Why do we need an on-chain Bitcoin lending protocol? Because today’s Bitcoin lending solutions carry too much risk, specifically custody and counterparty risk.
To lend BTC, you have to trust a third party with handling your BTC funds (custody risk) and lack visibility into who your BTC is being lent out to (counterparty risk). As a result, most Bitcoin sits idle in cold storage and isn’t used to grow the Bitcoin economy.
The counterparty risk of centralised Bitcoin lending solutions became extremely clear in May/June 2022, when it appeared that almost all Bitcoin lending platforms had been lending a significant amount of their assets to the same insolvent hedge fund (Three Arrows Capital). Because of the opaque nature of crypto lending, users had no way to find out how exposed their crypto lending platform was to the cascading defaults that ensued. Users also became increasingly concerned over custody risk of any centralised entity in crypto. As a result, users pulled their Bitcoin capital from centralised lending platforms en masse. The fledgling Bitcoin capital market imploded.
As Bitcoin credit dried up, even the most credit-worthy participants in the Bitcoin economy were no longer able to access Bitcoin capital. The crypto credit crunch left market-makers unable to facilitate liquidity on exchanges and forced miners to sell (part of) their BTC holdings. BTC price slid down to $18k. We learnt one lesson the hard way: functioning Bitcoin capital markets matter.
Any economy needs credit to live, breathe, and grow - and so does the Bitcoin economy. Market makers need access to credit to facilitate deep liquidity on exchanges. For Bitcoin to become the global reserve asset, it needs to trade in the world’s most liquid markets. Miners need access to credit to grow their hashpower and secure our wealth. Companies that are looking to adopt Bitcoin for payments should do so in the knowledge that they will be able to borrow against their future earnings in a global Bitcoin credit market. Without a resilient capital market, it’s hard to see Bitcoin growing to billions of users.