The Ethereum network gave birth to the concept of decentralized finance or DeFi, which is pitched as an alternative, more accessible financial ecosystem that anyone can access to save, lend, borrow and invest.
DeFi has grown to become a massive, multi-billion dollar global market, and numerous other blockchains, including Solana, Polkadot, Avalanche and Cardano have emerged to try and take on Ethereum, boasting of more efficient networks, faster transactions and more sophisticated smart contract capabilities. Yet to date, none of these alternatives have come close to taking away Ethereum’s crown as the number one DeFi chain.
So could Bitcoin be the one that finally does it? In the last few years, the Bitcoin community has innovated on ways to expand the usefulness of Bitcoin beyond its current, limited use cases of payments and a store of value. Given that Bitcoin remains by far and away the most valuable cryptocurrency, it’s reasonable to assume that it might be the one to threaten Ethereum’s dominance in DeFi.
What is Bitcoin DeFi?
Native DeFi on Bitcoin was introduced via a key upgrade to the underlying protocol, known as Taproot. Introduced in November 2021, Taproot extended the functionality of Bitcoin, enabling it to support more complex scripting and therefore, smart contracts, which are agreements that execute automatically when specified conditions have been met. Smart contracts are the fuel that powers DeFi, and their availability on Bitcoin opens the doors to a world of possibilities.
Previously, the only way to use BTC within the DeFi ecosystem was to bridge it to an alternative network, most commonly Ethereum. The idea is that you can convert BTC to an asset called wrapped BTC that’s compatible with Ethereum, and use this alternative asset to engage with DeFI protocols built on that chain. But thanks to the capabilities introduced with Taproot, it’s no longer necessary to use wrapped assets, for we can now build DeFi protocols natively on Bitcoin.
How Does Bitcoin DeFi Work?
Taproot doesn’t bring smart contract functionality to Bitcoin itself, but rather, it paves the way for Bitcoin’s blockchain to leverage Layer-2 networks and sidechains that support more advanced scripting languages.
A number of notable L2s and sidechains have emerged to take up the challenge of bridging DeFi to Bitcoin. They include MintLayer, which is an L2 scalability network that supports smart contracts for DeFi, NFTs, decentralized exchange platforms and more. It provides the infrastructure and tools required to build DeFi applications that sit atop of the Bitcoin network, as well as the Lightning Network, which is another Bitcoin L2 that’s used to scale transactions.
Alternatives to MintLayer include Stacks, which is rather unique in that it is in fact an independent Layer-1 network, although it’s often mistakenly referred to as a sidechain or L2. Stacks utilizes a novel Proof-of-Transfer consensus protocol that allows it to settle its transactions on the Bitcoin blockchain at regular intervals, which means it works much like an L2.
A third offering is the Rootstack project, which is an L2 that dates back to 2017 and operates as a sidechain to Bitcoin. It pioneered the concept of “merged mining” where Rootstock miners secure and earn RSK tokens while mining BTC.
What Are Some Bitcoin DeFi Protocols?
Bitcoin’s DeFi ecosystem is still nascent, but more than a few projects have already gained some impressive traction. For instance, the unified yield and liquidity layer Solv Protocol has created SolvBTC, which is a liquid yield token that offers BTC holders the chance to earn competitive interest on their holdings. The Solv protocol boasts multichain integration capabilities that link it not only to Bitcoin but also other chains, such as Ethereum, Arbitrum, BNB Chain and Merlin Chain. Through this architecture, it’s able to use SolvBTC to boost liquidity in emerging BTCfi markets on L1 and L2 networks.
The progress made by Solv is all too evident, with the protocol recently surpassing $1 billion in total value locked, according to DeFiLlama, becoming the 32nd largest DeFi protocol in the industry.
Another Bitcoin DeFi protocol making waves is BadgerDAO, which provides a way for BTC to be used as collateral in a range of DeFi applications. Its Sett Vaults offering makes it possible to earn passive income on synthetic or tokenized BTC by adding them to pools that are reinvested in other DeFi protocols via smart contracts, producing yield in the form of bTokens.
One of Stacks’ most promising projects is ALEX, which is building a Bitcoin-based DeFi hub, with services including BTC lending and borrowing. With it, users can either earn a fixed interest rate on their BTC by lending it out, or else borrow BTC using other assets as collateral.
Ultimately, ALEX intends to build a full DeFi ecosystem for Bitcoin, with a DEX, derivatives trading, yield farming and a launchpad for startups looking to raise BTC funding.
Why Do We Need Bitcoin DeFi?
Bitcoin is not just the oldest and most secure blockchain around, but its also the most valuable and widely adopted of all digital assets. Yet, the flagship cryptocurrency is quite useless compared to most others, with its only real use cases being payments and “hodling”, where people simply buy and hold onto the asset in the hope that its value goes up.
As such, there’s a lot of pent up demand from Bitcoin investors who would like to put their assets to work while “hodling” them. Bitcoin DeFi can transform BTC from an idle asset into one that has tons of utility, thereby boosting its value. At the same time, the security of Bitcoin itself will bring greater trust to DeFi, which is a world that continues to be riddled with scams and hacks.
Disclaimer: This article is provided for informational purposes only. It is not offered or intended to be used as legal, tax, investment, financial, or other advice.
