieving close to perfect Bitcoin alignment by incorporating native Bitcoin consensus, assets, and returns. Brick Towers focuses on Bitcoin as a long-term savings solution, aiming to provide customers with minimal trust reliance and a native approach to utilizing Bitcoin.
Their planned solution revolves around generating native income within Bitcoin, utilizing Brick Towers’ automated services for other nodes in the Lightning Network. By optimizing algorithms to address economic efficiencies, capital is strategically allocated to meet the liquidity needs of other network participants, optimizing capital efficiency while minimizing counterparty risk.
This approach not only promotes the growth of the Lightning Network but also enhances the practicality of Bitcoin as an asset, while providing customers with a seamless and secure way to earn income from holding Bitcoin. Importantly, Brick Towers’ solution avoids the use of wrapped coins, further reducing counterparty risk and reinforcing their commitment to the native Bitcoin ecosystem.
