Although Bitcoin is commonly considered a new form of money, it is far more nuanced.
Bitcoin is a multi-layered financial ecosystem with its own monetary system. Because of this monetary system, Bitcoin is independent of today’s existing financial and monetary system.
Bitcoin’s native monetary system is its chief achievement and a novelty. Over the last two decades, people have tried rebuilding finance using fintech. While many interesting financial applications have resulted from fintech innovations, they all remained bound to the traditional fiat system. True innovation in money and finance has only started with Bitcoin.
Pascal Hügli is the chief researcher at Insight DeFi, a Swiss research boutique. Insight DeFi publishes a bi-monthly newsletter in German here. He is also author of the book “Ignore at Your Own Risk: The New Decentralized World of Bitcoin and Blockchain.”
This is because Bitcoin’s native monetary policy is elegantly simple, and its immutable supply is free from human discretion, something no other money has had since gold. In contrast to the yellow precious metal though, Bitcoin's monetary policy is algorithmically determined and thus perfectly predictable, rule-based. It is neither event- nor emotion-driven.
By depoliticizing monetary policy and grounding it in a code that follows a strict formula, Bitcoin’s monetary asset is structured as neutrally as possible. Bitcoin (BTC) is truly sound money because it provides the highest degree of stability, reliability and security as a monetary system.
A base layer for money
Because this new form of global, digital money resides on a base layer, it’s more apt to speak of Bitcoin’s asset as being base money. This base money is being settled in a distributed fashion on Bitcoin’s blockchain, which acts as the final settlement network within Bitcoin’s native, global monetary system.
So, bitcoin the base money – also known as on-chain bitcoin or BTC that is settled on Bitcoin’s blockchain with finality – is really “just” the first or base layer for a rapidly evolving multi-layered financial order.
This all-important nuance was already clear to Bitcoin's anonymous founder, which is why he chose his terms carefully in the Bitcoin white paper. Satoshi Nakamoto described Bitcoin as an electronic cash system – a subtlety that many have unfortunately missed to this day.
In hindsight, Nakamoto probably should have emphasized the term "cash," as it carries a distinct meaning within monetary theory. Coming from the old French word casse, which means money box or money in hand, cash is defined as a bearer asset that is typically used to settle money transactions. It is therefore a base money asset. So, I believe that Nakamoto intended to introduce the Bitcoin blockchain as a base settlement infrastructure for a blockchain-native base money.
Financial logic on top of 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 is that this new system is not directly built into Bitcoin’s protocol code itself.
This quality contrasts starkly from so-called smart contract platforms like Ethereum, Solana, Avalanche, Terra or Binance Smart Chain. While these fully programmable blockchains – technically called Turing-complete systems – allow for native smart contract compatibility, Bitcoin’s programming languages script has been intentionally limited. By not going for full programmability on its base layer, Bitcoin has been optimized for stability, reliability as well as security.
With Bitcoin, the implementation of financial logic of any kind has been offloaded to a second layer within its multi-layered financial system. This layer is now populated by sidechains like RSK or Mintlayer, second-layer protocols such as the Lightning Network, or alternative layer 1 blockchains like Stacks that run parallel to Bitcoin and have their own history of transactions on Bitcoin.
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 Bitcoin’s expressive power in some form or another. Meanwhile, this layer is a layer of its own. This way the monetary layer can provide the essential assurances for a sound monetary base asset, while the expressive financial logic in the form of smart contracts is moved off Bitcoin’s blockchain onto the infrastructure layer higher up the stack.
Free-market for innovation on Bitcoin
Bitcoin’s infrastructure layer is spawning a free-market competition for building a financial system on top of Bitcoin. This competition is beneficial to users as more qualitatively different options mean more freedom of choice. So, the bigger and more diverse the decentralized finance (DeFi) ecosystem on Bitcoin, the better.
Regarding consensus and security, users must remember that all projects accept some trade-offs. Because the different protocols do things differently, these tradeoffs will differ by project. This variety also benefits users, who can opt for the options with which they feel most comfortable.
Bitcoin-based financial operating systems
The different DeFi approaches on Bitcoin infrastructure enable smart contract functionality for Bitcoin in various ways. To make this functionality helpful for as many users as possible, financial operating systems operating on Bitcoin and representing the third layer in Bitcoin’s multi-layered financial order will emerge slowly but surely. The components of the infrastructure layers – second layers and sidechains – will act as middlemen 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 Sovryn. 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 are, the more efficient and functional Bitcoin’s evolving financial order becomes. And this is what financial operating systems like Sovryn are helping 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 and permissionless setup is that everyone can provide useful software to interact with Bitcoin’s emerging financial order.
The myriad decentralized applications will make up the fourth layer within Bitcoin’s multi-layered financial order. Token swaps, leveraged trading, collateralized lending, uncollateralized lending and more are all emerging as a feature on top of Bitcoin. Depending on what infrastructure setup users prefer – be it RSK, Liquid, Mintlayer or any other that has yet to emerge – they can choose freely.
As the fifth and highest layer, wallets come most naturally to users and complete Bitcoin’s multi-layered financial order. The higher up the stack we move, the more room for innovation and development there is.
DeFi on Bitcoin is alive and progressing well. While it is still underdeveloped compared to the rest of DeFi, chances are that DeFi based on Bitcoin will grow.
After all, many more Bitcoiners might look for a place to use some of their Bitcoin stash to conduct their Bitcoin-powered finances.
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