Bitcoin-Powered Finance: Envisioning the ARC System for Efficient Bitcoin Collateral Management

BlockSpaces, at the forefront of bitcoin-based advancements, proposes the potential of the Auto-Reconciled Collateral (ARC) system for seamless intraday, post-trade collateral settlement in OTC Derivatives and Lending Markets.

Derek Jennison
August 15, 2023
Bitcoin-Powered Finance: Envisioning the ARC System for Efficient Bitcoin Collateral Management

In the fast-paced world of finance, staying ahead demands innovative solutions that streamline treasury management and bolster risk mitigation strategies. BlockSpaces, at the forefront of bitcoin-based advancements, is proposing the development of Auto-Reconciled Collateral (ARC) system that facilitates bitcoin intraday collateral settlement within the OTC derivatives and lending markets.

Tailored for Bitcoin Miners, Corporate Treasury Managers, OTC Desks, Exchanges, TradFi institutions, and Lenders, ARC is a game-changer in the financial ecosystem. Let's explore how ARC empowers these primary users and why they would find this cutting-edge system indispensable.

1. Bitcoin Miners: Hedging Efficiency and Security

Bitcoin miners can strategically utilize the bitcoin they earn through mining activities to protect themselves against price fluctuations and mitigate risks through over-the-counter (OTC) derivative contracts. By holding a portion of their mined bitcoins in their treasuries, miners can enter into various ISDA and CSA agreements, such as NDF forwards, that allow them to hedge their positions in the Bitcoin market. These OTC derivative contracts essentially function as insurance policies, enabling miners to lock in favorable prices or limit potential losses in case the value of Bitcoin declines.

One crucial factor in these OTC derivative contracts is collateral. Miners can deposit a certain amount of Bitcoin as collateral to participate in these agreements. As the market value of Bitcoin can be highly volatile, the collateral requirements may fluctuate over time. This introduces complexities in the process of intraday collateral settlement, where miners must adjust their collateral holdings continuously to meet the changing requirements of their derivative contracts.

This is where a novel product called ARC (Auto-Reconciled Collateral) comes into play. ARC serves as an automated and efficient collateral management system specifically designed for miners and their OTC derivative contracts. By integrating ARC into their operations, miners can streamline the collateral settlement process, ensuring they always have the right amount of Bitcoin to fulfill their obligations under the ISDA and CSA agreements. ARC utilizes Bitcoin’s Lightning Network to monitor the real-time market value of Bitcoin, adjust collateral holdings accordingly, and facilitate prompt settlement without the need for constant manual intervention.

The adoption of ARC not only simplifies the collateral management process for miners but also enhances the overall stability and liquidity of the Bitcoin derivatives market. With a more robust and automated system in place, miners can confidently engage in derivative contracts, knowing they have an effective tool to manage their collateral efficiently. As a result, miners are better equipped to safeguard their earnings from mining activities, hedge against price risks, and contribute to the healthy development of the broader cryptocurrency ecosystem.

2. Corporate Treasury Managers: Maximizing Bitcoin Treasuries Effectively

Corporate treasury managers are exploring using Bitcoin in OTC derivative and lending contracts to deploy their capital without triggering taxable events. In OTC derivative contracts, Bitcoin serves as collateral for positions and hedging without selling the asset. In lending contracts, corporate treasury managers can borrow or take out loans using their Bitcoin holdings as collateral without disposing of the underlying asset.

BlockSpaces’ ARC platform facilitates intraday collateral settlement when Bitcoin is used as collateral. ARC automates collateral management by verifying blockchain ownership and tracking real-time collateral value via the Lightning Network. It ensures the agreed collateral-to-loan ratio is maintained, minimizes counterparty risk, and streamlines collateral adjustments during market price fluctuations. This solution optimizes capital utilization and brings bitcoin into traditional financial practices.

3. OTC Desks: Navigating Bitcoin Collateral Seamlessly

Over-the-counter (OTC) desks play a critical and multifaceted role in the financial ecosystem, specifically in the realm of OTC derivatives and lending markets. OTC desks act as indispensable market makers, providing continuous bid and ask prices for various financial instruments such as swaps, options, and forwards.

As intermediaries, OTC desks serve as connectors in the market, linking diverse participants like institutional investors, hedge funds, corporations, and other financial institutions. This connectivity expands the potential counterparties available for a given trade, thereby enhancing overall market liquidity. It also enables participants to access a broader range of opportunities, which encourages greater engagement and trading activity.

In the context of collateralized transactions, OTC desks often handle the process of collateral management. Collateral is utilized to mitigate counterparty credit risk, but traditional settlement processes can be time-consuming and costly with traditional bitcoin transactions. With ARC (Auto-Reconciled Collateral), OTC desks can enable swift intraday collateral settlement with bitcoin. ARC improves collateral efficiency, offers real-time monitoring, automates collateral management, enhances liquidity, and provides transparent collateral through the bitcoin blockchain and Lightning Network technology. This fosters a more liquid and secure trading environment, attracting more participants to the market.

4. Exchanges, Licensed Custodians, Traditional Finance Collateral Management

Bitcoin has gained significant popularity and acceptance in the financial world, leading to the potential integration of this digital commodity as collateral within traditional finance (TradFi). As Bitcoin's value and market capitalization continue to rise, exchanges can leverage its use as collateral in derivative contracts and lending products. 

In this evolving landscape, TradFi collateral management companies can play a crucial role in efficiently managing and allocating Bitcoin collateral throughout the contract lifecycle or tenor of an OTC derivative. They act as intermediaries, ensuring proper collateral allocation and monitoring during financial transactions.

Licensed Bitcoin custodians also play a vital role in the adoption of Bitcoin as collateral in financial contracts. These custodians are specialized entities responsible for securely holding and safeguarding bitcoin on behalf of institutional clients and exchanges. As Bitcoin expands into other markets, licensed Bitcoin custodians can expand their services to customers wanting to use bitcoin as collateral.

ARC (Auto-Reconciled Collateral) can streamline intraday collateral settlement when Bitcoin is used as collateral within the TradFi ecosystem. This automated Bitcoin collateral optimization platform operates on the Bitcoin blockchain and Lightning Network, offering real-time tracking, verification, and rehypothecation protection of Bitcoin collateral, thereby enhancing capital efficiency and minimizing counterparty risk. Overall, the integration of Bitcoin as collateral in OTC derivatives and lending markets, supported by innovative solutions like ARC, reflects the growing potential of Bitcoin to reshape traditional finance and create a more efficient global financial ecosystem.

5. Bitcoin-Collateral Lenders: Securing Collateral and Mitigating Risk

Lenders have recognized the growing demand from their customers to utilize their Bitcoin capital without triggering taxable events, such as capital gains taxes. To cater to this market, some innovative lending products have emerged that allow borrowers to use Bitcoin as collateral. However, one of the main issues faced today is the requirement for overcollateralization at high Collateral to Principal (CTP) ratios. In some cases, lenders may require borrowers to put up as much as 250% of the loan amount in Bitcoin as collateral. This high CTP ratio limits the amount of USD that lenders can lend, hindering their potential revenue and limiting the borrowing capacity for customers.

Additionally, the collaborative custody setup used for holding bitcoin collateral introduces complications related to third-party dispute resolution since three parties each hold one key to move funds. Though this protects customers from rehypothecation, if a dispute arises between the lender and borrower over the collateral's value or ownership, resolution can be prolonged and costly, impacting the overall efficiency and trust in the lending process.

By implementing ARC, lenders can significantly lower their CTP ratios, allowing them to lend more USD while still maintaining robust risk management practices. The reduced CTP ratio empowers borrowers to access larger loan amounts with a lower Bitcoin collateral requirement. This development benefits both lenders and borrowers. Lenders can earn more revenue by lending more USD, while borrowers can access the funds they need without parting ways with their Bitcoin holdings or facing tax liabilities.

Furthermore, the non-rehypothecation feature in ARC provides an added layer of security and transparency for borrowers, as they can be assured that their Bitcoin collateral remains exclusively reserved for their loan agreement. This feature helps build trust between lenders and borrowers and can attract more participants to the lending market. 

Leveraging Bitcoin as collateral within lending products presents an exciting opportunity for lenders and borrowers alike. However, the existing high CTP ratios have limited the potential of such products. The introduction of ARC addresses these challenges, enabling lenders to offer more lending capacity by reducing the CTP ratio while ensuring the security and integrity of the collateral. As the adoption of Bitcoin as collateral continues to grow, innovative solutions like ARC are poised to shape the future of lending and further integrate cryptocurrencies into mainstream financial systems.

The Future of Bitcoin Collateral Management and Risk Mitigation

BlockSpaces' proposed ARC system holds the potential to usher in a new era of treasury management and risk mitigation. Bitcoin Miners, Corporate Treasury Managers, OTC Desks, Exchanges, Licensed Bitcoin Custodians, TradFi Collateral Management Companies, and Lenders are presented with a promising vision of a comprehensive post-trade collateral management system. With planned features such as ERP integration and intraday settlement capabilities, ARC could empower these entities to navigate the ever-changing financial landscape with agility, security, and unmatched efficiency.

Contact BlockSpaces today to discover how ARC can revolutionize your treasury management and risk mitigation strategies, opening up new possibilities for success in the world of cryptocurrency and finance.