A non-custodial Bitcoin interest rate account? Lightning Network May Be The Answer
A long-held view in the crypto and traditional financial markets is that in order to earn any interest in one’s assets, custody of those assets must be outsourced to a third party. But with Bitcoin’s (BTC) Lightning Network (LN), a new model for earning a non-custodial Lightning Network Reference Rate (LNRR) has emerged, according to one author.
According to Nik Bhatia, assistant professor of finance at the University of Southern California and author of the book Layered silver, the market for so-called routing fees on Bitcoin’s Lightning network could in the future serve as the first form of “unrequited income” for owners of capital.
“Smart contracts within LN allow its participants to establish a market for routing fees, and routers can earn a return denominated in bitcoin without ever relinquishing full control of the underlying capital,” Bhatia wrote in a recent blog. item on bitcoin interest rates.
He added that in traditional financial markets, returns can never be achieved without trusting the capital of a counterparty.
“How can a company, for example, return income to investors without initially having custody of outside capital? Impossible, ”wrote the popular author.
But while the Lightning Network routing fee can be earned without giving up custody of deployed bitcoins, it still does not constitute an entirely risk-free interest rate, as government bonds are generally considered in the traditional financial system. . The network is young and unknown risks or security holes may exist.
Additionally, routing fees aren’t the only interest rate that can be derived from a future bitcoin economy, the author argued.
Other potential sources of income in a future bitcoin economy could also include coin mixing fees, bitcoin term funding rates, or deposits and loans in exchange. However, the notable difference here is that all of these activities involve some form of counterparty risk.
Combined, all of these rates can form a “robust yield curve” in the bitcoin market, which will evolve into investment strategies based entirely on “the diverse complex of bitcoin rates,” Bhatia concluded.
In the past, other attempts to establish a risk-free interest rate for bitcoin, similar to the yield curve for U.S. and European government bonds, have primarily focused on the regulated bitcoin futures market.
Among these, a research item through Quantpedia.com looked at the rate that could be achieved by going long in the first month bitcoin futures contract on the regulated market Chicago Stock Exchange (CME), while simultaneously short selling the longest contract (from the previous month).
This would create a position that would not be exposed to bitcoin price fluctuations, but instead benefit from the price difference between futures contracts of different maturity.
And while the counterparty risk may be low in this case given that the CME is a regulated futures exchange, the risk is still there and no return can be generated without giving up the custody of bitcoins.
Others, meanwhile, agree with Bhatia’s view that the only unrequited interest rate on bitcoin is that which can be derived from Lightning Network routing fees.
According to to Patrick Heusser, Head of Trading at Digital Asset Brokerage Crypto-finance, a “Lightning Network benchmark rate” could even have implications for the pricing of bitcoin derivatives. Indeed, the rate means that the “opportunity cost of Bitcoin becomes measurable”
And judging by Heusser’s research, a Lightning Network benchmark rate might actually have even lower risk than assets generally considered risk-free in traditional finance.
“The Lightning Network, controversially, and the resulting LNRR are associated with less risk if the necessary knowledge is available to deal with operational risks,” Heusser explained, before adding:
“However, it is surely not wrong to regard LNRR as risk-free if your unit of account is Bitcoin.”
In other words, it looks like Bitcoin’s Lightning Network Fee could have a real chance of becoming the very first benchmark rate that is both risk-free and non-quid pro quo.
The old wisdom, which Bhatia summed up by saying that “returns are never earned without sending capital to a counterparty ”could thus be on the verge of tipping.
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