Your Keys, Your Coins with Zero

Brought to you by Onedigit

October 3, 2022

Every bitcoiner knows "not your keys, not your coins." This mantra underscores the counterparty risk that comes from allowing someone else access to our bitcoin through our keys. It also reminds us of the individual responsibility we assume when we store our value in a decentralized, permissionless asset. 

So how does this “your keys, your coins” principle apply in the world of defi? Is it possible to use your bitcoin as collateral for even a basic financial transaction like borrowing on Zero, where your bitcoin gets locked in a smart contract? 

A financial transaction like borrowing highlights the challenge of retaining possession of your keys. No one wants to make uncollateralized loans. They're too risky for the lender and too expensive for the borrower. Collateralized borrowing of stablecoins against your bitcoin allows you to inexpensively tap into the value of your bitcoin without selling. 

But how can you provide collateral without giving up your keys? In most cases with centralized lenders, you can’t. You simply have to trust in the good faith—and solvency!—of the lender. The best centralized lenders now employ multi-sig wallets—typically a 2-of-3 multi-sig for you, the lender, and the institution. While this reduces risk, it still exposes you to third-party risk from both the lender and the institution.

Borrowing on a defi protocol like Zero is another option. You lock your bitcoin collateral in a smart contract and receive stablecoins. Does this violate the "not your keys" principle? It does eliminate third-party risk. But you can't just walk away with your collateral, since it's locked.

Locking coins in a smart contract doesn't violate the "not your keys" principle. Why not? Consider the analogy of a mortgage on your house. If you have a mortgage, your house is collateral but it's still yours. You live in it and you hold the keys. Though you live in it and own it, it is legally "locked". You must carry insurance on it. You cannot sell it and walk away with the cash. The law will not let you do that. You have agreed to certain contractual obligations that prevent you from walking away with its value. 

Likewise, when you take out a defi loan, you are agreeing to a contract on your bitcoin. The contract is enforced by code—open source, auditable, and predictable in advance—rather than by people and institutions. You don't give up your keys. You just agree in advance to the terms.

If you want to borrow against your bitcoin, defi allows you to keep your keys and avoid trusting your wallet to a third party. In fact, collateralized borrowing using a smart-contract system like Zero may actually be the only way to borrow and retain your keys…and your coins. The Zero protocol allows you to borrow stablecoins against your bitcoin at zero-percent interest, allowing you to keep not only your keys but all of your coins too.

If you’d like to delve deeper into how Zero works, check out this article on our blog, If Bitcoin Is Magic Internet Money, Zero Is Magic Internet Borrowing. The article digs into the mechanics of the ‘magic’ behind Zero!

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