Developers are really looking to build a DeFi ecosystem on top of Bitcoin. We have the right to expect an explosive future of narratives in the Bitcoin Ecosystem such as: Bitcoin Layer 2, Bitcoin LSD, Bitcoin NFT and Bitcoin DeFi summer.
Introductions
As you know, the difference between Bitcoin Blockchain compared to Ethereum and later generation Blockchains is Smart Contract.
While Ethereum supports building smart contracts that help implement many different complex logics, Bitcoin only supports simple back-and-forth transactions, building dApps on Bitcoin was impossible in the past.
The 2021 Taproot upgrade has opened the door to the potential for building other pieces on the Bitcoin network. Maybe you've heard of Ordinals, a new trend that emerged in early 2021, allowing users to create and trade NFTs directly on the Bitcoin network, or some network expansion projects like Stacks, RSK. Developers are really looking to build an ecosystem on top of Bitcoin.
What is DeFi on Bitcoin and how does it work?
What is DeFi?
DeFi (Decentralized Finance) is a decentralized finance platform, it is operated by smart contracts on the blockchain platform, participants only need to trust and use smart contracts instead of another third party such as a Bank. or credit institutions in traditional finance.
DeFi inherits the core properties of blockchain:
Decentralized - Decentralized
Permissionless - Permissionless
No need to trust - Trustless
Transparent - Transparent
Self-Custody - Self-Custody
Thus, it can be seen that the foundation for developing the DeFi ecosystem lies in building dApps - or financial tools for users to interact.
What is Bitcoin DeFi?
DeFi on Bitcoin refers to the development of a decentralized financial platform that runs directly or indirectly on the Bitcoin network.
As mentioned in the first part, after the Taproot update, developers were able to build smart contracts, thereby opening the door to the DeFi ecosystem on Bitcoin. However, the scripting language of the Bitcoin network only supports simple logic, so the most optimal solution for Bitcoin DeFi is to build on its scaling solutions.
Currently there are 2 directions for deploying BTC-Fi:
The first is to wrap BTC into wrapBTC to use DeFi services available on other chains such as Ethereum.
Try two is to build a new DeFi ecosystem on expansion solutions such as sidechain or layer 2.
In both ways, users need to lock an amount of Bitcoin on the main chain through a contract lock, then an amount of Bitcoin on the new chain will be minted for users to participate in the DeFi ecosystem on it.
Potential and challenges with BTC-Fi
Potential
Since its launch until now, BTC has been used primarily as a store of value rather than as a means of payment. The development of scaling solutions leads to the growth of the DeFi ecosystem on Bitcoin. Bitcoin will have more utility than storing value, holders can participate in activities such as lending/borrowing, LP farming, buying NFTs, etc. easily and at low cost.
A developed DeFi ecosystem will be the premise to unlock the billions of dollars of Bitcoin liquidity that is sitting dormant solely for the purpose of storing value.
Challenge
However, there are still challenges for BTC-Fi:
First comes security. As analyzed in the operating mechanism section, currently to bring BTC into the DeFi ecosystem, users need to lock into a contract and then use a new token at the expansion layers. Although these layers have their own sophisticated security methods, they certainly cannot be as decentralized and secure as Bitcoin. If problems arise, it will affect the assets of the users who have given them. enter. Not to mention these bridges are often easy prey that hackers often target.
Second lies Bitcoin's inherent weakness, which is scalability. Bitcoin's TPS is about 7 transactions and space per block is limited. So the more the DeFi ecosystem grows, the more data is compressed onto the network, making it more cumbersome and expensive to operate, which can push transaction costs higher.
Third is compatibility. Bitcoin's programming language only provides simple logic and is unlikely to be compatible with complex smart contracts. Therefore, until now, in addition to Lightning Network as Layer 2 payment, the most suitable expansion solution for Bitcoin is still sidechain, developers can develop many complex dApps on this.
DeFi ecosystem on Bitcoin
Some outstanding projects in each category:
Infrastructure
Lightning Network
Lightning Network is a protocol that expands the Bitcoin network according to the Payment channel solution (a branch of the State channel). It helps reduce costs and congestion on Bitcoin's inherently slow network. Lightning Network is commonly known for its main purpose of payments after El Salvador accepted Bitcoin as legal currency.
The mechanism of Lightning Network is to allow two parties to agree to open a two-way payment channel and perform many different off-chain transactions. After completion, the final balance will be updated to the on-chain network system. This helps increase speed and greatly reduce the load on the Bitcoin network.
Stacks (STX)
Stacks is an open source blockchain closely linked to the Bitcoin network with the goal of unlocking Bitcoin's full potential.
Stacks uses a programming language called Clarity, which is described as allowing programmers to predict what a program will do, how much data it will consume, and how much the application will cost. This Smart Contract programming language is also used by the Algorand blockchain. Clarity allows developers to build unlimited dApps on Stacks according to their imagination.
Next, why is Stacks said to be closely linked to the Bitcoin network? That's thanks to a special magic mechanism called Proof of Transfer (PoX). There are 2 subjects participating in PoX: Miner and Stacker:
Miner: Transfer your BTC to Stacker for a chance to receive rewards from minting new blocks and transaction fees. Miners are selected based on the amount of BTC they send through an algorithm called “weighted random function”.
Stacker: Lock your STX tokens for one or more cycles. Based on the number of tokens that Stacker has locked, they can be selected to receive BTC from Miner.
The process of creating new blocks on the Stacks blockchain is synchronized with the Bitcoin blockchain, meaning every time Bitcoin creates a block, Stacks also creates a block. While each block on Bitcoin can only perform a small number of transactions, with its own power, in the same period of time, Stacks can perform thousands of transactions and collect them all into one block.
But the tight connection does not lie there, but in the fact that all transactions that the Stacks blockchain performs are hashed and transmitted, stored in the Bitcoin block. From there, transaction data inherits the immutability of the Bitcoin network and can be rolled back at any time.
If looked at in essence, Stacks acts as a sidechain of Bitcoin rather than Layer 2 as the information is communicated. Currently, Stacks is the expansion solution for Bitcoin that has the most developed ecosystem with about 100 dApps built on it.
Rootstock (RBTC)
Rootstock Smart Bitcoin (RBTC) or RSK is a blockchain developed to help Bitcoin increase scalability, it allows developers to build dApps using the Solidity programming language. Rootstock runs in parallel and records transaction packets to the Bitcoin network similar to Stacks.
There are 3 main ingredients in Rootstock:
Merged Mining: The RSK blockchain uses the same Proof-of-Work (PoW) consensus algorithm as Bitcoin, however, miners can create blocks much faster than Bitcoin's layer, then these transactions are sent to the Bitcoin network.
Powpeg: Powpeg is a two-way bridge to convert Bitcoin to Rootstock and vice versa. Powpeg protocol is implemented using RBTC token.
RSK Virtual Machine (RVM): This is a component capable of interacting with Smart Contracts on Ethereum. RVM is built on top of the Ethereum Virtual Machine, allowing the execution of Ethereum Smart Contracts on RSK. Developers can use the same source code, tools, and libraries when building RSK applications.
Mintlayer (ML)
Mintlayer (ML) is a scaling solution of the Bitcoin network. To easily imagine Mintlayer, you can understand Mintlayer as Layer 2 of Bitcoin, but not connected to Bitcoin. Mintlayer builds its blockchain network on the Proof of Stake mechanism and uses Bitcoin's hashing function as a parameter for the cycle of randomly selecting Validators. This consensus structure is called Dynamic Slot Allotments (DSA).
The Mintlayer blockchain is tied to Bitcoin: every Mintlayer block has a reference to a Bitcoin block. In each Mintlayer round, which lasts 1008 Bitcoin blocks, participants are selected from among stakers to collaborate on creating blocks of the chain.
ordinals
Ordinals is a protocol that enables the creation of NFTs on the Bitcoin network by Casey Rodarmor. Having only been around since early 2023, Ordinals has created a strong wave of Bitcoin NFTs with the number of minted NFTs reaching more than 500,000 in just a few months.
Ordinals allows NFT information to be "engraved" onto each sats of Bitcoin, thereby creating full on-chain NFTs that the Ordinals protocol founder calls a more advanced name than NFTs, "Digital Artifact".
The Ordinals wave has gained a lot of support from big names in the NFT field such as Yuga Labs, DeGods.
DeFi
Threshold (T)
Threshold (T) was born with the aim of becoming an encrypted network for blockchain applications by making user information and assets private. This is the product of the merger between two decentralized protocols, NuCypher (NU) and Keep Network (KEEP) in 2022.
Threshold's main product is BTC wrapped on the Ethereum network - tBTC. Threshold is also developing a stablecoin (thUSD) collateralized by tBTC.
Ren Protocol (REN)
Ren Protocol (REN), formerly known as Republic Protocol, was developed in 2017 and initially focused on the shadow OTC segment. Then rebranded to the current name and focused on cross-chain infrastructure.
Ren is operated through RenVM, which is a system of decentralized virtual machines called Darknodes. RenVM uses the following key technologies:
Shamir’s Secret Sharing: Platform helps RenVM not to make data public. These confidential data will be divided into parts held by the participants.
Secure multi-party computation (sMPC): an sMPC algorithm that allows developers to run scripts without revealing the input or output source.
Byzantine Fault Tolerance (BFT): The network thrives even when some nodes are unavailable or have malicious activity. The script continues to run and remains anonymous.
Hyperdrive: RenVM uses a modified version of the Tendermint consensus algorithm specifically designed for sharding and sMPC, helping to complete transactions at super fast speeds.
RenVM, in addition to allowing users to “discreetly” exchange tokens, also enables cross-chain interoperability. By locking tokens in one chain, users can mint tokens with a corresponding volume 1:1 in another chain. Currently, REN supports Bitcoin, Bitcoin Cash, Zcash, Doge, Ethereum, BNB Chain and Avalanche.
Badger DAO (BADGER)
The Badger DAO (BADGER) project is a community-governed DeFi protocol that aims to build the necessary infrastructure and create products to bring Bitcoin to the DeFi ecosystem.
Badger DAO has two main components in the ecosystem: Sett and Digg:
Set
SETT operates as yield farming projects that allow users to lock up assets and earn profits. Sett's mechanism is similar to Yearn.Finance. But it's different in that you can only farm with WBTC, renBTC or sBTC and BADGER.
Digg
DIGG is a token whose value is pegged to BTC. Every day, the supply automatically adjusts based on DIGG's USD value relative to BTC. If Digg's price is higher than BTC, your wallet balance will increase; If it is lower your balance decreases.
Sovryn (SOV)
Sovryn (SOV) is a Bitcoin-specific DeFi platform built on the Rootstock Bitcoin-sidechain. Sovryn provides users with a suite of non-custodial and permissionless tools including:
Spot trading
Derivatives trading with maximum leverage X5
Borrow and lend
Provide liquidity
Staking
Launchpad
Because it is deployed on the Rootstock sidechain, Sovryn inherits the inherent security of the Bitcoin network while still retaining the advantages of Layer 2 solutions such as cost savings and transaction speed.
Alex (ALEX)
Alex is one of the first DeFi projects built on Stacks - Bitcoin sidechain. Similar to Sovryn, Alex provides users with a DeFi toolkit that includes:
Swap
Borrow and lend
Provide liquidity
Launchpad
Stacking
In addition, the project is developing the Orderbook feature (similar to CEX), which now has a testnet version.
According to Defillama data, Alex is leading TVL on the Stacks network with about $25 million in value locked.
Alex is operated by the ALEX Lab Foundation, which is a non-profit organization that supports the governance and development of the ALEX DeFi protocol.
NFT
Bitcoin's Taproot upgrade not only opens the door to Bitcoin DeFi but also the NFT ecosystem on Bitcoin as well. Everything started from the historic 4MB block with the message "make Bitcoin magical again", the movement broke out strongly, leading to the development of the NFT ecosystem on Bitcoin.
Ordinals Market
One of the first marketplaces in the Ordinals ecosystem, allowing users to easily trade their Bitcoin NFTs.
Ordinals Market uses technology developed by Emblem Vault to enable fast transactions through the Ethereum network. The developers explained that, although it was possible to make transactions directly on the Bitcoin network, it would reduce the user experience due to speed and gas fees, so they used Emblem's solution. Vault to optimize the experience.
Learn more about how Ordinals Market works here: https://docs.ordinals.market/
Gamma
Gamma is a Bitcoin NFT marketplace that supports both the Bitcoin mainnet and the Stacks sidechain. Currently, Gamma holds 95% of the Bitcoin NFT trading market share on the Stacks network. Gamma allows creating Bitcoin NFT collections simply with the “no-code Ordinals Launchpad". It also helps users easily buy, sell, and store Bitcoin NFTs.
Currently the most popular activities in the Bitcoin NFT ecosystem are still creating, buying, selling. Bitcoin NFTfi pieces have also begun to appear allowing users to stack, lend/borrowing with their NFTs such as: Ordinals Finance, Liquidium, but they are all still too new, we need to wait for more such projects to appear. development time
Conclude
Bitcoin DeFi is not a new field but its potential is being exploited very little. Along with the development of Bitcoin network scaling solutions will come the development of not only the DeFi ecosystem but also NFTs on it.
We have the right to expect an explosive future of narratives in the Bitcoin Ecosystem such as: Bitcoin Layer 2, Bitcoin LSD, Bitcoin NFT and Bitcoin DeFi summer.
Source: Coin68