LN Markets Upgrades Bitcoin Trading with DLC

Bitcoin is fixing money.

Thanks to Bitcoin, anyone around the world can freely transfer money through a peer-to-peer network without going through a financial institution. It is money that cannot be censored by authorities, devalued by governments, monopolized by corporations, and blocked by borders.

However, when it comes to trading, you still need to do it through a trusted third party. Why is that a problem? Because trusted third parties have always been and always will be a security hole.

Bitcoin trading stopped

Both individuals and financial institutions rely on trusted third parties, such as clearinghouses and exchanges, to clear Bitcoin spot and derivatives transactions.

“Banks must be trusted to store our money and transfer it electronically, yet they lend in waves of a credit bubble with virtually no reserves.” – Satoshi Nakamoto, November 2, 2009

Sound familiar? Yes, that’s exactly what happened during the 2022 pandemic event that saw the collapse of Chelsea, Terra, Three Arrows Capital, BlockFi, Voyager, FTX, and more. In most cases, end users who trusted these third parties lost everything.

Centralized exchanges are inherently unsafe because they allow funds to be raised without supervision. Trading and storage should never be mixed.

Looking at the above list of bankruptcies, you might feel helpless and declare that you can stop trading Bitcoin. Instead, we took another look and wondered whether Bitcoin transactions really need to take place on a trusted third-party ledger. surely. And Bitcoin itself provides the solution!

Bitcoin is a complex and dynamic system that has not yet found its balance, and no one can predict the ultimate role it will play. Defining Bitcoin is difficult because it intersects with multiple domains. Some see it as a financial asset, others as a currency, a network, or even an ideological statement.

As developers of innovative trading solutions, we are particularly interested in one aspect: Bitcoin as a technological infrastructure. This technical dimension is perhaps the least noticeable due to its relative complexity, but we have found it to be one of the most fascinating aspects of this UFO (Unidentified Financial Object).

And we firmly believe that the Bitcoin protocol provides the ideal building blocks for the development of sound financial services.

Building the Future of Bitcoin Transactions

Bitcoin’s code consists of operations that, when combined, form a script. The list of available default actions has evolved over time with new actions being added to enable more complex scripts. These advances are often slow, but this incremental pace helps keep the protocol stable and secure.

Of course, the simplest script is to transfer units of value peer-to-peer. The first trading platforms were built incorporating this functionality. This means that it is now possible to transfer funds directly from your wallet to the platform for processing.

The Lightning Network is an application built with more complex scripts. This allows you to transfer BTC instantly and without risk. LN Markets was the first trading platform to integrate this new protocol into its core development.

Targeted at the retail market, this value proposition drastically simplifies the trading experience. It takes just seconds for users to complete everything, from account creation to collateral transfers, and it all happens instantly in their Lightning wallet. The value proposition of instant trading has resulted in over $2 billion in cumulative trading volume.

Based on this success, it was natural for us to turn our attention to Discreet Log Contracts. DLC is a basic “smart contract” built on top of Bitcoin that can deliver rewards based solely on the oracle’s price disclosure.

Today, we believe it is time to build a DLC protocol to enable completely trustless transactions and stop the pooling of funds by trusted third parties.

Trust-minimizing trading on Bitcoin is now a reality.

Over the past few months, we have been building a trustless OTC derivatives trading platform in stealth mode, designed to meet the needs of DLC Markets, a crypto financial institution.

All types of financial instruments, including Bitcoin futures and options, hashrate and blockspace products, and potentially any asset in the world can be traded on the DLC market without counterparty risk.

Traditionally, institutional trading has always been centralized and standardized. At some point, a clearing house (CCP) takes control of the funds and manages payments. Paradoxically, despite technological advancements, Bitcoin trading is much riskier than traditional trading. There is no regulation, trading and storage in the same place, resulting in conflicts of interest, numerous risks and frequent bankruptcies.

DLC Markets aims to solve these problems. Inspired by traditional OTC transactions, we are developing a marketplace where participants can meet and transact. Similar to ISDA/CSA contracts, collateral is exchanged directly between peers.

To manage payments, a smart contract (DLC) acts as a CCP. These smart contracts are unique to each transaction and ensure segregated fund management, full transparency for transaction participants, and confidentiality from external actors.

Market participants can chat with each other and submit bilateral requests for quotations (RFQs). Upon mutual agreement on the transaction, they confirm the transaction parameters and submit the initial margin to a smart contract on the Bitcoin blockchain. While a trade is in progress, margin calls, clearing and settlement can occur and the corresponding results can be unlocked in the smart contract. The calculation of all settlements is entirely dependent on the announcement of an independent oracle.

Oracle is a trusted third party that accurately verifies certain events. Unlike escrow, Oracle is not responsible for interpreting or enforcing contracts. No explicit approval is required from Oracle to enter into a contract or settle it unilaterally. The only requirement is to use data regularly published by Oracle, which is freely available and shareable.

Existing DLCs can be cumbersome to implement, but we introduce a new approach that uses coordinators to solve the free option dilemma when a DLC is launched. This approach also allows margin calls, clearing, and netting to be integrated into the DLC process.

Time flow diagram of the margin call phase and hedging period for the most anticipated trading formats of DLC.

For a technical deep dive into our solutions, check out our whitepaper.

the future is now

DLC Markets represent a paradigm shift, providing a trustless and secure alternative to the centralized exchanges that have long dominated the financial sector. You can already sign up and try out the beta!

To accelerate Bitcoin as infrastructure, we have completed raising a $3 million seed round led by Ego Death Capital along with Lemniscap and Timechain, joining current investors Arcario, Bitfinex, and Fulgur Ventures. We are excited to partner with investors who share our belief that Bitcoin-based companies will change the world.

Welcome to a new era of transparency, efficiency and resilience in derivatives trading.

More information: https://lnmarkets.com/ & https://dlcmarkets.com/

This is a guest post from LN Markets. The opinions expressed are solely personal and do not necessarily reflect the opinions of BTC Inc or Bitcoin Magazine.