UTXO Investment Thesis: The Settlement Chain

UTXO Investment Thesis: The Settlement Chain

This post aims to outline the investment thesis of UTXO Management. 


Three Powerful Cultural and Technological forces are challenging our understanding of Bitcoin as a network and as an asset

  1. Bitcoin narratives are always changing and the introduction of Ordinals and BitVM is changing the way that we understand the Bitcoin network
  2. The possibility to build on Bitcoin has initiated a brain drain from the crypto ecosystem back to Bitcoin
  3. Being early to fuel companies bringing more utility and value to bitcoin represents a unique opportunity to build a truly decentralized economy

Bitcoin narratives evolve over time 

If you’ve been in Bitcoin for a while, then you know that narratives tend to change and evolve over time as our understanding of Bitcoin itself evolves. This is a natural part of our collective psyches wrestling to make sense of the ever-evolving catastrophe that is modern economics. When inflation reaches generational highs, we tend to focus more on the absolute certainty that the ever-decreasing issuance of Bitcoin offers, and when our governments attempt to restrain our freedom, we tend to focus on the censorship-resistant nature of the blockchain.

A close friend of mine used to say that “Bitcoin is still a teenager” and therefore, we should not be so quick to judge it. Teenagers don’t know who they are, we’ve all been through an identity crisis at some point during those formative years. He’s right, Bitcoin is no different, and –– as the collective brain that can conceptualize it –– we should be wary of choosing Bitcoin’s final identity so early. Imagine if the emo people in school remained the same until they were 30 years old. 

The first thing that comes to mind when attempting to define Bitcoin’s identity is to make a clear difference between Bitcoin the network, and bitcoin (BTC) the asset. BTC is the currency that lives within the network, that is protected by the network (miners and nodes) and that is exchanged on the chain (blockchain transactions). As an asset, bitcoin is very well understood and its “identity” is not that controversial. 

More recently, however, much ink has been spilled to settle on what Bitcoin the network should be. And for all the love we have for bitcoin the asset, the most valuable piece of freedom technology that was invented in the last 20 years is Bitcoin the network; its decentralized nature, its clock-like system that gives certainty in the ordering of things, its capacity to send and receive data without permission, etc. 

I’ve always been of the opinion that we should consider Bitcoin as a settlement chain for all economic activity, rather than “just” a network to send and receive BTC. 

Why? For these four simple reasons: 

  1. Suppose we ever want to see BTC adopted as a medium of exchange, a true currency for the world. In that case, we have to create economic incentives to use bitcoin, to spend it, to invest with it, to use it as the most pristine form of collateral that exists. It already has the biggest network effects, and that will never be replicable by other chains. 
  2. Bitcoin the network is the most secure, decentralized, and reliable blockchain that exists. Therefore, the laws of the free market would dictate that its blockspace is the most valuable commodity among blockchains, which in turn will inevitably increase the demand from rational economic actors to access it.
  3. The security of Bitcoin relies on miners being financially profitable and therefore, we should incentivize all forms of economic activity that would help create a sustainable fee market (without inviting centralizing forces of course) as block subsidies are cut in half roughly every four years (ie. the security budget question). 
  4. Bitcoin is a permissionless network, as long as you follow the rules set by nodes and as long as you pay the corresponding transaction fees to miners, you are welcome to use it. If those two criteria are met, there is no reason to exclude any form of economic activity that would diverge from “normal” financial transactions. If more people use Bitcoin, it makes it more likely to become a medium of exchange and harder for governments to attack. 

Not so long ago, many criticized Bitcoin for its lack of programmability and conservative approach to governance in opposition to the “move fast and break things” attitude adopted in crypto circles.    

However, this narrative changed once again with the introduction of Ordinals, competing token standards, and the publication of the BitVM white paper. The same idea that allowed for the creation of the Lightning Network (LN) therefore became obvious once again: the Bitcoin network can be the bedrock for a new way of settling economic activity, we just need to build on top of it without changing its core properties. 

Since then, the popularity of Bitcoin among crypto developers has skyrocketed as many had the following realization: “What if I could build on Bitcoin now?”. For them, Bitcoin became “fun again.”

Why is UTXO Betting on the Settlement Chain Thesis? 

At UTXO, our company motto is “Fueling the companies and technologies striving for hyperbitcoinization,” and our investment thesis revolves around the thesis outlined above: Bitcoin will become a settlement chain that will directly challenge all competing blockchains for fee revenue. 

In a very Peterson-esque manner, you could ask: “What do Fueling companies and technologies even mean”, and “What do you mean by striving for hyperbitcoinization?”. We’ll get to it in this article. 

As an investment fund, we have two tools on our belt - money and research. Research helps us identify and shape the narratives emerging on Bitcoin while money helps us fund (on the venture side) and support (on the liquid fund side) the most talented founders aligned with our investment mandate. That’s the “Fueling” part. 

Why fueling and not helping, you could ask? As we’ve outlined earlier, the Bitcoin ecosystem has undergone a radical mutation over the past year with individuals and companies building the engine of the settlement chain and they just need the fuel to power the true explosion of innovation happening within those combustion chambers. 

Furthermore, in order for the settlement chain to be successful you need new scaling technologies and innovative companies. Who is building that future now? 

The Burgeoning Bitcoin Ecosystem

Creating a successful financial ecosystem on top of a blockchain always faces a fundamental issue: is DeFi a matter of products or infrastructure? In this section, we’ll explore some of the companies building exciting new Bitcoin verticals, and promising technological innovations that will help to make those verticals more efficient. 

When we look at our portfolio today, we can outline three broad categories of companies building on Bitcoin: 

  1. Bitcoin Layers/Protocols & BTCfi: Run it all back?

Among the most interesting verticals that have emerged on Bitcoin over the past year, Bitcoin layers, protocols, and financial infrastructure are the ones that caught the most attention. 

The introduction of BitVM challenged the boundaries of “what could be done” on Bitcoin and, as a result, an onslaught of new protocols attempting to become the financial layers of tomorrow have emerged. 

The security model and trust assumptions of those companies’ products vary widely, but one thing is for certain –– market demand is here. Valuations and TVLs have gone through the roof over the year's first half as companies rushed to develop new solutions. 

In the meantime, every successful product on the market is being recreated on Bitcoin, with new innovative ideas: staking and re-staking on Bitcoin, PoS x PoW shared security, stablecoins, yield vaults, AMM, hashrate derivatives… the list goes on. Will these new products eat market share away from other chains? Or will they unlock a massive wave of dormant Bitcoin liquidity waiting for years to be deployed? Tune in Bitcoin land later this year to find out.

  1. Bitcoin Infrastructure and UX: First Principles 

In crypto, UX is often the determining factor between a successful product and a forgotten one. That is why we have decided to invest in companies like AnchorWatch, OYL, Lava, and others. Infrastructure companies are the bedrock of a solid ecosystem, but those on Bitcoin need to catch up in order to reach the same levels of experience that the ones in some other ecosystems can provide. Wallets and reinforced custody solutions are among the most critical pieces of infrastructure necessary today, especially as the fragmentation of liquidity and token standards forces users to interact with many different tools. (Hopefully not for long!) 

  1. King of the Hill: Defining a Token Standard for Bitcoin 

Ever since Ordinals were introduced to Bitcoin, multiple token standards have emerged with the hope of providing an attractive competitor to ERC-20s, first with BRC-20, then CBRC-20, and finally Runes. Because Bitcoin lacks programmability at the script level, developers have had to find innovative ways to go around it, either by building metaprotocols, leveraging the OP_RETURN field, or both. 

However, most of the existing standards are somewhat inefficient, expensive to exchange, and hard to interact with. Fortunately, many companies are trying to make the experience of trading tokens on Bitcoin more pleasing. We’ve even seen lending protocols like Liquidium give users the ability to leverage their Ordinal assets to generate native BTC yield. 

One question remains, which token standard will manage to stick around? As of today, it would appear that Runes are the superior standard, but with the emergence of Taproot Assets, competition will be fierce, especially as the LN finance narrative takes off. Ultimately, if we expect that both standards will be able to be exchanged on Lightning rails, lowering minting and trading costs, community narratives and UX will become the differentiating factors. 

We are still early

The risks and architecture trade-offs

While everything that we’ve outlined above is exciting, we have to remember that at the time of writing, most of these projects haven’t released their final mainnet products. If history can teach us anything, it's that innovative ideas are inherently risky, and as Schumpeter once outlined, the process of creative destruction should not be ignored. Mistakes will be made, smart contracts will be exploited, and token prices will crater. 

As a venture fund, UTXO is committed to encouraging and helping companies take the necessary steps to mitigate those risks. Our internal research is aimed at helping companies think through design choices and their consequences based on the experiences of the past. Narratives often evolve faster than technology, and the risks preference of bitcoin users evolves with them as well. Understanding those narratives is therefore paramount. But narratives are also shaped, and our intent is to help shape the narratives that will benefit the most responsible builders. 

In addition to technological risks, reputational risks are greater on Bitcoin than on any other chain. Navigating the complex history of Bitcoin and its many tribes can be complicated, and even confusing. That is why we believe we are uniquely positioned to help builders get their message across chains and communities. We’ve mentioned the liquidity fragmentation issue earlier, but mindshare fragmentation is an equally important challenge to consider. 

Furthermore, everyone knows how much the “first-mover advantage” can influence the success or failure of a company. This will lead companies to cut corners to achieve this status and the most likely victim will be decentralization. Companies move faster than technology.

However, being early is also an opportunity. An opportunity for researchers and analysts to come together and help shape what the path toward decentralization could look like for these companies. Not everything requires complete decentralization, but we at least have a chance to build something different from other chains. Something that is aligned with the ethos and values of OG Bitcoiners. Something that can change the world. 

This is why we are also proud to actively support the Bitcoin Layers project spearheaded by Janus and Red. It’s often hard for market participants to understand the trade-offs inherent with the products or layers they are interacting with; having a comparative platform with detailed risk assessments will not only help everyone, it will also help spur debates around the merits of each layer's architecture decisions. 

DeFi projects and Bitcoin “layers” have often been criticized for their lack of true decentralization or direct relationship with the Bitcoin base layer, but as the ideas of Bitcoin builders get analyzed and become distributed in the community, we hope to stir the ecosystem away from the pitfalls of designs traditionally used on other chains and towards something better. Expect more research collaborations with Bitcoin Layers in the months to come. 

The Bitcoin Economic Layer Will Look Very Different by the End of 2024

Yes, the challenges ahead are great, but the opportunities are even greater. By the end of 2024, the Bitcoin ecosystem landscape will be drastically different, and it's clear that the majority of market participants are still scrambling to decide how to get exposure to what is about to happen. 

For us, exposure can also take the form of supporting early entrepreneurs with just an idea. After all, everything always starts with just an idea. As the brain drain from the Ethereum and Solana ecosystems continues, we expect many builders to need “a place to start” and that is why we’re supporting the Bitcoin Startup Lab –– a Bitcoin accelerator tailored for ambitious Bitcoiners. So far, we’ve had the pleasure of supporting exceptional individuals from Liquidium, Velar, and Bison Labs. 

So, with all these new companies and technologies emerging, where are things going from there? We see five distinct trends shaping the second half of this year:

  1. New Bitcoin “layers” competing to attract TVL and companies: Free markets are inherently chaotic but with every eye on Bitcoin this year, competition will be fierce to attract TVL and new incentive campaigns will temporarily transform the ecosystem into a giant PvP battlefield. Therefore, allocating capital to the right projects will be very important, but not so much as understanding which projects will manage to keep their users after those programs expire will be paramount. 
  2. Liquidity fragmentation will subside in Q4: Most companies expect to release a mainnet product between Q2 and Q3 2024, which means that we should start seeing liquidity fragmentation slowly reverse by Q4, converging towards a few winners. This is when accurate valuations will also start to emerge, giving us an accurate yardstick to measure the market's appetite for Bitcoin-based infrastructure.  
  3. The Holy Grail of Stablecoins: Stablecoins have always been the Holy Grail of a crypto ecosystem, and Bitcoin is no different. We expect to see clear winners emerge by the end of the year. One question remains, could these “winners” become popular enough to compete directly with some of the legacy projects and/or centralized alternatives like USDT and USDC? We believe that as the regulatory noose continues to tighten for centralized stablecoins, the market will slowly and cautiously look for less centralized alternatives. Obviously, legacy players will benefit the most, but the value proposition of Bitcoin as the most censorship-resistant chain could sway enough capital to create new crypto behemoths. 
  4. The Covenants Wildcard: If you’ve been following Bitcoin for a while then you know that the governance process is notoriously long and messy. However, consensus has been slowly building on Covenants as more use cases for them emerged (Ark and BitVM in particular). The two main contenders are OP_CAT and OP_CTV. These new opcodes could act as “the great equalizers” by forcing existing projects to adapt quickly and giving a chance for newcomers to build new products and infrastructure based on covenants. While CTV seems to be the inherently battle-tested, efficient, and conservative option, CAT could open up a larger design space for developers looking to enable more powerful features using Bitcoin natively. 
  5. Rollups and MEV on Bitcoin: One of the obvious beneficiaries of covenants would be the teams building Rollups, and we expect the competition to be fierce. However, as Matt Corallo recently pointed out, a subset of rollups designs called “Based Rollups” could introduce new forms of MEV on Bitcoin because it gives miners an opportunity to select and order rollups transactions. Outside of the obvious consideration for the threat that this may pose, we expect MEV “resistance” and/or “optimization” to become an important new vertical on Bitcoin (similar to ETH) with extremely sophisticated players reaping the highest rewards. 

We are confident that 2024 will be the year that bitcoin the asset will add another weapon to its arsenal of bullish narratives because its utility is going to increase as a function of the Bitcoin network realizing its full potential by becoming “the apex predator of economic settlement”. A gigantic wave of brainpower and liquidity is coming back to Bitcoin and we are prepared to ride it. Are you? 

If you are looking to build on Bitcoin we’d love to hear from you! You can reach out to us directly on the website or at @GuillaumeUTXO on TG. 

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