The decentralized finance market grew exponentially in 2020 and peaked in 2021 reaching an impressive total value locked (TVL) of $110B. Furthermore, a lot of ecosystems and projects are featured mostly on the Ethereum blockchain. However, Bitcoin is catching up and fast too.
The Ethereum ecosystem birthed the modern era of decentralized finance and introduced new financial tools like decentralized exchanges (DEXs) and non-fungible tokens (NFTs). Ethereum ran the show. Bitcoin holders in the past have had to access the DeFi ecosystem by using Wrapped Bitcoin (WBTC), a version of Bitcoin that can be used on Ethereum. But the first cryptocurrency on the market is building its own DeFi ecosystem and looks set to give Ethereum a run for its money, literally.
What is DeFi
Decentralized finance (DeFi) is a niche in the crypto ecosystem that is powered by smart contracts. Unlike centralized finance, DeFi offers many of the services that centralized financial institutions like Banks offer but without the middlemen, paperwork, and long timelines. Kind of how Netflix brings the cinema to your home but DeFi brings more.
Users can lend, borrow, earn, insure, and even create their own tokens without a middleman. DeFi is everything Satoshi envisaged for Bitcoin, he only forgot to make the blockchain programmable.
To access the DeFi market, you need decentralized applications (dApps) which serve as the gateways to the DeFi ecosystem. The majority of them are built on the Ethereum blockchain which allows developers to build on its network. Uniswap, the largest decentralized exchange, and OpenSea, the largest NFT marketplace by trading volume are two examples.
DeFi has also begun to develop on other blockchains notably Solana and Avalanche. Bitcoin is finally starting to open up its blockchain to developers and this article examines how it is developing its own DeFi ecosystem.
Despite being the most secure and decentralized blockchain, DeFi was not possible on Bitcoin because the network did not support complex smart contracts. This changed with the taproot upgrade to the Bitcoin network in 2021 which among other things made Bitcoin programmable. The taproot upgrade also increased the scalability on Bitcoin allowing for the creation of decentralized applications. There are three ways to access DeFi on Bitcoin – Wrapped Bitcoin, Layer-1 blockchains, and Sidechains.
Bitcoin DeFi with Wrapped Bitcoin (WBTC)
If you are a Bitcoin holder looking to access Ethereum’s DeFi ecosystem, you can do this with Wrapped Bitcoin (WBTC). The token is pegged 1:1 to Bitcoin and can be used on other blockchains. On Ethereum, there is an ERC-20 WBTC that can be used to access financial services like lending and derivatives. With WBTC, you can borrow stablecoins on platforms like MakerDAO and Compound and use their BTC as collateral.
Wrapped BTC gives Ethereum access to Bitcoin’s high liquidity while Bitcoin holders get access to fast and diverse trading options on the Ethereum blockchain.
Bitcoin DeFi via Layer-1 blockchains
Independent layer-1 blockchains like Stacks are adding new functionality to the Bitcoin mainchain without altering the code of the mainchain. Both blockchains are connected via Proof-of-Transfer (PoX) consensus mechanism which allows Stack to leverage Bitcoin’s security. Miners transfer and lock STX tokens on the network and receive transferred BTC as mining rewards. Stacks brings smart-contract functionality and a suite of decentralized applications to Bitcoin with its Clarity programming language. The protocol also unlocks over $500B worth of liquidity on Bitcoin.
The Xverse wallet built on Stacks allows users to connect to dApps built on Stacks and secured with Bitcoin. The Gamma NFT marketplace offers users a marketplace for all NFTs created on Bitcoin. Transactions on Stacks are secured and settled on the Bitcoin mainchain. The Counterparty protocol is another layer-1 on Bitcoin offering smart-contract functionality and DeFi apps. Users can write any smart-contract code via CounterParty and execute it on the Bitcoin blockchain. The protocol has four different wallets and an array of projects that includes gaming and staking applications.
Bitcoin DeFi via Sidechains
A third alternative to access DeFi on Bitcoin is through sidechains and Rootstock (RSK) is a popular option. RSK adds smart-contract functionality to Bitcoin with its EVM-compatible infrastructure. Users pay for transaction fees on RSK with Smart-Bitcoin (RBTC) which is pegged 1:1 to the price of Bitcoin. Once you lock a certain amount of Bitcoin on the mainchain, the RSK sidechain releases the corresponding amount to you. The protocol allows developers to move dApps from Ethereum to the RSK blockchain and operate them with the underlying Bitcoin infrastructure. Unlike Ethereum, RSK provides a faster transaction speed and cheaper gas fees.
Developers also enjoy Bitcoin’s unmatched security and liquidity when they port with RSK. Some projects that have launched on the platform include RSK Swap which is a fork of Uniswap on Ethereum. The platform also has multiple stablecoins, bridges, and, wallets.
DeFi Projects on Bitcoin
Several DeFi projects are building on Bitcoin and they include Ren VM, Badger DAO, Liquid Network, and Lightning Network.
It is a decentralized protocol that creates ERC-20 versions of cryptocurrencies including Bitcoin and sends them to other blockchains. With Ren VM, users can wrap their BTC and access DeFi on different blockchains.
The Badger decentralized autonomous organization (DAO) allows BTC holders to use the coin as collateral on different dApps. The platform also offers yield earning streams for users with tokenized or synthetic Bitcoin with its Sett vault.
This layer-2 sidechain on Bitcoin enables the issuance of digital assets like stablecoins on the Bitcoin network. To mint assets on the sidechain, users send BTC to a lightning network address on the Bitcoin network. Then, an equivalent amount of LBTC (Liquid BTC) will be minted and sent to the user’s address.
This layer-2 solution uses smart contracts to speed up peer-to-peer (P2P) transactions on the Bitcoin network. The protocol since its launch has reduced congestion on Bitcoin while offering cheap gas fees.
What Next for DeFi on Bitcoin?
The total value locked on Wrapped Bitcoin (WBTC) currently stands at $4.21B, a 1000-fold increment from early 2020. With the success of protocols like Stacks, RSK, and Liquid network, more projects will migrate to the oldest and most secure blockchain in cryptocurrency.
The successful launch of Ordinals NFT on Bitcoin in January 2023 has also positioned Bitcoin as a blockchain poised to take a bite at the NFT pie. The DeFi ecosystem is still predominantly Ethereum-based with over half of the ecosystem’s $48B TVL locked within protocols on the chain. Bitcoin however has the advantage of liquidity, security, and complete decentralization, features that developers in DeFi Love.
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