This is an opinion editorial by Leon VanCum, one of the first financial economics students to write a thesis about bitcoin in 2015.
Today, real estate is the most common form of collateral used by a borrower to secure repayment of the loan to the lender. This practice is common among mortgages, personal loans and business loans. Banks lend to people and institutions that own real estate. Other common forms of collateral include business inventory, cash, stocks and bonds. I will show why bitcoin has the potential to become the collateral of choice in the future.
A variety of lending products have emerged around bitcoin. Bitcoin acts as the principal collateral as a bearer-free instrument. Due to its deterministic supply schedule, which is hard-capped, there is an incentive to hold bitcoin. This has created a demand for bitcoin users to lend their holdings and receive a yield or cash in return. Borrowing against your bitcoins makes economic sense for two reasons. Firstly there is a capital gains tax if you sell and secondly, from a “spend perspective” we are encouraged to spend fiat, not bitcoin, as long as the value of bitcoin is faster than fiat interest rates. growing from.
However, bitcoin should only be used to borrow against it, not to earn a yield. Earning a 6% yield despite being able to lose it all isn’t worth it. And for lending purposes, you can use non-custodial solutions like Hodl Hodl that are available. A multi-signature wallet (a type of wallet that requires more than one signatory to transfer funds) allows lenders and borrowers to share access to funds.
You can still have a cryptographic relationship with your bitcoins as a borrower. Let’s say you borrow on your bitcoins 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 collateral is stored in the same place and even monitor your escrow account in real-time. This prevents rehypothecation risk, a practice whereby banks and brokers use assets posted by their clients as collateral for their own purposes.
As explained by Nick Newman, the fact that bitcoin transactions and addresses are publicly verifiable takes an enormous amount of risk out of the financial system. It allows proof of reserves, where a financial institution must provide its bitcoin address or transaction history to show its reserves. Transparency requires more ethical behavior from financial service providers.
Bitcoin storage is very simple, there is no daily maintenance. Bitcoin needs to be protected from cyber attacks. A financial services provider can set up their own cold wallet (a device that stores cryptocurrency offline) and protect their bitcoins from the threat of theft. Bitcoin can also be stored in a multisignature wallet. It allows both lenders and borrowers to manage funds simultaneously and protects borrowers from the risk of lender insolvency. In this case, the borrowers will lose their coins.
With bitcoin, the maintenance of collateral is reduced. Banks usually have a large number of appraisers and auditors who continuously evaluate the collateral deposited. Real estate appraisal is particularly time-consuming. There are standards according to which real estate is valued. But these are constantly changing and properties must be appraised individually based on location and condition. Bitcoin, on the other hand, has a real-time market cap that is accessible to all.
Social issues are also associated with the use of real estate as the preferred form of collateral. This has created a special financial system in which credit has become harder to build as real estate becomes expensive and less accessible.
House prices have increased nearly 70-fold since 1971, which corresponds 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 heralded 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, the rate of inflation has risen steadily. Many people have turned to real estate to secure their wealth. As a result, real estate is stripped of its fair value based on its usefulness – it is an income-generating asset and can be used for manufacturing purposes. It now primarily serves 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 less than a dollar. Bitcoin allows very easy access to credit.
Using bitcoin as collateral allows easy access to credit systems especially for developing countries. In places with less access to credit markets such as Indonesia, bitcoin will be adopted as a savings tool and eventually used for credit.
In addition, bitcoin allows for a much more private financial system. A lender can use a cryptographic key to authenticate a borrower without requiring the borrower to reveal sensitive private information that can be leaked over the Internet in the event of a data breach.
Finally, like selling stocks, bitcoin can be sold quickly if a borrower defaults. Unlike the stock market, the bitcoin market operates 24 hours a day, 365 days a year. Therefore, it can be sold at any time if needed. Real estate, on the other hand, usually has to go through an auction process if the borrower defaults. This is another reason why bitcoin is predisposed to be used as collateral. Due to the volatile price of bitcoin, most lenders are required to overcollateralize bitcoin-backed loans. However, this is a feature rather than a bug as it requires more financial discipline from the borrower which usually leads to greater efficiency and higher productivity. Even though, volatility tends to decrease with increasing adoption, this practice will change in the future as well.
conclusion
Overall, the outstanding properties of bitcoin make it an ideal type of collateral for both borrowers and lenders. Bitcoin lending services will reduce the incentive for anyone to sell, which will certainly have a positive effect on the price – see: Alan Farrington and Sacha Meyers, “Bitcoin Is Venice,” page 161.
Improved property systems in the West over the past 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 around the world. As a digital asset, bitcoin will create a financial system where owning an asset and using it for credit will be far more accessible than it is today. It enables greater productivity and efficiency in the global economy.
This is a guest post by Leon VanCum. The opinions expressed are solely their own and do not necessarily reflect those of BTC Inc. or Bitcoin Magazine.