AAlthough Bitcoin is generally considered a new form of currency, it is much more nuanced.
Bitcoin is a multi-tiered financial ecosystem with its own monetary system. Due to this monetary system, Bitcoin is independent of the financial and monetary system existing today.
The native monetary system of Bitcoin is its main achievement and a novelty. Over the past two decades, people have tried to rebuild finance using fintech. While many interesting financial applications have resulted from fintech innovations, they have all remained tied to the traditional fiat system. True innovation in money and finance only started with Bitcoin.
Pascal Hügli is chief researcher at DeFi Overview, a Swiss research boutique. Insight DeFi publishes bi-monthly newsletter in German here. He is also the author of the book “Ignore at Your Peril: The New Decentralized World of Bitcoin and Blockchain.”
Indeed, Bitcoin’s native monetary policy is elegantly simple and its immutable supply is free from human discretion, something no other currency has had since gold. Unlike the yellow precious metal, Bitcoin’s monetary policy is determined algorithmically and therefore perfectly predictable, rule-based. It is neither eventful nor emotional.
By depoliticizing monetary policy and basing it on a code that follows a strict formula, Bitcoin’s monetary asset is structured in the most neutral way possible. Bitcoin is a truly sound currency because it offers the highest degree of stability, reliability, and security as a monetary system.
A base coat for the money
Since this new form of global digital currency resides on a base layer, it is more appropriate to refer to Bitcoin’s asset as base currency. This base currency is settled in a distributed manner on the Bitcoin blockchain, which acts as the last settlement network within Bitcoin’s native global monetary system.
So Bitcoin the base currency – also known as on-chain bitcoin or BTC which is settled on the Bitcoin blockchain with finality – is really “just” the first or base layer of a multi-layered financial order. rapidly evolving.
This very important nuance was already clear to the anonymous Bitcoin founder, which is why he carefully chose his terms in the Bitcoin whitepaper. Satoshi Nakamoto described Bitcoin as a electronic cash system – a subtlety that many have unfortunately missed to date.
In hindsight, Nakamoto probably should have emphasized the term cash, as it has a distinct meaning in monetary theory. Future From the old French word casse, which means piggy bank or money in hand, cash is defined as a bearer asset that is generally used to settle monetary transactions. It is therefore a basic monetary asset. So, I believe that Nakamoto intended to introduce the Bitcoin blockchain as the basic settlement infrastructure for a blockchain-native base currency.
Financial logic above Bitcoin
While most people are familiar with Bitcoin’s monetary layer, what goes unnoticed by many is Bitcoin’s rapid development into a financial ecosystem. The reason for this is that this new system is not directly integrated into the protocol code of Bitcoin itself.
This quality contrasts sharply with so-called smart contract platforms such as Ethereum, Solana, Avalanche, Terra or Binance Smart Chain. While these fully programmable blockchains – technically called Turing Complete Systems – allow native smart contract compatibility, the scripting of Bitcoin programming languages has been intentionally limited. By not opting for full programmability on its base layer, Bitcoin has been optimized for stability, reliability as well as security.
With Bitcoin, the implementation of all financial logic has shifted to a second layer within its multi-layered financial system. This layer is now populated with sidechains like RSK Where Mintsecond layer protocols such as Lightning Networkor alternative layer 1 blockchains like Battery which operate alongside Bitcoin and have their own Bitcoin transaction history.
These different approaches make up the building blocks of what I call the infrastructure layer within Bitcoin’s financial system. Its purpose is to enhance the expressive power of Bitcoin in one form or another. Meanwhile, this layer is a full-fledged layer. This way, the monetary layer can provide the essential assurances for a strong monetary base asset, while expressive financial logic in the form of smart contracts is moved from the Bitcoin blockchain to the infrastructure layer further up the stack. .
Open Market for Bitcoin Innovation
Bitcoin’s infrastructure layer spawns competition in the open market to build a financial system on top of Bitcoin. This competition is beneficial for users because more qualitatively different options mean more freedom of choice. So, the larger and more diverse the DeFi ecosystem on Bitcoin, the better.
When it comes to consensus and security, users should remember that all projects accept some compromise. Because different protocols do things differently, these trade-offs will differ depending on the project. This variety also benefits users, who can opt for the options they feel most comfortable with.
Bitcoin-based financial operating systems
Different DeFi approaches on Bitcoin infrastructure enable smart contract functionality for Bitcoin in different ways. To make this feature useful to as many users as possible, financial operating systems running on Bitcoin and representing the third layer of Bitcoin’s multi-layered financial order will slowly but surely emerge. The components of the infrastructure layers – the second layers and the side chains – will act as intermediaries between Bitcoin’s base layer blockchain and the financial operating systems.
The most prominent Bitcoin-powered financial operating system (OS) to date is built by Sovrin. What Windows OS or Mac OS is to computers, Sovryn is to Bitcoin – an interface that makes financial primitives built on the infrastructure layer usable for everyday users. These financial primitives are liquidity, leverage, risk taking and arbitrage. The more pronounced these primitives, the more efficient and functional Bitcoin’s scalable financial order becomes. And that’s what financial operating systems like Sovryn help to do.
Bitcoin’s Native Application Layer
While a financial operating system like Sovryn can provide various decentralized applications (dApps) in one place, these financial applications can also exist as standalone applications. The beauty of Bitcoin’s open, permissionless setup is that anyone can provide useful software to interact with Bitcoin’s emerging financial order.
The myriad of decentralized applications will be the fourth layer of Bitcoin’s multi-layered financial order. Token swaps, leveraged trading, secured lending, unsecured lending, and more all appear as a feature besides Bitcoin. Depending on the infrastructure configuration that users prefer – be it RSK, Liquid, Mintlayer or any other that has yet to emerge – they are free to choose.
Wallets play a decisive role in this monetary system. Digital wallets that allow interaction with Bitcoin-powered services like Muun, Hiro, Quality or with Ethereum Metamask are to blockchains what browsers are to the internet. They allow users easy access to the underlying technology.
As the fifth and highest layer, wallets come most naturally to users and complement Bitcoin’s multi-layered financial order. The higher up the stack, the more room there is for innovation and development.
As we’ve seen throughout this three-part miniseries, DeFi on Bitcoin is alive and well. Although still underdeveloped compared to the rest of DeFi, there is a good chance that Bitcoin-based DeFi will grow.
After all, many more Bitcoiners might be looking for a place to use some of their Bitcoin stash to manage their Bitcoin-powered finances.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.