The Future of Bitcoin in Payments: Overcoming Stablecoin Dominance with Fiatless Fiat

Stablecoins have so far dominated the crypto payments market, 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. Today, despite the project’s strong success among Bitcoin enthusiasts and online merchants, the landscape of cryptocurrency payments 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 fringes of the payment processing arena.

Fueled by growing demand for stable currency options, particularly US dollars, stablecoins have quickly taken over the cryptocurrency payments market. This growth has left many Bitcoin enthusiasts struggling to cope with the reality that these dollar-linked assets could reinforce the very system Bitcoin was designed to challenge – the hegemony of the US dollar. As stablecoins continue to gain traction, Bitcoin promoters are at a crossroads, questioning how to preserve Bitcoin’s vision of financial sovereignty in a market that leans more toward stability than decentralization.

A new proposal emerging from the Lightning ecosystem caught Dorier’s eye, and the veteran developer believes it could solve that hurdle. Speaking to a packed audience at the recent BTCPay Server annual community meeting in Riga, Dorier introduced the concept of “fiatless fiat” – a native Bitcoin alternative to treasury-backed stablecoins like Tether and USDC.

Synthetic USD

In 2015, BitMEX co-founder and CEO Arthur Hayes 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 looking to hedge against bitcoin volatility without having to sell their underlying Bitcoin positions.

For readers less familiar with 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. Essentially, by taking a position against their bitcoin holdings in a futures contract, traders can hedge against price fluctuations without having to sell their bitcoin or rely on a US dollar instrument.

More recently, services such as 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 currency. In this model, the wallet operator acts as a “dealer” by hedging the user’s fixed balance using futures contracts on centralized exchanges. The operator then tracks those obligations, ensuring that the user’s fixed balance maintains its value in relation to the chosen currency. (More detailed information about the mechanism can be found on the Stablesats website.)

Obviously, this setup comes with a significant trade-off. By using Stablesats or similar services, users effectively relinquish custody of their funds to the wallet operator. The operator must then manage the hedging process and maintain the necessary contracts to hold the synthetic peg.

Stable channels and virtual balances

In Riga, Dorier pointed out that a similar effect can be achieved between two parties using a different type of contract: lightning channels. The idea follows recent work by Bitcoin developer Tony Klaus on a mechanism called stable channels.

Instead of relying on centralized exchanges, stable channels connect users who want to hedge their Bitcoin exposure with “stability providers” through the Lightning Network. A stable channel essentially works like a shared Bitcoin balance, where funds are allocated based on the desired exposure of the “stability receiver”. Using Lightning’s rapid settlement capabilities, the balance can be continuously adjusted in response to price fluctuations, with the village moving to either side of the channel as needed to maintain the agreed distribution.

Here’s a simple chart to illustrate what the breakdown of the fund can look like over time:

credit: Tony Klaus

Clearly, this strategy involves considerable risk. As illustrated above, stability providers who take long leveraged positions in the stock market are exposed to high downward price volatility. Furthermore, once the reserves of these stability providers are depleted, users who wish to lock in their dollar value will no longer be able to absorb further price declines. While these types of rapid reductions are increasingly rare, Bitcoin volatility is always unpredictable and it is conceivable that stability providers will seek to hedge their risks in different ways.

On the other hand, the structure of this construct allows the participants’ exposure within the channel to be tied to any asset. Provided both parties independently agree on a price, this can 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 elaborate version of this idea called the Rainbow Network.

The good, the bad, the ugly

The concept of “fiatless fiat” and stable channels is compelling because of its simplicity. Unlike algorithmic stablecoins that rely on complex and unsustainable economic models involving exogenous assets, the Bitcoin dollar, as envisioned by Dorier and others, is merely the result of a voluntary self-custody agreement between two parties.

This distinction is critical. Stablecoins typically involve a centralized governing body that oversees a global network, while a stablecoin is a localized arrangement where risk is limited for the participants involved. Interestingly, it doesn’t even have to rely on network effects: a user can choose to receive equivalent USD payments from another and then transfer the stability contract to another provider at their discretion. Providing stability has the potential to become a core service from various types of Lightning service providers that compete and offer different rates.

The focus on local interactions helps mitigate systemic risk and fosters a more innovation-friendly environment, echoing the original end-to-end principles of the Internet.

The protocol allows for a number of implementations and use cases, tailored to different user groups, while both stability providers and receivers retain full control of their underlying bitcoin. No third party, not even an oracle, can confiscate a user’s funds. Although some existing stablecoins offer some degree of self-custody, they, by contrast, remain vulnerable to censorship, with operators able to blacklist addresses and effectively reduce associated funds.

Unfortunately, this approach also inherits some of the challenges and limitations inherent in self-custody 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 that disconnects can disrupt peg maintenance, leading to potential instability. In an article further detailing his thoughts on the idea, Dorier hosts various potential solutions to a party going offline, mainly insisting that restoring funds already allocated to a channel “is a cheap operation.”

Another potentially viable solution to complex peg management involves the creation of ecash mints, which would issue stable notes to users and manage the channel relationship with the stability provider. This approach already has real-world implementations and could be adopted more quickly due to its superior user experience. The obvious trade-off is that custody risks are reintroduced into a system designed to eliminate them. However, proponents of ecash argue that its strong privacy and censorship-resistant properties make it a far superior alternative to popular stablecoins, which are prone to surveillance and control.

Beyond that, the complexity of the Lightning protocol and the inherent security challenges of keeping funds at risk on “hot” channels will require careful consideration when scaling operations.

Perhaps the most pressing challenge to this technology is the dynamic nature of the peg, which can attract uncooperative actors looking to exploit short-term erratic price movements. Called the “free option problem,” a malicious participant could stop honoring the peg, leaving counterparties exposed to volatility and the burden of re-establishing an agreement with another supplier. In a post on the developer-focused Delving Bitcoin forum, channel stable developer Tony Klaus outlines several strategies to mitigate this problem, offering potential safeguards against these types of opportunistic behaviors.

While there is no silver bullet, the emergence of a market for stability providers could encourage reputable counterparties whose long-term commercial interests will outweigh the short-term gains of defrauding 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 potential appeal.

“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 and new infrastructure. It’s something longer, more forward-looking.”

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