The Time Value of Bitcoin and Bitcoin Capital Markets - Nik Bhatia

The Time Value of Bitcoin and Bitcoin Capital Markets presented by Nik Bhatia at Bit Block Boom.

Blog post by Cousin Edgar Stumblefield.

Outline

About Me

  • BA in Economics from USC
  • Masters in Finance, IE Business School, Madrid, Spain
  • CFA charter holder

 

Overview

  • Lightning Network is without counterparty risk, but has security risk, payment channel management risk
  • Lightning allows for interest rate calculations
  • We should develop a reference rate using these calculations
  • Reference rates anchor the entire capital market, this is why bitcoin needs LNRR
  • Bitcoin Risk Spectrum, credit spreads
  • Vision for the future

If your bitcoin is not in cold storage, it is in a hot wallet, however, Lightning network is still good for Bitcoin

We can calculate interest in Lightning channel payment channels, but there is not, at the present time, a set way to do so. There is some talk on money made, but it has not been expressed as an interest rate.

 

Lightning Network

  • Fees, time-value , and security risk premiums are discussed in the The Bitcoin Lighting Network: Scalable Off-Chain instant Payments by Joseph Poo and Thaddeus Dryja

 

Lightning Calculations

  • A = P * ( 1 + r ) ^ t
  • P = starting balance in LN payment channel(s)
  • t = time of blocktime
  • A = P + all routing fees collected
  • Solve for r to determine interest rate

You can decide what you use for “t” (blocktime or earth time) ; you can also use hash time ; I do not have a magical solution as to what you should use for this equation ; the conversation needs to be had as to what should be used for these variables

 

LNRR (Lightning Network Reference Rate)

  • Rates are published on a payment channel / HTLC / LN node level
  • Rates are cryptographically provable due to hashing on all necessary inputs
  • Rates are then published and averaged to form LNRR, somewhat following a LIBOR model (London interbank offered rate)

 

US Dollar Reference Rates

  • US Treasuries are the “risk-free” rate, however any government can default at any time. The US Treasury is considered the most reliable (which is why money is lent at this rate plus a certain amount)
  • LIBOR is an inter-dealer rate
  • OIS (Overnight Indexed Swap ) is a swap rate using Fed Funds
  • SOFR is a new repo-based reference rate
  • US Dollar relies on one country
  • US dollar relies on discretionary monetary policy

SOFR started by the Federal Reserve due to the manipulation of LIBOR. Took 2 or 3 years and thought of different ways for a reference rate. They take out the tails and come out with an average. Reference rates do not just happen. They have to be planned, so we need to plan out a rate for the Lightning Network. Over time can determine which works better than others and come up with a consensus.

 

US Dollar Risk Spectrum

  • Corporate bonds, structured products, global agencies reference these rates for pricing, and investors use for relative value comparisons.

The more likely the product is to go up and down in value, the more risky it is viewed. Risk assessment is a moving picture due to the changing of variables and factors.

 

Bitcoin Risk Spectrum

  • bitcoin in cold storage
  • LNRR
  • counterparty risk

Cold storage is the lowest risk level on the spectrum for bitcoin. Cold storage is the foundation for this capital market. Once you start to take counterparty risk, those keys are longer yours. They are controlled by ETFs , other corporations, etc. Some would rather take the counterparty risk because they trust the counterparty more than themselves (not confident in their own OpSec).

Example, I have some bitcoin in cold storage, I want to start a Lightning Node, but don't want to take a big counterparty defalt risk. Again, it is not risk free, but it is a different type of risk than if you lent your bitcoin off chain. When you do that, you take your bitcoin off chain, you are at the mercy of that person paying that you back (especially if you do not have any written agreement). If I am going to lend money on an exchange, you can ask for an interest rate above today's LNRR rate.

LNRR is potentially exciting because it gives the possibility of lending at a certain rate for off chain lending.

What is the difference between a loan at a bank or a bitcoin? If you had millions of dollars, you would have a liability risk. You put it in the bank, the bank now carries the risk. If you buy a treasury bond, the US Government now carries the risk.

 

Concerns

  • Privacy
  • Hashing of necessary variables
  • Manipulation

Banks publish the interest rate to each other. They would prefer not to do this due to competition, but it is best to do so for the benefit of the market.

Reason LIBOR was manipulated was that those banks could make a little more money by bumping the rate in their favor ;

 

The Future

  • bitcoin-denominated banks
  • Hashed credit ratings
  • Debt capital markets in your palm
  • Reserve currency status

If a person borrows money through bitcoin, what if that person had a way to prove that they paid the money back? Then they would be able to increase their credit rating. Hash credit ratings could solve the problems of fake ratings in the lending world.

The word ‘banks' does not seem to be the prettiest word in the Bitcoin world. Maybe Lightning Network nodes can be developed to that kind of world. Would be nice if people could have access to off chain lending with a hash provable credit rating. We should have new words for bitcoin trading and lending.

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Q: Do you think it is possible to create something that keeps someone's anonymity and still give someone a way to prove their credit worthiness?

A: That would be great if someone could keep their anonymous status and improve their credit rating ;

Nik Bhatia, a CFA charter holder, has worked at Payden & Rygel since 2016. At Payden & Rygel, a Los Angeles based investment firm, Nik currently works as an Investment Manager where he trades US Treasuries, interest rate futures, and other assets worth over $100 billion. His goal is to bring a capital market to Bitcoin in order for it to achieve status as a global reserve currency. Nik received his Bachelors in Social Sciences (Economics) from the University of Southern California in 2011, and received his Masters in Finance from IE University in Madrid, Spain in 2013.

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