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Introduction

Bitcoin-backed lending reveals a clear market gap. Borrowers want access to liquidity without losing their long-term Bitcoin exposure, while lenders seek predictable returns without bearing unlimited downside risk. Current models, both centralized and decentralized, fail to reconcile these opposing needs. Centralized custodians introduce counterparty and rehypothecation risks, while decentralized protocols depend on oracle-driven liquidations that penalize borrowers during volatility.

HodlFi emerges to address this unmet demand. By anchoring collateral in borrower-controlled Taproot contracts and replacing liquidations with market-based hedging, HodlFi provides a principled framework that eliminates forced sales, ensures transparent pricing, and keeps custody with the user. This sets the stage for a lending primitive aligned with Bitcoin's ethos of decentralization and trust minimization.

Rationales

Traditional crypto lending models expose participants to systemic weaknesses that neither protect borrowers nor fully safeguard lenders.

• Centralized lenders require users to surrender collateral and often rehypothecate assets, creating exposure to counterparty failures.
• Decentralized protocols such as MakerDAO or Aave avoid direct custody but rely on continuous price feeds and liquidation auctions. These mechanisms trigger involuntary liquidations during short-term volatility, frequently punishing solvent borrowers and mispricing collateral.

The core problem is one of risk misallocation. Borrowers are forced to shoulder volatility risk, though they lack tools to manage it effectively. Lenders, meanwhile, remain vulnerable to systemic shocks and uncertain recovery from auctions.

HodlFi addresses these issues by redesigning the borrower–lender relationship:

• Self-Custody & Trust Minimization: Collateral always remains under borrower control in a Taproot script, removing the need for custodians or discretionary intermediaries.
• No Mid-Term Liquidations: Loans run to maturity without margin calls. Borrowers either repay and reclaim their BTC or forfeit it at term, eliminating the stress of forced liquidations.
• Market-Aligned Hedging: Downside risk for lenders is absorbed by an embedded hedge purchased in external markets. This shifts volatility away from borrowers and ensures that protection is transparently priced by professional risk markets.

By structuring loans in this way, HodlFi eliminates liquidation as the default risk-control tool and aligns both sides of the transaction with Bitcoin's principles. Borrowers gain liquidity without fear of losing their long-term position, and lenders earn returns with clear, bounded risk exposure. The specifics of pricing mechanics, cost–leverage trade-offs, and scenario analyses are presented in the Economic Model section.

System Architecture

HodlFi's architecture is designed to be trust‑minimized and secure across both the Bitcoin and Ethereum (or other EVM) networks. It is organized in two layers: a contract layer that defines cross‑chain agreements, and a component layer that defines the roles of participants and off‑chain agents. This section highlights the structure, roles, and security boundaries, leaving time‑sequence details to the Loan Lifecycle.

Contract Layer

At the contract layer, three interlocking agreements bridge the Bitcoin and Ethereum ecosystems to enable lending:

• Bitcoin Collateral Script (Taproot, hash‑lock with adaptor fallback): Collateral is locked in a Taproot script with repayment, fallback, and default paths. This ensures borrower control, prevents mid‑term seizure, and guarantees settlement at maturity.
• Loan Escrow Contract (on Ethereum): Stablecoin principal is held in an immutable escrow that mirrors the commitments of the Bitcoin script. Funds are released only after proof of collateral lock and repayment, aligning collateral release with repayment fairness.