Here’s Why Fears Regarding Bitcoin Rehypothecation In Layer 2 Protocols Might Be Overstated…

Here’s Why Fears Regarding Rehypothecation in Layer 2 Protocols Might Be Overstated…

If investors started to look at some of the concerns related to rehypothecation in layer 2 protocols for Bitcoin, they would realize that most of these issues have been blown out of proportion. Investors must realize that we don't have to fear rehypothecation, rather, accurately price its risk premiums.

However, before we proceed any further, it is of utmost importance that we learn more about the concept of rehypothecation and what it really means.

Simply put, we can see that rehypothecation is a practice that is most commonly employed by banks and brokers wherein they use assets that have previously been posted as collateral by their clients. In this regard, it is worth remembering that clients who allow for the rehypothecation of their collateral are usually reimbursed in one of the following two ways:

  • Lowered cost of borrowing from the institution itself
  • Rebate on service charges and fees.

Rehypothecation And The Lightning Network

As most of our regular readers probably already know, in its default mode of operation, the LN (Lightning Network) requires a lot of BTC — in a fully-collateralized fashion— so as to facilitate real-time monetary transfers.

In this regard, Rehypothecation of BTC across Lightning Nodes can become a reality if specific digital channels are created in such a way that they can operate on un-collateralized trades. Not only that, when talking in the context of “HTLC-like trades with a time-based escrow”, we can see that network participants have the ability to “underwrite any failures” so as to still deliver and function in a completely streamlined manner.

Here’s How Bitcoin Can Become The King Of Modern-Day Collateral

To start off with, the Lightning Network needs to swap Dex’s, which in turn will allow for the development of “Inter-chain Counterparty Value Adjustment Options Exchanges”. This will help clients gain the ability to yield synthetic cash as well as other niche offerings such as:

  • Leveraged bets
  • Options markets
  • New derivatives frontiers

    If that wasn't enough, it will also showcase to the world what a “parallel, independent, systemic risk-quantified financial system can look like.”

Why Fears Regarding Rehypothecation are Overstated?

It is worth remembering that while most of the fears related to rehypothecation may be a bit over-exaggerated, it is still quite possible that the future of BTC will depend on the influence of fiat-liquidity into its system— which will most likely ”dilute supply through leverage”. In the same vein, it is also worth remembering that “safe-returns-seeking capital” usually tends to have an opposite effect on the market — especially when put on a 1:1 fully collateralized position.

Final Take

In closing out this piece, it should be remembered that HTLCs when used for creating ‘margining general derivative contracts’ with BTC come laden with a host of counterparty risks that need to be taken into consideration — so as to ensure that HTLC’s incentive-aligned trading mechanisms actually work and are able to provide investors with timely returns.

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