DeFi on Bitcoin: Is BTCFi a breakthrough or a bubble?

BTCFi: Breakthrough or Bubble in Bitcoin DeFi?

Author: Kadeem Clarke, CEO of M6 Labs

Translation: Felix, BlockingNews

Ethereum, as the leading smart contract platform and the second largest blockchain by market capitalization, has an advantage in DeFi on the Ethereum network. In addition, benefiting from the first-mover advantage in the DeFi field, Ethereum became the first public chain to support decentralized applications since 2015.

However, emerging blockchains such as Solana, Avalanche, Cardano, and Polkadot are posing increasing challenges to the Ethereum network. Bitcoin, the flagship public chain aimed at achieving peer-to-peer online transactions, has been frequently mentioned in this discussion.

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Bitcoin network developers have recently discovered ways to extend network functionality beyond payments and launch native DeFi applications in the Bitcoin ecosystem.

What is DeFi on Bitcoin?

The Taproot upgrade allows the vision of making the Bitcoin network support decentralized applications to be realized, making Bitcoin a viable alternative to Ethereum for developers who want to launch dApps.

Before launching DeFi applications on the Bitcoin network, BTC holders could convert their BTC holdings into wrapped versions on other blockchains. The most popular asset (ERC-20 token) on the Ethereum network is the wrapped BTC (wBTC) asset.

wBTC allows BTC holders to participate in Ethereum-based DeFi protocols by locking their assets in smart contracts and obtaining equivalent assets (i.e. a 1:1 ratio) in derivative protocols. Users can then participate in liquidity mining, deposits, borrowing, and passive income on these platforms.

However, since the launch of Bitcoin-based DeFi platforms, exchanging for other assets has become a thing of the past, and users can now use native BTC tokens on these Bitcoin-based DeFi platforms.

The most common way DeFi interacts with Bitcoin is by using wrapped versions of BTC on non-Bitcoin blockchains. Users send BTC to custodians, who store the BTC and return wBTC to users at a 1:1 ratio.

For example, if you send one BTC, you will receive one wBTC. Wrapped tokens can be used in Ethereum-based DeFi protocols such as Curve, Balancer, or AAVE. wBTC can also be exchanged for BTC, and the custodian (smart contract) will return your tokens.

With the release of the Bitcoin Taproot upgrade, DeFi can now be used on Bitcoin with one exception: The native Bitcoin blockchain does not support smart contracts. Taproot introduces second-layer scaling solutions and sidechains that achieve this advanced functionality. Sidechains and second-layer protocols can host dApps in various markets, such as DeFi, NFTs, and GameFi.

Top 3 companies building DeFi on Bitcoin

Stacks

Stacks, like Bitcoin, is an independent L1 blockchain. Stacks is linked to the Bitcoin network through a process called “proof of transfer.” Miners must send Bitcoin to the Bitcoin network to mine Stacks. Multiple network transactions of Stacks can correspond to a single Bitcoin network transaction.

On the Stacks blockchain, various DeFi applications are feasible, ranging from “staking” Stacks tokens to earn Bitcoin rewards to decentralized applications providing various DeFi strategies like staking and liquidity mining.

Rootstock

The Rootstock blockchain runs as a sidechain of the Bitcoin blockchain, and its native token is Smart Bitcoin (RBTC). On the Rootstock blockchain, RBTC is used to pay fees, just as ETH is used to pay fees on the Ethereum blockchain.

The price of RBTC is pegged 1:1 to the cost of Bitcoin. Since the Rootstock blockchain is a sidechain of Bitcoin, RBTC and BTC are bi-directionally pegged, and both assets can be exchanged back and forth between the two blockchain networks.

Mintlayer

Mintlayer is a second-layer scalability solution for Bitcoin that supports smart contracts for DeFi, NFTs, and DEXs. With security comparable to Bitcoin, Mintlayer is seen as a strong competitor to Ethereum.

Mintlayer aims to develop and deploy infrastructure for DeFi on Bitcoin and the Lightning Network. Mintlayer is a Layer2 payment protocol designed to enable small payments on the Bitcoin blockchain.

Like Ethereum, Mintlayer is a platform on which developers can release dApps, unlocking and scaling Bitcoin’s full potential, addressing the three problems DeFi faces on Bitcoin (scalability, compatibility, and security).

WBTC token

WBTC was launched on October 26, 2018 and went live on January 31, 2019. WBTC is a tokenized version of Bitcoin that runs on the Ethereum blockchain and was created by three organizations: BitGo, Kyber Network, and Ren. It is compliant with the Ethereum blockchain’s ERC-20 standard, making it fully integrated with Ethereum’s ecosystem of DEXes, crypto lending services, and other ERC-20 supporting DeFi applications.

Benefits of WBTC

Faster

WBTC doesn’t run on the Bitcoin network. Therefore, their block speed and network speed are based on the Ethereum blockchain rather than Bitcoin. The time it takes for Ethereum validation to be added to a block is much less, resulting in faster transaction speeds on the network.

Lower Fees

Ethereum’s transaction fees are lower than Bitcoin’s, to encourage developers to use the network. As a result, WBTC holders can trade at lower costs than BTC holders.

For example, if a user intends to make multiple fund transfers, they are more likely to use WBTC. The fee difference is caused by the congestion on the Bitcoin network. Transactions on the Bitcoin network are more blocked, and clearing blocks is more expensive, while clearing on Ethereum is faster.

Strong Interoperability

WBTC provides an opportunity to transfer encrypted assets quickly between blockchains. Interoperability has been a long-standing and frustrating issue for crypto users, especially DeFi users.

However, wrapped cryptocurrencies, including WBTC, are a viable solution to solve this problem. This feature means that users do not have to sell Bitcoin to access DeFi services on Ethereum, and they can exchange their tokens at any time.

Differences between Bitcoin and DeFi

Comparing email and the internet can explain the difference between Bitcoin and DeFi well. When the internet first became available to the public, it only allowed for sending email. People thought of the internet as a technology that allowed for fast communication. However, as internet technology developed and became more widespread over the following years, everyone realized it was not limited to just email, but was an entirely new world full of infinite possibilities.

Similarly, when the blockchain world was only focused on Bitcoin, it was viewed as a way for users to conduct anonymous P2P transactions. However, in less than a decade, the true potential of this technology has emerged. Blockchain payments are not just a feature that makes payments faster and cheaper, but a complete system that allows you to do anything related to money, free from the constraints of banks and financial institutions.

Why DeFi on Bitcoin is Needed?

The underlying technology blockchain connects Bitcoin and DeFi. Although there are differences, Bitcoin is not the same as DeFi. It should be seen as a part of a broader decentralized finance system. People can only use real-world money to perform some special operations supported by DeFi.

As fiat currency or legal tender like the US dollar or Euro involves banks and central institutions, it directly violates DeFi principles. Therefore, Bitcoin and other crypto tokens (digitally stored value) can be used as governance currencies for the DeFi world.

BTC is mainly used as a store of value and to a lesser extent as a payment method. Through DeFi, Bitcoin increases its utility while attracting a wider user base. However, DeFi requires the security that Bitcoin has, which is what most DeFi investors and users value. Sometimes, hacks can cause users to lose their funds, leading to a loss of trust. DeFi on Bitcoin solves these problems while increasing the credibility of various solutions, making it more attractive to potential developers and investors.

Challenges of DeFi on Bitcoin

DeFi on Bitcoin faces three major challenges:

• Scalability
• Compatibility
• Security

Bitcoin is currently one of the slowest blockchains on the market, processing around 7 TPS. Ethereum can process around 12-15 TPS, while Cardano and Polkadot can process up to 1000 TPS. Scalability is an important consideration factor for developers looking for a blockchain network for their DeFi platform. Bitcoin may currently be more scalable due to limited scripting language. In contrast, Bitcoin’s competitors, such as Ethereum, are built from scratch and have stronger composability. Therefore, DeFi developers tend to choose Ethereum as their preferred protocol to launch their applications. These protocols make development easier as they can access a wide range of easily compatible assets, which are free to use and comply with various internal coding standards.

Although these L2 blockchains rely on secure infrastructure validated by Bitcoin, they bring security risks similar to those faced by other dApps and dApp platforms on competing networks. The vulnerability of smart contracts is a significant risk that every investor and developer must consider before interacting with them.

Most DeFi platforms and applications on the Bitcoin network are new, which means they have not yet been thoroughly tested, iterated, and improved, and may lack security in ensuring the safety of managed assets.

Bitcoin L2

It all started with Ordinals. Ordinals are a way of minting NFTs on Bitcoin. Many venture capital funds are laying out in this area, and the heat is expected to continue. Yuga Labs also released an Ordinal series. With Stacks deployed on Bitcoin L2, the BTC layer narrative was born. Badger announced the launch of LSD-supported Bitcoin. LSD-supported Bitcoin will be called eBTC. It is supported by ETH collateral and denominated in BTC, similar to DAI, which is supported by many assets but denominated in USD.

Potential Projects

In addition to Ordinals and LSD-supported Bitcoin, there are several projects worth watching, such as:

Ren

Ren Protocol (formerly Republic Protocol) was founded in 2017 and focuses on trustless off-chain trading. Ren Protocol aims to develop interoperability, a platform that allows users to securely trade tokens across different blockchains. The project launched its mainnet in May 2020, allowing BTC, Bitcoin Cash, and Zcash to be converted to ERC 20 networks through wrapping and RenVM.

ZeroDAO

ZeroDAO is a messaging protocol that connects Bitcoin/Zcash and Ethereum and other assets. To integrate the Ethereum ecosystem with the Bitcoin layer, a reliable way to transfer assets from Bitcoin to Ethereum is needed. ZeroDAO was previously based on Ren technology, but now that Ren has shut down, ZeroDAO is being developed from scratch and will be launched soon.

Conclusion

Continuous innovation is needed to overcome widely adopted obstacles or challenges, and one of those innovations is wrapping cryptocurrencies. Bitcoin is the safest open network and one of the most well-known and trusted networks. As a result, it is becoming increasingly attractive to DeFi developers and investors. However, whether Bitcoin DeFi will become popular enough to replace Ethereum as the preferred dApp deployment platform remains to be seen. Overall, the constantly building BTCFi projects may bring new opportunities.

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