Bitcoin is undergoing an intriguing transformation, with various perspectives on its role. Some see it as a currency for daily transactions, others as a modern equivalent of gold for storing value, and still others as a decentralized global platform for securing and validating off-chain transactions. While each perspective holds some truth, Bitcoin is increasingly being recognized as a digital base money.

Similar to physical gold, Bitcoin acts as a bearer asset, an inflation hedge, and provides currency denominations like the dollar, reshaping the concept of monetary base assets. Its transparent algorithm and fixed supply of 21 million units ensure a non-discretionary monetary policy. In contrast, traditional fiat currencies like the US dollar depend on centralized authorities to manage their supply, which raises questions about their predictability and effectiveness in today's volatile, uncertain, complex, and ambiguous (VUCA) world.

This difference is especially significant in light of Nobel laureate Friedrich August von Hayek's critique of centralized monetary decision-making in his work "The Pretense of Knowledge." Bitcoin's transparent and predictable monetary policy starkly contrasts with the opaque and potentially unpredictable management of traditional fiat currencies.

To Leverage, or Not to Leverage Bitcoin

For dedicated Bitcoin supporters, the immutable supply cap of 21 million is sacred. Changing this cap would fundamentally alter Bitcoin, transforming it into something entirely different. Consequently, there is widespread skepticism within the Bitcoin community regarding leveraging Bitcoin. Many see leverage as akin to fiat currency practices, which they believe undermine Bitcoin's core principles.

This skepticism is based on the distinction between commodity credit and circulation credit, as described by Ludwig von Mises. Commodity credit is backed by real savings, while circulation credit is not, resembling unbacked IOUs. Bitcoiners view leverage that creates "paper Bitcoin" as economically risky and destabilizing.

Even the more nuanced perspectives within the community remain cautious about leveraging, aligning with voices like Caitlin Long, who has long warned about the dangers of leveraging Bitcoin. The collapse of leveraged Bitcoin lending companies such as Celsius and BlockFi in 2022 further validated the concerns raised by Long and others about the risks associated with leveraging Bitcoin.

Celsius and Co. Proved the Point

The crypto market experienced a major upheaval in 2022, similar to the Lehman Brothers collapse, causing a widespread credit crunch that impacted many players in the crypto lending sector. Contrary to popular belief, most crypto lending activities were not peer-to-peer and carried significant counterparty risks. Customers lent directly to platforms, which then used these funds for speculative strategies without proper risk management.

The rise of major DeFi protocols during the DeFi summer of 2020 offered promising yield generation opportunities. However, many of these protocols lacked sustainable business models and tokenomics. They heavily relied on protocol token inflation to maintain attractive yields, creating an unsustainable ecosystem disconnected from fundamental economic principles.

The 2022 crypto credit crunch exposed various issues with centralized yield instruments, highlighting concerns about transparency, trust, and risks such as liquidity, market, and counterparty risks. It also underscored the pitfalls of centralization and off-chain risk management processes, which, when applied to blockchain-based "banking services," mimic traditional banking flaws.

Despite the optimism during the 2020/21 bull market, many institutions like Voyager, Three Arrows Capital, Celsius, BlockFi, and FTX collapsed due to the lack of these necessary processes. The inability to implement transparent and independent checks and balances often leads to over-regulation, recurring failures, and fraud, mirroring the historical challenges of traditional banking systems. However, the absence of regulation is not a solution either.

Bitcoin-based Yield is not Optional

Where does this leave us? Following the events of 2022, many Bitcoiners are questioning whether to embrace Bitcoin yield products or if they pose too great a risk, mirroring characteristics of the fiat system. While there are valid concerns, expecting Bitcoin-based yield products to disappear entirely is unrealistic.

This question is becoming more prevalent with the emergence of a new Bitcoin ecosystem. Increasingly, projects are claiming to build financial infrastructure and applications directly on Bitcoin. Could this recreate the same issues witnessed in the broader crypto sphere?

Most likely, yes. This is inherent in the nature of the game. Since Bitcoin is a permissionless protocol, anyone can build on it, including those wanting to create Bitcoin-powered financial products. And finance inevitably involves credit and leverage.

Historically, in any thriving society, the need for credit and yield naturally arises, acting as a catalyst for economic growth. Without credit, underdeveloped economies struggle to move beyond subsistence living. Access to credit is essential for developing a more sophisticated and productive economic structure.

To realize a Bitcoin-based economy, proponents recognize the need for credit and yield mechanisms to develop atop the Bitcoin protocol. While Bitcoin is often praised as a form of money, it needs a native economy to function effectively as a currency.

This highlights the importance of Bitcoin-based yield products in fostering a robust Bitcoin-centric economy. Such an ecosystem would use Bitcoin as its digital base money while leveraging yield products to drive adoption and utilization.