Why Bitcoin Is Pristine Security – Bitcoin Magazine
This is an opinion editorial by Leon Wankum, one of the first financial economics students to write a thesis on Bitcoin in 2015.
Today, the most common form of collateral used by a borrower to secure repayment of a loan to a lender is real estate. This practice is common among mortgages, personal loans and business loans. Banks lend to individuals and institutions that own property. Other common forms of collateral include business inventory, cash, stocks, and bonds. I will show why bitcoin has the potential to become the security of choice in the future.
There is an emergence of a number of lending products around bitcoin. Bitcoin as a bearerless instrument acts as principal security. Because of its deterministic supply schedule, which is severely limited, there is an incentive to hold bitcoin. This has created a demand for bitcoin users to lend their holdings and receive returns or cash in return. Borrowing against bitcoin makes financial sense for two reasons. First, there is a capital gains tax if you sell and second, from a “consumption perspective” we are encouraged to use fiat, not bitcoin, as long as the value of bitcoin increases faster than fiat interest rates.
However, bitcoin should only be used to borrow against it, not to earn returns. Earning a 6% return while potentially losing everything is not worth it. And for lending purposes, you can use non-custodial solutions such as Hodl Hodl that are available. Multi-signature wallets (a type of wallet that requires more than one signatory to move funds) allow lenders and borrowers to share access to funds.
You can still have a cryptographic relationship with your bitcoin as a borrower. Suppose you borrow against your bitcoin using a multisig address. In that case, you can always access this address, not only through the platform’s interface, but also using any blockchain explorer. With it, you can always double check that your security is stored in the same place and even monitor your escrow account in real time. This prevents rehypothecation risk, a practice where banks and brokers use assets pledged by their clients for their own purposes.
As explained by Nick Neuman, the fact that bitcoin transactions and addresses are publicly verifiable takes a huge amount of risk out of the financial system. It allows for proof of reserves, where a financial institution must provide their bitcoin address or transaction history to show their reserves. Transparency requires more ethical behavior from providers of financial services.
Bitcoin storage is quite simple, there is no daily maintenance. Bitcoin only needs to be protected against cyber attacks. A financial service provider can set up their own cold wallet (a device that stores cryptocurrency offline) and protect their bitcoin from the threat of theft. Bitcoin can also be stored in a multi-signature wallet. This enables both lenders and borrowers to manage funds together and protects borrowers against the risk of the lender going bankrupt. In this case, the borrower will lose his coins.
With bitcoin, security maintenance is reduced. The banks usually have a large number of appraisers and auditors who continuously evaluate the collateral deposited. Valuation of property is particularly time-consuming. There are standards by which real estate is valued. But these are constantly changing and properties must be valued individually based on location and condition. Bitcoin, on the other hand, has a real-time market price that is accessible to everyone.
Social issues are also linked to the use of real estate as the preferred form of security. It has created an exclusive financial system where it has become increasingly difficult to build credit as property has become expensive and less available.
Housing prices have increased nearly 70-fold since 1971, equivalent to the “Nixon shock” of August 15, 1971, when President Nixon announced that the United States would end the convertibility of the US dollar into gold. This decision ushered in a new era in which central banks began operating a fiat money-based system with floating exchange rates and no currency standard (history.state.gov). Since then, inflation has risen steadily. Many have turned to property to secure their wealth. As a result, property has been priced away from fair value based on its utility value – it is an income generating asset and can be used for production purposes. It now serves primarily as a store of value for institutions and those trying to beat monetary inflation. In contrast, bitcoin is easy to access, buy, store, use and maintain. You can buy bitcoin for as little as one dollar. Bitcoin provides much easier access to credit.
Using bitcoin as collateral provides particularly easy access to credit systems for developing countries. In places with little access to credit markets like Indonesia, bitcoin will be adopted as a savings tool and eventually be used for credit.
In addition, bitcoin opens up a much more private economic system. A lender can use a cryptographic key to authenticate a borrower without requiring the borrower to reveal sensitive private information that could then be leaked over the Internet in the event of a data breach.
Finally, much like selling a stock, a bitcoin sale can be done quickly if a borrower defaults. Unlike the stock market, bitcoin markets run 24 hours a day, 365 days a year. A sale can therefore be made at any time if necessary. Property, on the other hand, usually has to go through an auction process if the borrower defaults. This is another reason why bitcoin is destined to be used as a security. Due to the volatile bitcoin price, most lenders require bitcoin-backed loans to be oversecured. However, this is more of a feature than a bug as it requires more financial discipline from the borrower, which usually leads to more efficiency and higher productivity. However, as volatility decreases with increased adoption, this practice will also change in the future.
Conclusion
Overall, bitcoin’s excellent properties make it the ideal type of security for borrowers and lenders alike. Bitcoin lending services will reduce the incentive for anyone to sell, which of course will have a positive impact on the price – see: Allen Farrington and Sacha Meyers, “Bitcoin Is Venice,” page 161.
The improved property systems in the West in recent centuries enabled economic actors to discover and realize the potential of their economic activity and generate additional productivity. Fiat money has distorted this system. Bitcoin will restore it and expand it worldwide. As digital property, bitcoin will create a financial system where owning property and using it for credit will be far more accessible than it is today. This enables greater productivity and efficiency in the global economy.
This is a guest post by Leon Wankum. Opinions expressed are entirely their own and do not necessarily reflect the opinions of BTC Inc or Bitcoin Magazine.
