Bitcoin does not have a native yield. When custodied properly offline, without a custodian, no bitcoin returns are generated. While this makes it an alternative base-layer hard money like gold, it doesn’t satisfy global capital allocators’ demand for passive cash flows in their reserves. This is the 3-month Treasury Bill’s role today; the most sought-after fixed-income instrument for its low-risk profile and stable cash flows.
This is where the Lightning Network (LN) comes in. Its continued development has led to several options for earning a rate of return on deployed capital
We are finally inching closer to a consensus interest rate calculation methodology for LN. Standardization and positive nominal interest rates will attract bank-like entities
seeking to earn a positive return using efficient channel management and security.
Physical Gold incurs no default risk, counterparty risk, and custodial risk if held physically and securely by the owner. U.S. Treasuries are higher up the risk curve, for despite being touted as the risk-free dollar instrument, there is explicit and implicit default risk with these vehicles via M2 dilution. Corporate Bonds have higher default risk, so they trade at a spread to U.S. Treasuries. Equities and Venture Capital have the highest level of associated risk.
Like the U.S. dollar ecosystem has several assets with different risk-return profiles, so does the Bitcoin ecosystem.
You can lease channel liquidity for a set period of time in liquidity marketplaces like Magma by Amboss Technologies, Pool by Lightning Labs, and the Liquidity Ad Marketplace by LNRouter. These are the first major examples of standardized methods for calculating and reporting realized interest rates
of Lightning channels, a substantial leap in turning the Lightning Network into a fully-fledged capital market.
Additionally, the Taro protocol in active development by Lightning Labs would allow for issuing assets on Bitcoin that can be transferred over Lightning — allowing for any currency to route through existing network liquidity and take advantage of near-instant settlement. In other words, Taro makes Bitcoin and Lightning interoperable with everything. A position in the Lightning Network now allows node operators to extract time value from routing bitcoin and from routing any other asset. Dollars, euros, yen, and the pound sterling could all flow through bitcoin liquidity soon; this is a surefire way to attract on-the-fence capital allocators by making the Bitcoin and Lightning Networks interoperable with the traditional currencies and forms of collateral that they are familiar with. The time value of bitcoin held on Lightning Network has taken new forms never seen before in finance.
Bitcoin’s capital market and the risk profile of each instrument can be illustrated with the conceptual Bitcoin-Lightning Risk Curve.
Standardized language has been used to describe each point on the curve. LN Liquidity Lease formalizes marketplaces like Magma, all trading at a spread notated in basis points to the counterparty-free LN Reference Rate — the bitcoin capital market equivalent of the risk-free rate
provided by U.S. Treasuries. Only the non-yielding, non-custodial, counterparty-free Cold Storage bitcoin could be considered devoid of all default, counterparty, and custodial risks, mirroring Physical Gold in its risk profile. Taro Asset Lending is a name I’ve assigned to the theoretical lending of a Taro-issued asset, which incurs all of the risk associated with any independent asset issuer.
Therefore, the basis point spread above LNRR can fluctuate by a wide margin. At the end of the curve sits Off-Chain Lending, which has the largest counterparty risk profile, not present in the first three points on the curve, as it’s taking place entirely off the Bitcoin network, but using the time value of bitcoin on Lightning Network as its reference rate.
Optionality exists for different risk appetites and different technical expertise. This slew of financial
instruments will attract capital allocators of all stripes to deploy liquidity over the Bitcoin and Lightning networks, incurring a lower overall risk profile than the U.S. dollar capital market in doing so. The differentiator in Bitcoin’s capital market is that no central entity distorts each instrument’s price. There is no Satoshi Reserve that sets the policy interest rate, only the natural supply and demand for capital which drives the fluctuation of interest rates — a free and unfettered marketplace for money. This non-distorted cost of capital makes capital deployed on the Lightning Network an arguably closer risk-free rate than the proverbial one offered by 3-month U.S. Treasury bills.
Lightning Network-derived interest rates fluctuate based on supply and demand for channel liquidity, factoring in one’s own node history like a credit score, all without a central bank in sight, a set of reference rates that cannot be orchestrated by a central bank that adjusts in real-time through the business cycle, not only after the fact. Gone is the boom-and-bust cycle of yesteryear. Here to stay
is a regularly functioning business ecosystem where steady gains to productivity are made on a foundation of sound borrowing and responsible investment, not cheap credit.
Bitcoin restores the lost notion of a free and open money market, unmanipulated and guided solely by willing participants.
This is a return to real price signals, unperturbed by interest rate manipulation. This is a return to real capital allocation, where companies borrow only for projects in pursuit of net positive economic value, rather than pursuing ventures for the cheapness of credit alone. This is a return to real consumption, focusing on the necessities and what will improve the individual and the economy at large rather than the gluttony and excess of today.
A global capital market underpinned by BTC-LN reference rates will create a world where incentives are better aligned, and capital is allocated toward economically valuable ventures.