Why Bitcoin Does Not Need DeFi, But DeFi Needs Bitcoin
Dr. Chiente Hsu is CEO and cofounder of ALEX (Automated Liquidity Exchange), the first complete DeFi exchange on Bitcoin.
Bitcoin is the only way to get truly decentralized finance (DeFi). DeFi is still not a game-changing technology. This is because it requires fully expressive smart contract, which isn’t possible with the core Bitcoin protocol due its security trade-offs. There are many projects that are working on layering solutions that will allow DeFi to become a reality.
As Bitcoin DeFi increases, it will allow sovereign groups to determine their bitcoin yield curve, increase capital efficiency, and accelerate mass adoption of the bitcoin currency.
Truly Become Your Own Central Bank
We want to be clear that Bitcoin does not need DeFi. Bitcoin existed long before DeFi was created, and Bitcoin will continue to exist even if DeFi is discontinued. DeFi is dependent on Bitcoin. Without the immutability and security that Bitcoin offers, DeFi will not be widely adopted.
Bitcoin, the ultimate form money, was only recently discovered. Modern civilization, which we now recognize as modern civilization, was not built on money, but on finance. Because of the banking systems, global debt will always outweigh physical currency in circulation. Finance includes financial instruments, credit, and market places. Currency is only one asset class. Consider that there is about $1.5 trillion dollars of physical USD in circulation, yet the U.S. national debt alone is over $30 trillion dollars.
This is because time is more valuable than money. The medium of exchange for the money’s time value is debt, specifically in the form yields and interest rates. There are people who require money now and will pay a premium to get it. Some people will not need their money for the future, but are willing to pay a premium in return for the chance of lending it out until they are needed.
A favorite phrase among Bitcoiners, it allows you to “become a central bank” because you own hard assets and are responsible for keeping your bitcoin safe. However, a bank is more than a vault. A bank borrows money from depositors at low rates of interest and then invests the funds by lending them out at a higher rate and reaping the spread. You are responsible for your bitcoin’s safety and productivity as an asset.
Capital efficiency, or maximising the productivity of your capital over the course of time, is the engine of modern finance. Who determines interest rates at present? The overnight rates are set by central banks. The bond market pricing determines the rest of the yield curve (different yields at various maturity dates). The economy slows down and borrowing becomes more expensive when interest rates are raised. The opposite happens when interest rates are lowered. Inflation is now a threat to the stability of the entire system.
Bitcoin allows sovereign individuals. It is likely that these individuals will join sovereign collectives. These collectives will be able to set their own sovereign interest rates using Bitcoin DeFi. This trustless and decentralized transaction will allow them to do so. Through the emergence of a bitcoin yield curve, sovereign collectives will become the “Decentralized Bank of Bitcoin.”
Fixed-Rate And Fixed-Term Lending And Borrowing
The lending and borrowing that currently exists in DeFi is variable, meaning the yield you are receiving today is not the same as the yield tomorrow or the week after, causing significant uncertainty.
Recreating zero-coupon bonds in DeFi, analogous to a certificate of deposit that pays a fixed interest to its holder at a predefined maturity date is needed to lessen uncertainty. These financial properties can be coded into yield tokens that can be trustedlessly exchanged. This makes swaps of these tokens equivalent to borrowing and lending. This may not sound very exciting but it’s actually the point.
Lending should not be considered risky, and should be boring in order to encourage mass adoption of DeFi. These building blocks are the foundation of finance. By mastering them, we can progressively create all the higher finance in DeFi.
Bitcoin Borrowing Without Liquidation Risk Through Dynamic Collateral Rebalancing Pools
Lending on all other DeFi platforms works with your collateral being in a single asset pool. If the collateral is bitcoin, the value of your collateral is directly bitcoin’s value, which is highly volatile (approximately six times the average volatility of the S&P 500). If the price of bitcoin drops and your loan-to-value ratio falls below the protocol minimum, you are liquidated, your position sold and you are charged fees as high as 50% of collateral value.
If bitcoin is a risky asset, such as it is, the pool will shift to taking on more risk to maximize the upside. To minimize losses, the pool will shift towards less risk when the market is falling. The pool will shift to less risk if the market falls below a predetermined threshold. This is similar to having seatbelts and airbags for your collateral. In an emergency, it will protect your collateral so that you don’t have to worry about liquidation.
DeFi And The Power Of Bitcoin Capital Management
When it comes to funding, the traditional asset class for corporate treasuries are corporate bonds. Rising U.S. inflation will result in high yield bonds. This will cause current bond holders to race for the exits when prices plummet. Bond yields and prices are inversely linked. These treasuries will have to shift to alternative asset types like cryptocurrencies.
The recent market downturn and bitcoin’s price correlation with tech, shows us that institutional investors perceive bitcoin as a speculative high-risk/high-return asset rather than as a store of value. They are fundamentally wrong. Bitcoin is not a regional currency. It is not included in regional monetary or economic policies that direct other asset types and markets, like bonds.
As Bitcoin’s market cap increases and regulatory clarity is provided it will allow corporate treasury mangers to navigate traditional financial markets during times of distress or market uncertainty.
However, the bond market is prohibitively expensive for small- and medium-sized corporate Treasury managers. Many small- to medium-sized companies find it difficult to access the bond markets due to the costs of investment banking, legal and operating fees.
Bitcoin is able to solve this problem. Bitcoin’s decentralized foundations mean that holders don’t necessarily have to go through all the hoops associated traditional centralized financial services. However, the current high volatility poses a challenge for Treasury management. Dynamic collateral rebalancing is a great solution for corporate treasuries that helps them manage volatility and cash flow.
At the core of finance is security. DeFi must use Bitcoin to replace traditional and centralized finance, as Bitcoin is the most secure network known to man. Bitcoin DeFi does not make any changes to the base layer. It uses the best form sound money as the foundation to build the new gold standard in finance.
This is a guest post by Dr. Chiente Hsu. These opinions are not necessarily those of BTC Inc. or Bitcoin Magazine HTML1.
I have been writing professionally for over 20 years and have a deep understanding of the psychological and emotional elements that affect people. I’m an experienced ghostwriter and editor, as well as an award-winning author of five novels.