Can Bitcoin be a productive asset?

Original authors: Pascal Hügli, Brick Towers

Original translation: Luccy, BlockBeats

Editor's note: With the maturation of the Bitcoin market and the emergence of various income products, people are beginning to consider how to promote its financial process while maintaining the local characteristics of Bitcoin. This 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.

In analyzing existing solutions, using the Brick Towers project as an example, Pascal Hügli demonstrates how to achieve a close match to Bitcoin by combining local Bitcoin consensus, assets, and income. This 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 direction of financial technology with its localized design and fundamental characteristics.

Bitcoin is undergoing a remarkable evolution, and there are multiple views on its fundamental nature. Some people think it is a currency for daily transactions, some believe it is a modern gold for storing value, and others see it as a decentralized global platform for protecting and validating off-chain transactions. While these views all have their merits, Bitcoin is increasingly seen as a digital base currency.

The function of Bitcoin is similar to physical gold, serving as a holding asset, hedging tool against inflation, and providing a currency denomination similar to the US dollar. Bitcoin is reshaping the concept of the basic currency asset. 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, raising questions about their predictability and effectiveness in the volatile, uncertain, complex, and ambiguous (VUCA) era.

This contrast is particularly prominent in the criticism of centralized currency decision-making by Nobel laureate Friedrich August von Hayek in his book 'The Pretense of Knowledge'. The transparent and predictable monetary policy of Bitcoin contrasts sharply with the opaque and potentially unpredictable characteristics of traditional fiat currency management.

Do you want to make use of BTC

For staunch Bitcoin supporters, the 21 million supply cap is sacred and inviolable. Changing this limit would fundamentally alter the nature of Bitcoin, making it completely different. Therefore, the Bitcoin community generally views leveraged Bitcoin with skepticism. Many believe that any form of leverage is akin to the practices of fiat currency, undermining the core principles of Bitcoin.

This suspicion of 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 lacks such support and is similar to unsecured promissory notes. Bitcoin supporters believe that leveraged trading creates 'paper Bitcoin' that is economically risky and unstable.

Even some more nuanced viewpoints within the community are cautious about leveraged Bitcoin, consistent with the stance of Caitlin Long and others. Caitlin Long has been warning about the dangers of leveraged Bitcoin. In 2022, the collapse of leveraged Bitcoin lending companies such as Celsius and BlockFi further reinforces Long's and others' concerns about the risks of leveraged Bitcoin.

Celsius and other companies have proven this.

The encryption market experienced a major upheaval similar to the collapse of Lehman Brothers in 2022, triggering widespread credit tightening and affecting multiple participants in the encryption lending field. Contrary to popular belief, most encryption lending activities are not peer-to-peer and there is considerable counterparty risk, as customers lend funds directly to platforms which then invest these funds in speculative strategies without adequate risk management.

During the 2020 DeFi summer, the rise of major DeFi protocols provided promising avenues for generating returns. However, many of these protocols lack sustainable business models and tokenomics. They heavily rely on inflation of protocol tokens to sustain attractive returns, resulting in an unsustainable ecosystem that deviates from fundamental economic principles.

The cryptocurrency credit tightening in 2022 exposed various problems with centralized income tools, highlighting concerns about transparency, trust, liquidity, market and counterparty risk. In addition, it also highlighted the shortcomings of centralized and off-chain risk management processes, which mimic the shortcomings of traditional banks when applied to blockchain-based 'banking services'.

Although the bull markets in 2020 and 2021 brought optimism, many institutions such as Voyager, Three Arrows Capital, Celsius, BlockFi, and FTX have collapsed due to the lack of these necessary processes. The inability to implement necessary checks and balances transparently and independently often leads to overregulation and continual failures and fraud, reflecting the historical challenges of the traditional banking system. However, the lack of regulation is not the solution either.

Bitcoin Profit is not an Option

So how should we respond? In light of this event in 2022, more and more Bitcoin supporters have raised the question: should we accept Bitcoin income products or do they carry too much risk, similar to the fiat currency system? While 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 establishing or claiming to develop financial infrastructure and applications directly on Bitcoin. Will this once again bring about the problems we have already seen in the wider encryption field?

It's very likely. Because that's the nature of the game. Since Bitcoin is a permissionless protocol, anyone can build on top of it, including those who want to build Bitcoin-driven financial systems. And financial systems inevitably need credit and leverage.

This is a historical fact: in any prosperous society, the demand for credit and returns naturally arises and becomes a catalyst for economic growth. Without credit, underdeveloped economies find it difficult to escape the state of survival. Only by obtaining credit can a more complex and efficient economic structure be formed.

To achieve the economic vision based on Bitcoin, supporters realize 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 in order to function effectively as a currency, it needs a local economy to support it.

This highlights the importance of Bitcoin-based yield products in promoting Bitcoin-centric economic growth. Such an ecosystem will leverage Bitcoin as its digital base currency and drive its adoption and use through yield products.

This is all a trust range, anonymous

A Bitcoin-driven financial system will inevitably be built in layers. From a systemic perspective, this is not much different from the current financial system, as there are inherent levels in similar currency assets. To correctly understand these inevitable trade-offs, we need a high-level framework to distinguish Bitcoin implementations at different levels.

When providing Bitcoin returns, it is important to understand that these options can be built along a triple trust range. The main focus should be on:

• Consensus
• Assets
• Revenue

Evaluating Bitcoin-class assets and Bitcoin-yield products based on the degree of Bitcoin's localism provides a valuable framework for assessing their consistency with the spirit of Bitcoin. Assets and products that score higher on this spectrum typically minimize trust, reduce reliance on intermediaries, and instead rely on transparent and flexible code.

This shift reduces counterparty risk, as reliance on off-chain intermediaries has been replaced by code. The transparency of the code enhances flexibility compared to the need for trusted intermediaries.

This is a development direction worth exploring, creating local income options for Bitcoin should be the gold standard and ultimate goal of the Bitcoin community.

Consensus Perspective

According to the consensus of the Bitcoin blockchain, Bitcoin revenue products can be divided into four categories.

No consensus: This category refers to infrastructure that is still centralized off-chain. For example, centralized platforms like Celsius or BlockFi have complete control over users' assets, exposing users to counterparty risks and reliance on intermediaries. Although these platforms use Bitcoin, their profit strategies are primarily 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 own consensus mechanisms independent of Bitcoin, and are not explicitly linked to the consensus of Bitcoin.

Inherited Consensus: In this category, the infrastructure is decentralized and represented by distributed consensus from 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.

Local Consensus: This category relies on the consensus mechanism of Bitcoin itself as the basis of the security model. It does not use independent blockchains or sidechains, but instead utilizes encryption to link to off-chain state channels of the Bitcoin blockchain. The Lightning Network is a significant example of this approach, providing a high level of trust minimization by fully relying on the consensus of Bitcoin.

Bitcoin income products that are closer to the local consensus of Bitcoin have a higher degree of fit with Bitcoin and are generally considered to have a higher degree of trust minimization. However, in these two categories of independent consensus and inherited consensus, there are subtle differences in the degree of decentralization and security of the infrastructure.

Overall, decentralized without consensus and minimal trust level is the lowest, while local consensus is considered to provide the highest level of minimal trust, although consensus security and decentralization considerations still need further analysis.

Source: Brick Towers

Asset Perspective

When considering the assets used in Bitcoin yield products, they can be divided into three categories based on their fit with Bitcoin.

Non-BTC: This category includes solutions that use assets other than BTC, resulting in lower alignment with Bitcoin. An example is the stacking option for Stack, where Stack's native token STX is used to generate BTC yield.

Tokenized BTC: Here, the asset used is a tokenized version of BTC, which enhances compatibility 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), etc. In addition, tokenized BTC is hosted on Bitcoin sidechains with inherited consensus mechanisms, such as sBTC, XBTC, aBTC, L-BTC, and RBTC.

Local BTC: This asset category is on-chain Bitcoin (BTC) without any tokenized versions, providing the highest level of Bitcoin compatibility. Various CEX solutions and Babylon's Bitcoin staking protocol directly utilize BTC. Babylon aims to extend the security of Bitcoin by adapting Proof of Stake mechanisms for Bitcoin staking. Additionally, projects like Stroom Network utilize the Lightning Network for liquid staking, where users can earn Lightning Network income by staking BTC and minting wrapped tokens such as stBTC and bstBTC on EVM-based blockchains for a wider DeFi ecosystem.

Source: Brick Towers

Income Perspective

When it comes to examining the returns of Bitcoin investment products, it involves the issue of alignment with Bitcoin, resulting in similar categorizations as in assets: non-BTC, tokenized BTC, and domestic BTC.

Non-BTC earnings: Babylon provides earnings 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 provides returns in the form of lnBTC token. Sovryn, which runs on Rootstock, promotes Bitcoin lending business by using tokenized BTC (RBTC) as returns. On the Liquid Network, Blockstream Mining Note (BMN) provides returns in BTC or L-BTC upon maturity, providing accredited investors with a way to obtain Bitcoin computing power through USDT security tokens that comply with EU standards.

Local BTC earnings: Stacks offers various options, including earning in tokenized BTC in certain revenue applications using sBTC. However, for the stacking options of Stacks, earnings are accumulated in local BTC. Similarly, some centralized revenue products offered by CEX distribute local BTC as earnings to users.

Source: Brick Towers

The Gold Standard of Bitcoin: Full Localization

Considering the ideal Bitcoin-based yield products, the gold standard product will combine the following three characteristics: local Bitcoin consensus, local Bitcoin assets, and local Bitcoin yield. Such a product will mimic a close-to-perfect Bitcoin fit.

Currently, such solutions are just beginning to be built. One actively developing project is Brick Towers. Their conception of an ideal Bitcoin-based income product covers achieving close to perfect Bitcoin fit by incorporating local Bitcoin consensus, assets, and income. Brick Towers focuses on using Bitcoin as a long-term savings solution, aiming to provide customers with minimal trust reliance and localized approaches to utilize Bitcoin.

Their planned solution revolves around generating local revenue in Bitcoin, using Brick Towers' automated service for other nodes in the Lighting Network. By optimizing algorithms to solve economic benefits, capital is strategically allocated to meet the liquidity needs of other network participants, while minimizing counterparty risk and optimizing capital efficiency. 01928374656574839201

This method not only promotes the growth of the Lighting Network, but also enhances the practicality of Bitcoin as an asset, while providing customers with a seamless and secure way to earn Bitcoin holding income. Importantly, Brick Towers' solution avoids the use of wrapped coins, further reducing counterparty risk and reinforcing their commitment to the Bitcoin local ecosystem.