Stablecoins have so far dominated the crypto payments market, but some bitcoin developers believe there is a proposal that could offer a legitimate alternative.
Seven years ago, Dorier, a highly experienced developer, set out to democratize bitcoin payment processing by releasing a free and open-source alternative to the then-dominant BitPay: BTCPay Server. Today, despite the project’s huge success among bitcoin enthusiasts and online merchants, the cryptocurrency payments landscape has evolved dramatically since Dorier began his journey. The rise of stablecoins has quickly dominated the space, pushing bitcoin (the world’s largest digital asset) into the background in the payment processing arena.
Fueled by the growing demand for stablecoin options, particularly the US dollar, stablecoins have quickly taken over the cryptocurrency payments market. This rise has left many bitcoin enthusiasts struggling to come to grips with the reality that these dollar-pegged assets could reinforce the very system bitcoin was designed to challenge: the hegemony of the US dollar. As stablecoins continue to gain traction, bitcoin proponents find themselves at a crossroads, wondering how to preserve bitcoin’s vision of financial sovereignty in a market that is increasingly leaning toward stability over decentralization.
A new proposal emerging from the Lightning ecosystem has caught Dorier’s attention, and the veteran developer believes it could address this hurdle. Speaking to a packed audience at the recent BTCPay Server annual community meeting in Riga, Dorier introduced the concept of a “fiat-less fiat currency,” a native bitcoin alternative to Treasury-backed stablecoins like Tether and USDC.
Synthetic USD
In 2015, BitMEX co-founder and then-CEO Arthur Hayes described in a Blog entry How to use futures contracts to create synthetic US dollars. Although this idea never gained widespread acceptance, it became a popular strategy among traders looking to hedge against bitcoin volatility without having to sell their underlying bitcoin positions.
For readers less familiar with financial derivatives, a synthetic dollar (or synthetic position) can be created by two parties entering into a contract to speculate on the price movement of an underlying asset, in this case, bitcoin. Essentially, by taking a position opposite their bitcoin holdings in a futures contract, traders can protect themselves from price swings without having to sell their bitcoins or rely on a US dollar instrument.
More recently, services like Blink Wallet have embraced this concept through the Stablesats protocol. Stablesats allows users to peg a portion of their bitcoin balance to a fiat currency, such as the US dollar, without converting it to traditional currency. In this model, the wallet operator acts as a “dealer” by hedging the user’s pegged balance using futures contracts on centralized exchanges. The operator then tracks the respective liabilities, ensuring that the user’s pegged balance maintains its value relative to the chosen currency. (More detailed information on the mechanism can be found on the Stablesats website.) website.)
Obviously, this setup comes with a major drawback. By using stablecoins or similar services, users effectively hand over custody of their funds to the wallet operator. The operator must then manage the hedging process and maintain the contracts necessary to preserve the synthetic peg.
Stable channels and virtual balances
In Riga, Dorier noted that a similar effect can be achieved between two parties using a different type of contract: Lightning channels. The idea stems from recent work by bitcoin developer Tony Klaus on a mechanism called stable channels.
Rather than relying on centralized exchanges, stable channels connect users looking to hedge their bitcoin exposure with “stability providers” via the Lightning Network. A stable channel essentially functions as a shared bitcoin balance, where funds are allocated according to the “stability receiver’s” desired exposure. Leveraging Lightning’s fast settlement capabilities, the balance can be continuously adjusted in response to price fluctuations, with sats shifted to either side of the channel as needed to maintain the agreed distribution.
Below is a simple chart to illustrate what the fund's breakdown might look like over time:
Clearly, this strategy entails considerable risks. As illustrated above, stability providers who take leveraged long positions on the exchange are exposed to significant downward price volatility. Furthermore, once these stability providers’ reserves are depleted, users who want to secure their dollar-denominated value will no longer be able to absorb further price drops. While such rapid drops are becoming increasingly rare, bitcoin’s volatility is always unpredictable, and it is conceivable that stability providers will seek to hedge their risks in different ways.
Furthermore, the structure of this construct allows for participants’ exposure within the channel to be tied to any asset. As long as both parties independently agree on a price, this can facilitate the creation of virtual balances on Lightning, allowing users to gain synthetic exposure to a variety of traditional portfolio instruments, such as stocks and commodities, assuming these assets maintain sufficient liquidity. Researcher Dan Robinson Originally proposed an elaborate version of this idea under the name of Rainbow Network.
The good, the bad and the ugly.
The concept of “fiat money without fiat” and stablecoins is appealing for its simplicity. Unlike algorithmic stablecoins that rely on complex and unsustainable economic models involving exogenous assets, the bitcoin Dollar, as envisioned by Dorier and others, is purely the result of a voluntary, self-custodial agreement between two parties.
This distinction is critical. Stablecoins typically involve a centralized governing body overseeing a global network, while a stable channel is a localized arrangement where risk is limited to the participants involved. Interestingly, it doesn’t even have to rely on network effects: one user can choose to receive equivalent USD payments from another, and subsequently move the stability contract to a different provider at their discretion. Providing stability has the potential to become a core service of various types of competing Lightning service provider entities offering different rates.
This focus on local interactions helps mitigate systemic risk and fosters a more conducive environment for innovation, echoing the original model. end-to-end principles from the internet.
The protocol allows for a variety of implementations and use cases, tailored to different user groups, while both stability providers and receivers maintain full control over their underlying bitcoins. No third party, not even an oracle, can confiscate a user’s funds. While some existing stablecoins offer a degree of self-custody, they are otherwise still vulnerable to censorship, and operators can blacklist addresses and effectively render associated funds worthless.
Unfortunately, this approach also inherits several challenges and limitations inherent to self-custody systems. The use of Lightning and payment channels introduces online requirements, which have been cited as barriers to widespread adoption of these technologies. Because stablecoins monitor price fluctuations through regular and frequent settlements, any party that goes offline can disrupt peg maintenance, leading to potential instability. bitcoin-dollar#stability-mechanisms”>article Elaborating further on his thoughts on the idea, Dorier discusses several potential solutions for a party that is going offline, insisting primarily that restoring the fixed value of funds already allocated to a channel “is a cheap operation.”
Another potentially viable solution to complex peg management involves the creation of electronic mints, which would issue stable notes to users and manage the channel’s relationship with the stability provider. This approach has already been implemented in the real world. Implementations and could see faster adoption due to its superior user experience. The obvious downside is that custodial risks are reintroduced into a system designed to eliminate them. Still, ecash proponents argue that its strong privacy and censorship-resistance properties make it a far superior alternative to popular stablecoins, which are prone to surveillance and scrutiny.
Beyond this, the complexity of the Lightning protocol and the inherent security challenges posed by holding funds at risk in “hot” channels will require careful consideration when scaling operations.
Perhaps the most pressing challenge for this technology is the dynamic nature of the peg, which can attract uncooperative actors looking to exploit erratic short-term price movements. In what is known as the “free choice problem,” a malicious participant could stop honoring the peg, leaving its counterparties exposed to volatility and the burden of reestablishing a peg with another provider. mail On the developer-focused Delving bitcoin forum, stablecoin developer Tony Klaus outlines several strategies to mitigate this problem, offering potential safeguards against such opportunistic behavior.
While there is no silver bullet, the emergence of a market for stability providers could foster the emergence of reputable counterparties whose long-term business interests outweigh the short-term gains they make by defrauding users. As competition increases, these providers will have strong incentives to maintain trust and reliability, creating a more robust and reliable ecosystem for users seeking stability in their transactions.
Concluding his presentation in Riga, Dorier acknowledged the novelty of this experiment but encouraged attendees to also consider its potential appeal.
“It's a very crazy idea, a new idea, a new kind of money. You need new business models, new protocols, and new infrastructure. It's something more long-term, more forward-looking.”
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