DeFi on Bitcoin: BTCFi Breakout or Bubble?

By Kadeem Clarke, Head of M6Labs

Compiled by: Felix, PANews

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

However, emerging blockchains such as Solana, Avalanche, Cardano, and Polkadot pose increasing challenges to the Ethereum network. Bitcoin, the flagship public chain designed to enable peer-to-peer online transactions, has frequently received attention in this discussion.

Bitcoin network developers have recently found ways to extend network functionality beyond payments, launching DeFi applications native to the Bitcoin ecosystem.

**What is DeFi on Bitcoin? **

The Taproot upgrade brings to life the vision of the Bitcoin network supporting decentralized applications, making Bitcoin a viable alternative to Ethereum for developers looking to launch dApps.

Before the launch of DeFi applications on the Bitcoin network, BTC holders can convert their BTC holdings into wrapped versions on other blockchains. The most popular assets (ERC-20 tokens) on the Ethereum network are Wrapped BTC (wBTC) assets.

wBTC allows BTC holders to participate in the Ethereum-based DeFi protocol by locking their assets in a smart contract and obtaining an equivalent amount of assets (that is, a 1:1 ratio) in a derivative agreement. Users can then participate in liquidity mining, deposit, borrow and earn 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 a wrapped version of BTC on a non-Bitcoin blockchain. The user sends BTC to the custodian, and the custodian stores the BTC and returns wBTC to the user at a ratio of 1:1.

For example, if you send 1 BTC, you will receive 1 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 refund your tokens.

With the release of the Bitcoin Taproot upgrade, DeFi is now available on Bitcoin with the exception that the native Bitcoin blockchain does not support smart contracts. Taproot introduces a second-layer scaling solution and sidechains to enable this advanced functionality. Sidechains and second-layer protocols host dApps in various marketplaces such as DeFi, NFTs, and Gamefi.

Top 3 Big Companies Building DeFi** on Bitcoin**

Stacks

Stacks, like Bitcoin, is an independent L1 blockchain. Stacks and the Bitcoin network are linked together through a process known as "proof of transfer." Miners must send bitcoins to the bitcoin network to mine Stacks. Multiple network transaction Stacks can correspond to a single Bitcoin network transaction.

All kinds of DeFi applications are viable on the Stacks blockchain, from "staking" Stacks tokens for Bitcoin rewards, to decentralized applications that offer various DeFi strategies such as staking and liquidity mining .

Rootstock

The Rootstock blockchain operates as a sidechain of the Bitcoin blockchain, and its utility token is Smart Bitcoin (RBTC). On the Rootstock blockchain, RBTC is used to pay fees in the same way that 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, there is a two-way peg between RBTC and BTC, and the two assets can be exchanged back and forth between the two blockchain networks.

Mintlayer

Mintlayer is a layer 2 scalability solution for Bitcoin, supporting smart contracts such as DeFi, NFT and DEX. Mintlayer is considered a strong competitor to Ethereum due to its security comparable to Bitcoin.

Mintlayer aims to develop and deploy infrastructure for DeFi on Bitcoin and the Lightning Network. Mintlayer is a Layer 2 payment protocol designed to implement micropayments on the Bitcoin blockchain.

Like Ethereum, Mintlayer is a platform where developers can publish dApps that can unleash and expand the full potential of Bitcoin, solving the three problems that DeFi faces on Bitcoin (scalability, compatibility, security).

WBTC Token

WBTC was released on October 26, 2018 and launched on January 31, 2019. WBTC is a tokenized bitcoin that runs on the Ethereum blockchain and was co-created by three organizations: BitGo, Kyber Network and Ren,. WBTC complies with the ERC-20 standard of the Ethereum blockchain, enabling it to fully integrate into DEXs, encrypted lending services, and other DeFi applications that support ERC-20 in the Ethereum ecosystem.

Benefits of WBTC

faster

WBTC does not run on the Bitcoin network. Therefore, their block speed and network speed are based on the Ethereum blockchain and not Bitcoin. It takes much less time for Ethereum to verify that it is being added to a block, so transactions are faster on the network.

FEE** LOWER**** LOWER**

Ethereum has lower transaction fees than Bitcoin to encourage developers to use the network. Therefore, WBTC holders can transact at a lower cost than BTC holders.

For example, if a user intends to make multiple fund transfers, they would prefer to use WBTC. The difference in fees is caused by how congested Bitcoin is. Transactions clog up on the Bitcoin network, and blocks are more expensive to clear, while ethereum clears faster.

Interoperability****Strong

WBTC provides the opportunity to quickly transfer crypto assets between blockchains. Interoperability issues have been a long-standing and vexing problem for crypto users, especially DeFi users.

However, with wrapped cryptocurrencies, including WBTC, interoperability is a viable solution to this problem. This feature means that users do not have to sell Bitcoin to access DeFi services on Ethereum, and users can redeem their tokens back at any time.

The difference between Bitcoin and DeFi

The difference between Bitcoin and DeFi can be well explained by comparing email to the internet. When the internet was first opened to the public, the internet only allowed email. People think of the Internet as a technology that enables rapid communication. However, as Internet technology developed and became ubiquitous in the next few years, everyone realized that it was not just limited to e-mail, but a whole new world full of infinite possibilities.

Likewise, when the blockchain world only focuses on Bitcoin. Bitcoin allows users to conduct P2P transfers anonymously. In less than a decade, however, the true potential of the technology became apparent. It's not just a feature that makes blockchain payments faster and cheaper. It's a complete system where you can do anything with money, free from the shackles of banks and financial institutions.

**Why do you need DeFi on Bitcoin? **

The underlying technology blockchain connects Bitcoin and DeFi. Despite the differences, Bitcoin is different from DeFi. It should be considered an integral part of the wider decentralized financial system. People can only use real-world money to perform some special operations supported by DeFi.

Since banknotes or fiat currencies, such as dollars or euros, involve banks and central authorities, it is directly against the principles of DeFi. Therefore, Bitcoin and other crypto tokens (digital stores of value) can be used as the governance currency of the DeFi world.

BTC is primarily used as a store of value and to a lesser extent as payment. 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 hacking incidents result in the loss of user funds, resulting in a loss of trust. DeFi on Bitcoin solves these problems while improving the credibility of various solutions, making them more attractive to potential developers and investors.

DeFi****Challenges on Bitcoin

DeFi on Bitcoin faces three major challenges, namely:

• Scalability
• Compatibility
• Safety

Bitcoin is currently one of the slowest blockchains on the market with a processing speed of around 7 TPS. Ethereum can handle about 12-15 TPS, while Cardano and Polkadot can handle up to 1000 TPS. Scalability is an important consideration for developers looking for a blockchain network for their DeFi platform. Bitcoin may currently be more scalable due to its limited scripting language. In contrast, Bitcoin's competitors, such as Ethereum, are built from the ground up and are more composable. As a result, DeFi developers tend to use Ethereum as their protocol of choice for launching applications. These protocols make development easier due to access to a wide range of easily compatible assets, are free to use and adhere to various internal coding standards.

Although these L2 blockchains rely on Bitcoin’s proven security infrastructure, they pose security risks similar to those faced by other dApps and dApp platforms on Bitcoin’s rival 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 nascent, which means that they have not been thoroughly tested, iterated, and improved to ensure the security of the assets under management.

Bitcoin L2

It all started with Ordinals. Ordinals are a way to mint NFTs on Bitcoin. Many venture capital funds are deploying in this field, and this enthusiasm is expected to continue. Yuga Labs also released an Ordinal series. As Stacks are deployed at Bitcoin L2, the BTC layer narrative is born. Badger announced the launch of LSD-backed Bitcoin. Bitcoin backed by LSD will be called eBTC. Backed by liquid collateralized ETH and denominated in BTC, similar to DAI backed by many assets but denominated in USD.

Potential Project

In addition to Ordinals and LSD-backed Bitcoin, there are several projects worth looking at, such as:

Ren

Founded in 2017, Ren Protocol (formerly Republic Protocol) focuses on trustless OTC transactions. Ren Protocol aims to focus on developing interoperability, a platform that allows users to securely trade tokens between different blockchains. The project launched its mainnet in May 2020, allowing BTC, Bitcoin Cash and Zcash to switch to the ERC 20 network through wrappers and the Ren virtual machine.

ZeroDAO

ZeroDAO is a messaging protocol that connects assets like Bitcoin/Zcash and Ethereum. Integrating the Ethereum ecosystem with the Bitcoin layer requires a reliable way to transfer assets from Bitcoin to Ethereum. ZeroDAO was previously based on Ren technology, but now that Ren has stopped serving, ZeroDAO is being developed from scratch and will be launched soon.

in conclusion

Continuous innovation is required to overcome barriers or challenges to widespread adoption, and one such innovation is wrapped cryptocurrencies. Bitcoin is the most secure open network, and one of the most known and trusted. Therefore, it is becoming more and more attractive to DeFi developers and investors. However, as Bitcoin DeFi develops, it remains to be seen whether it will become popular enough to replace Ethereum as the preferred dApp deployment platform. In general, the constantly building BTCFi projects may bring new opportunities.