The Dawn of Bitcoin’s Yield Curve
The US Treasury Yield Curve is the foundation of the global financial system.
The yield curve gives us insight on how the market is valuing Wall Street’s “risk free” asset, the US Treasury Bond. In short, it displays the amount of annual yield you can expect to receive for buying a Treasury bond with a specific amount of duration.
Typically, the market rewards investors for locking up their capital in longer duration bonds by paying them a higher yield. Today this is the case.
Since the US Treasury yield curve is the foundation of our current financial system, all financial assets are priced based on the interest rates of Treasury bonds.
Why? Because Treasury bonds offer the “risk free” rate of return.
For example, if you could buy a 10 Year Treasury bond yielding 5% annually, nobody would be willing to purchase an Amazon bond yielding 1%. Instead if Amazon tried to issue new bonds to raise capital, the market would value their bonds at the 5% (risk free rate) + [Amazon’s “Credit Risk”].
As you can see, investors price every financial asset (stocks, bonds, real estate, etc.) off of this yield curve.
The Problem
The issue with using US Treasury bonds as the global “risk free” asset is that they are NOT actually risk free.
US Treasury Bonds have risk for 2 reasons.
- It is possible that the US could default (not pay you), but this is very unlikely.
- More likely, Currency Risk EXISTS — You could buy a 10 Yr bond yielding 0.8%, but in 10 years the purchasing power of the money you get back may be worth less (or even significantly less) than the purchasing power you started with.
What this means is that the foundation of the global financial system is unstable because it is at the mercy of politicians and central bankers, and historically they are very consistent at breaking that trust.
USD Risk Spectrum
Unfortunately, the entire financial system is based on this instability.
With interest rates at all time lows, we have seen the market push further out on the risk spectrum in order to generate yield and to grow / maintain their purchasing power.
Enter Bitcoin
Instead of continuing to base our financial system off an asset whose value is manipulated by politicians and central banks, Bitcoin is the base of an alternative financial system.
This alternative system is drastically different. As opposed to trusting politicians and central bankers to preserve your purchasing power. You can now trust mathematics and the laws of thermodynamics itself.
Bitcoin requires you to trust no one.
It is a perfectly scarce asset with no counterparty risk. Bitcoin happens to be one of the greatest discoveries in the history of humankind, and it is the base of the next global financial system.
BTC Risk Spectrum
The Bitcoin risk spectrum has two unique blocks as the foundation of this new financial system.
Unlike every block in the USD Risk Spectrum, these two blocks require no counterparty risk, meaning you can hold these assets into perpetuity without having to worry about dilution or a default.
Bitcoin in cold storage is the ultimate savings tool. Its ability to preserve and grow its purchasing power with no counterparty risk is unprecedented, and it will likely be a large position in all investors’ portfolios.
With that said, there will still be a financial system built around the base of Bitcoin.
It is just that the base of this system will be significantly stronger and play a larger role in every investors portfolio.
Lightning Channel Leases (Lightning Pool)
The second layer of this financial system appears to be developing on the Bitcoin Lightning Network, which is used to send small Bitcoin payments immediately with very little fees and without trusting any 3rd party to facilitate the payments.
For the lightning network to function properly, payment channels must be created and utilized to add liquidity to the network in order to send Bitcoin from one individual to another.
A new open source technology called Lightning Pool, has created a non-custodial marketplace to trade Lightning Network Liquidity. This means if you have Bitcoin that you don’t mind locking up in a Lightning Network channel for [x] number of Bitcoin blocks, you can open channels and earn a yield on your Bitcoin without exposing yourself to counterparty risk.
This technology enables you to earn counterparty-free yield denominated in an asset that cannot be diluted.
You can think of these Lightning Channel Leases as “virtual roads” to send and receive Lightning Network payments.
Lightning Pool is nothing more than an open source non-custodial marketplace that helps market participants build these virtual roads for highly demanded routes on the network.
Currently the buy-side (those purchasing inbound liquidity) on Lightning Pool includes merchants, exchanges, popular lightning network applications, and routing nodes. Bitrefill, Bitfinex, and Strike are just a few of the Bitcoin companies that use the Lightning Network, and they have a constant need to properly balance their inbound and outbound liquidity in order to send and receive large quantities of payments.
The sell-side (those selling outbound liquidity) on Lightning Pool includes routing nodes, Bitcoin companies, and Bitcoin holders looking for the opportunity to lock up Bitcoin for a specific period of time to earn counterparty-free yield.
This technology will likely lay the foundation for this new financial system. Investors will be able to use the Lightning Pool yield they can generate as a reference rate for all other potential investments.
Just like you wouldn’t loan Amazon money at a 1% yield if the 10 Yr Treasury is yielding 5%, you wouldn’t loan Amazon any Bitcoin at a 1% yield if you can earn a 3% yield using Lightning Pool (no counterparty risk).
This no counterparty risk bitcoin yield curve will lay the foundation for how investors value Bitcoin denominated debt (if there is any), and how investors value equities (through a discounted cash flow analysis).
We are in the very early stages of Bitcoin’s yield curve, and it will be fascinating to watch this new financial system form around the world’s most valuable asset, Bitcoin.
Written by Joe Burnett (@Moon__Capital), Research Analyst at Mimesis Capital.
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Thank you to Nik Bhatia (@timevalueofbtc) and Ryan Gentry (@RyanTheGentry) for their work on the Time Value of Bitcoin and Lightning Pool. In addition, thank you to Lightning Labs (@lightning) and Bitcoin Core developers for their great work.
https://medium.com/@timevalueofbtc/the-time-value-of-bitcoin-and-lnrr-e0c435931bd8
https://medium.com/@timevalueofbtc/the-lightning-network-reference-rate-98e41a9dadfa
https://lightninglabs.substack.com/p/lightning-pool-is-open-for-business
https://lightning.engineering/posts/2020-11-02-lightning-pool/
https://lightning.engineering/posts/2020-11-02-pool-deep-dive/
https://lightning.engineering/lightning-pool-whitepaper.pdf
https://anchor.fm/tales-from-the-crypt/episodes/206-Ryan-Gentry-elvgsf
