Stablecoins have dominated the crypto payments market so far, but some Bitcoin developers believe there is a proposal that could provide a legitimate alternative.
Seven years ago, Dorier, a longtime developer, set out to democratize Bitcoin payment processing by launching a free and open-source alternative to the then-dominant BitPay: BTCPay Server. Despite the project’s widespread grassroots success among Bitcoin enthusiasts and online merchants, the cryptocurrency payments landscape today has evolved dramatically since Dorier began his journey. The rise of stablecoins quickly dominated the space, pushing Bitcoin, the world’s largest digital asset, to the sidelines in the payment processing arena.
Fueled by the growing demand for stable currency 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 terms with the reality that these dollar-pegged assets could reinforce the very system that Bitcoin was designed to challenge: the hegemony of the US dollar. As stablecoins grow in popularity, Bitcoin proponents find themselves at a crossroads, wondering how to preserve Bitcoin’s vision of financial sovereignty in a market increasingly tilted toward stability over decentralization.
A new proposal emerging from the Lightning ecosystem has caught Dorier’s attention, and the veteran developer believes it can address this hurdle. Speaking to a packed room at BTCPay Server’s recent annual community meeting in Riga, Dorier introduced the concept of “fiatless fiat”—a Bitcoin-native alternative to treasury-backed stablecoins like Tether and USDC.
Synthetic USD
In 2015, Arthur Hayes, co-founder and then CEO of BitMEX, outlined in a blog post how to use futures contracts to create synthetic us dollars. While this idea never gained widespread traction, it became a popular strategy among traders who wanted to hedge against bitcoin’s 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. In essence, traders can protect themselves from price fluctuations by taking an opposite position to their bitcoin holdings in a futures contract, without having to sell their bitcoin or rely on a US dollar instrument.
More recently, services like Blink Wallet have adopted this concept through the Stablesats protocol. Stablesats allow users to peg a portion of their bitcoin balance to a fiat currency, such as the US dollar, without converting it to traditional currencies. 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 holds the respective liabilities, ensuring that the user’s pegged balance retains its value against the chosen currency. (More detailed information about the mechanism can be found on the Stablesats website.)
Of course, this setup comes with a significant trade-off. By using Stablesats 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 necessary contracts to maintain the synthetic peg.
Stable channels and virtual balances
In Riga, Dorier pointed out that a similar effect can be achieved between two parties using another type of contract: Lightning Channels. The idea follows 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, with funds allocated based on the “stability receiver”’s desired exposure. By leveraging Lightning’s fast settlement capabilities, the balance can be continuously adjusted in response to price fluctuations, with sats shifting to either side of the channel as necessary to maintain the agreed-upon distribution.
Below is a simple chart to illustrate what the fund’s distribution might look like over time:
Clearly, this strategy carries significant risks. As illustrated above, stability providers who take leveraged long positions on the exchange are exposed to large downward price volatility. Furthermore, once these stability providers’ reserves are depleted, users who wish to lock in their dollar-denominated assets will be unable 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 may wish to hedge their risks in various ways.
On the other hand, the structure of this construct allows for participants’ exposure within the channel to be tied to any asset. Provided both parties independently agree on a price, this could 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 elaborated version of this idea under the name Rainbow Network.
The good, the bad, the ugly
The concept of “fiatless fiat” and stable channels is appealing because of its simplicity. Unlike algorithmic stablecoins that rely on complex and unsustainable economic models with exogenous assets, the Bitcoin Dollar, as proposed by Dorier and others, is purely the result of a voluntary, self-preserving agreement between two parties.
This distinction is crucial. Stablecoins typically involve a centralized governing body that oversees 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 USD-equivalent payments from another and then move the stability contract to another provider at their discretion. Stability provisioning has the potential to become a staple of various Lightning Service Provider-type entities competing with each other and offering different rates.
This focus on local interactions helps mitigate systemic risks and creates an environment more conducive to innovation, which reflects the original thinking. end-to-end principles from the internet.
The protocol allows for a range of implementations and use cases tailored to different user groups, while both stability providers and receivers retain full control over their underlying bitcoin. No third party, not even an oracle, can seize a user’s funds. While some existing stablecoins offer a degree of self-governance, they remain vulnerable to censorship, with operators able to blacklist addresses and effectively render associated funds worthless.
Unfortunately, this approach also inherits several challenges and limitations inherent to self-custodial systems. Building on Lightning and payment channels introduces online requirements, which have been cited as barriers to widespread adoption of these technologies. Because stable channels monitor price fluctuations through regular and frequent settlements, any party going offline could disrupt the maintenance of the link, leading to potential instability. In a article Dorier elaborates on his thoughts on the idea, considering several possible solutions for a party that goes offline. He particularly emphasizes that re-establishing the linkage of funds already allocated to a channel is “a cheap operation.”
Another potentially viable solution to the complex peg management involves the creation of ecash mints, which would issue stable notes to users and handle the channel relationship with the stability provider. This approach has already achieved real-world implementations and could see faster adoption due to its superior user experience. The obvious trade-off is that custody risks are reintroduced into a system designed to eliminate them. Still, proponents of ecash argue that its strong privacy and censorship-resistant properties make it a far better alternative than popular stablecoins, which are susceptible to surveillance and auditing.
Additionally, when scaling operations, we must carefully consider the complexities of the Lightning Protocol and the inherent security challenges presented by keeping funds at risk in “hot” channels.
Perhaps the most pressing challenge for this technology is the dynamic nature of the peg, which can attract uncooperative actors seeking to exploit short-term, erratic price movements. This is called the “free-option problem” and a malicious participant could stop honoring the peg, exposing its counterparties to volatility and the burden of re-establishing a peg with another provider. In a after On the developer-focused Delving Bitcoin forum, stablecoin developer Tony Klaus outlines several strategies to mitigate this problem and offers potential protection against this type of opportunistic behavior.
While there is no silver bullet, the emergence of a market for stability providers could potentially encourage reputable counterparties whose long-term business interests outweigh the short-term gains of ripping off 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 enticing possibilities.
“It’s very far-fetched, it’s a new idea. It’s a new kind of money. You need new business models. You need new protocols, new infrastructure. It’s something that’s more long-term, more forward-looking.”
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