Can Bitcoin Become a "Productive Asset"?

Original title: "CAN BITCOIN BE A PRODUCTIVE ASSET?"
Original author: Pascal Hügli, Brick Towers
Original translation: Lucy, BlockBeats

Editor's note:
As the Bitcoin market matures and various income products emerge, people begin to think about how to promote its financialization process while maintaining Bitcoin's native characteristics. From Bitcoin's native consensus, assets to income, this article discusses different categories of Bitcoin income products and emphasizes the importance of localized design in reducing trust dependence and counterparty risk.

While analyzing existing solutions, taking the Brick Towers project as an example, Pascal Hügli shows how to achieve a near-perfect Bitcoin fit by combining native Bitcoin consensus, assets, and income. This article emphasizes the importance of balancing innovation and risk management in the process of digital currency financialization. Despite many challenges and unknown factors, Bitcoin, as an open and decentralized protocol, will continue to lead the development of financial technology with its localized design and basic characteristics.

Bitcoin is undergoing a remarkable evolution, with multiple views on its nature. Some see it as a currency for everyday transactions, others as a modern-day gold for storing value, and still others as a decentralized global platform for securing and verifying off-chain transactions. While each of these views has merit, Bitcoin is increasingly viewed as a digital base currency.

Functioning similarly to physical gold, Bitcoin is reinventing the concept of a monetary base asset as a holding asset, inflation hedge, and providing a dollar-like monetary denomination. Its transparent algorithm and fixed supply of 21 million units ensure a non-discretionary monetary policy. In contrast, traditional fiat currencies such as the dollar rely on central authorities to manage their supply, raising questions about their predictability and effectiveness in an era of volatility, uncertainty, complexity, and ambiguity (VUCA).

This contrast is particularly prominent in Nobel Prize winner Friedrich August von Hayek’s critique of centralized monetary decision-making in his book The Prepense of Knowledge. Bitcoin’s transparent and predictable monetary policy stands in stark contrast to the opaque and potentially unpredictable nature of traditional fiat currency management.

To Leverage Bitcoin

For staunch Bitcoin supporters, the 21 million supply cap is sacrosanct. Changing this cap would fundamentally change the nature of Bitcoin and make it something completely different. As a result, the Bitcoin community is generally skeptical of leveraging Bitcoin. Many believe that any form of leveraged operations are similar to the practices of fiat currencies and undermine 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 backing and is akin to an unsecured IOU. Bitcoin proponents argue that leveraging to create “paper Bitcoin” is economically risky and unstable.

Even some of the more nuanced views within the community remain cautious about leveraged Bitcoin, in line with the stance of Caitlin Long and others, who have been warning about the dangers of leveraged Bitcoin. The collapse of some leveraged Bitcoin lending companies like Celsius and BlockFi in 2022 further reinforced the concerns of Long and others about the risks of leveraged Bitcoin.

Celsius and Others Prove This

The crypto market experienced a major turmoil in 2022 similar to the collapse of Lehman Brothers, triggering a widespread credit crunch that affected multiple players in the crypto lending space. Contrary to assumptions, most crypto lending activity is not peer-to-peer and carries considerable counterparty risk, as clients lend funds directly to platforms, which then invest those funds in speculative strategies without adequate risk management.

During the DeFi Summer of 2020, the rise of major DeFi protocols offered promising avenues for yield generation. However, many of these protocols lacked sustainable business models and token economics. They relied heavily on inflation of protocol tokens to maintain attractive yields, resulting in an unsustainable ecosystem divorced from fundamental economic principles.

The 2022 crypto credit crunch exposed various issues with centralized yield instruments, highlighting concerns about transparency, trust, and liquidity, market, and counterparty risk. Furthermore, it highlighted the flaws of centralized and off-chain risk management processes, which, when applied to blockchain-based “banking services,” mimicked the flaws of traditional banks.

Despite the optimism brought about by the bull run in 2020 and 2021, the lack of these necessary processes has seen many institutions such as Voyager, Three Arrows Capital, Celsius, BlockFi, and FTX collapse. The inability to transparently and independently implement the necessary checks and balances often leads to over-regulation and ongoing failures and fraud, reflecting the historical challenges of the traditional banking system. However, lack of regulation is not the solution either.

Bitcoin Yield Is Not Optional

So how do we respond? In light of this event in 2022, a growing number of Bitcoin supporters are asking the question: should we accept Bitcoin yield products, or are they too risky, similar to the fiat currency system? While these concerns are valid, it is unrealistic to expect Bitcoin yield products to disappear entirely.

This question becomes more prominent as the nascent Bitcoin ecosystem develops. More and more projects are building or claiming to develop financial infrastructure and applications directly on Bitcoin. Will this again raise the same issues we have already seen in the wider crypto space?

Very likely. Because that is the nature of the game. Since Bitcoin is a permissionless protocol, anyone can build on it, including those who wish to build a Bitcoin-powered financial system. And a financial system inevitably requires credit and leverage.

It is a historical fact: in any prosperous society, the need for credit and yield naturally emerges as a catalyst for economic growth. Without credit, underdeveloped economies struggle to escape survival. Only through access to credit can more complex and efficient economic structures be formed.

In order to realize the vision of a Bitcoin-based economy, supporters recognize the need to develop credit and yield mechanisms on top of the Bitcoin protocol. While Bitcoin is often praised for its role as a currency, the reality is that in order to operate effectively as a currency, it needs a native economy to support it.

This highlights the importance of Bitcoin-based yield products in promoting economic growth centered around Bitcoin. Such an ecosystem would leverage Bitcoin as its digital base currency while leveraging yield products to drive its adoption and usage.

It’s all a trust spectrum, anonymity

A Bitcoin-powered financial system will necessarily be built in layers. From a systemic perspective, this is not too different from the current financial system, and there are inherent layers in currency-like assets. To properly understand these inevitable trade-offs, we need a high-level framework to distinguish Bitcoin implementations at different levels.

When offering Bitcoin yield, it is important to understand that these options can be built along a three-fold trust spectrum. The main ones to focus on are:

· Consensus

· Asset

· Yield

Evaluating Bitcoin-like assets and Bitcoin yield products based on their degree of Bitcoin nativeness provides a valuable framework to assess their alignment with the Bitcoin ethos. Assets and products that score higher on this spectrum are generally trust-minimized, reducing reliance on intermediaries and instead relying on transparent and resilient code.

This shift reduces counterparty risk as reliance shifts from off-chain intermediaries to code. Transparency in code enhances resiliency over trust-required intermediaries.

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

Consensus Perspective

Bitcoin yield products can be divided into four categories based on the consensus consistency of the Bitcoin blockchain.

No consensus: This category refers to centralized platforms where the infrastructure remains off-chain. For example, centralized platforms such as Celsius or BlockFi, which have full control over the user's assets, expose users to counterparty risk and dependence on intermediaries. Although these platforms use Bitcoin, their yield strategies are mainly executed off-chain through traditional financial mechanisms. While these platforms are a step towards Bitcoin adoption, they are still highly centralized and resemble traditional financial institutions, but usually lack regulation.

Independent consensus: In this category, the infrastructure is decentralized and 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 Bitcoin's consensus.

Inherited consensus: In this category, the infrastructure is decentralized and represented by the distributed consensus of Bitcoin sidechains or Layer-2 solutions. While 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 underlying security model. Rather than using a separate blockchain or sidechain, it leverages off-chain state channels that are cryptographically linked to the Bitcoin blockchain. The Lightning Network is a key example of this approach, providing a high degree of trust minimization by relying entirely on Bitcoin’s consensus.

The closer a Bitcoin yield product is to Bitcoin’s native consensus, the more aligned it is with Bitcoin and is generally considered to be more trust-minimized. However, there are subtle differences in the level of decentralization and security of the infrastructure within the two categories of independent consensus and inherited consensus.

Overall, no consensus offers the lowest level of decentralization and trust minimization, while native consensus is considered to offer the highest level of trust minimization, although considerations of consensus security and decentralization require further analysis.

Source: Brick Towers

Asset Perspective

When considering the assets used in Bitcoin income products, their compatibility with Bitcoin can be divided into three categories.

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

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

Native BTC: The asset in this category is on-chain Bitcoin (BTC), without any tokenized version involved, providing the highest level of Bitcoin alignment. Various CEX solutions and Babylon’s Bitcoin staking protocol utilize BTC directly. Babylon aims to extend Bitcoin’s security by adapting a proof-of-stake mechanism for Bitcoin staking. Additionally, projects like Stroom Network leverage the Lightning Network to enable 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 use in the broader DeFi ecosystem.

Source: Brick Towers

The Yield Perspective

When looking at the yield side of Bitcoin yield products, the question of fit with Bitcoin comes into play, leading to a similar categorization as on the asset side: non-BTC, tokenized BTC, and native BTC.

Non-BTC Yield: Babylon offers yield through assets native to its Proof-of-Stake (PoS) blockchain, which enhances the security of the blockchain through Babylon’s staking mechanism.

Tokenized BTC Yield: Stroom Network offers yield in the form of lnBTC tokens. Sovryn, running on Rootstock, facilitates Bitcoin lending by using tokenized BTC (RBTC) as yield. On Liquid Network, Blockstream Mining Note (BMN) offers yield in BTC or L-BTC upon maturity, providing qualified investors with access to Bitcoin hashrate via EU-compliant USDT security tokens.

Native BTC Yields: Stacks offers various options, including yields paid in tokenized BTC in certain yield applications, leveraging sBTC. However, for Stacks’ stacking options, yields are accumulated in native BTC. Similarly, some CEX-provided centralized yield products distribute native BTC as yield to users.

Source: Brick Towers

The Gold Standard for Bitcoin: Native All the Way

Considering the ideal Bitcoin-based yield product, a gold standard product would combine the following three features: native Bitcoin consensus, native Bitcoin assets, and native Bitcoin yields. Such a product would mimic a near-perfect Bitcoin fit.

Currently, such solutions are only beginning to be built. One project that is actively developing this is Brick Towers. Their vision for an ideal Bitcoin-based yield product encompasses achieving a near-perfect Bitcoin fit by incorporating native Bitcoin consensus, assets, and yield. Brick Towers is focused on Bitcoin as a long-term savings solution, aiming to provide clients with a trust-minimized and native approach to leveraging Bitcoin.

Their planned solution revolves around generating native yield in Bitcoin, leveraging Brick Towers’ automated services for other nodes in the Lightning Network. Solving the economics through an optimization algorithm, capital is strategically deployed to meet the liquidity needs of other network participants, thereby optimizing capital efficiency while minimizing counterparty risk.

This approach not only promotes the growth of the Lightning Network, but also advances the utility of Bitcoin as an asset, while providing clients with a seamless and secure way to earn yield on their Bitcoin holdings. Importantly, Brick Towers’ solution avoids the use of wrapped coins, further reducing counterparty risk and reinforcing their commitment to the Bitcoin native ecosystem.

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