The Decentralized Financial Ecosystem (DeFi) continues to attract billions of dollars from cryptocurrency enthusiasts. While the term “decentralized finance” could certainly apply directly to Bitcoin in and of itself, the recent growth in the DeFi industry has been referring to a number of projects based mostly on smart Ethereum contracts and cryptocurrency-based loans, prediction markets or others support financial services.
While the emphasis on Ethereum makes it seem like Bitcoin and DeFi are not mingling, there are some fascinating initiatives to bring the two together. However, these services require some changes to make them more attractive to those who use Bitcoin.
The state of DeFi services for Bitcoin
As the world’s leading cryptocurrency, everyone has to wonder whether Bitcoin can even benefit from newer DeFi applications. In particular, can Bitcoin benefit from innovations forged through the DeFi projects that the market currently seems to be favoring? Given options like the return on cryptocurrency borrowing and borrowing that has some potential, these are worth investigating. However, integrating BTC into these decentralized finance use cases has proven difficult.
Thanks to projects like RSK, DeFiChain and Sovryn, Bitcoin users can now access decentralized financial solutions. There’s also Liquid by Blockstream, a sidechain that can be used to get L-USDT assets with Bitcoin holdings and explore DeFi through services like Hodl Hodl. This platform allows users to lend and borrow cryptocurrency without custody: borrowers deposit Bitcoin as collateral, which is repaid as soon as the borrowed money is fully repaid.
As innovative or appealing as these services may seem, some nonetheless require users to pack their Bitcoin holdings (through “wrapped bitcoin,” users create an ERC-20 token with a one-to-one link to BTC, with both assets are interchangeable). what many see as an unnecessary extra step. Nobody cannot deny the added functionality of an asset like wrapped bitcoin. This doesn’t necessarily mean that users want to use Bitcoin in a DeFi environment. Since BTC already has a far more robust price than any other DeFi asset that one “farms” (or that can be used to generate returns), it does not seem immediately necessary to consider these options.
Better incentives could help
In the current DeFi landscape, Bitcoin users don’t have too many options to explore unless they want to wrap up tokens, convert them to other assets, or take other risks. This situation is far from ideal. However, I am convinced that there are better methods that can be explored, such as providing liquidity on decentralized exchanges with automated market maker (AMM). This gives users a chance to empower themselves by choosing a decentralized exchange and liquidity pair to earn fees from, rather than having those fees go to centralized exchange operators. Unfortunately, it is next to impossible to find such an exchange that will support Bitcoin in its original form.
In this SIL Finance whitepaper, I found an exciting reward structure that might make more sense: users would not only earn AMM fees by trading in the liquidity pool, but native DeFi tokens as well. This would provide two sources of income while only requiring users to provide one type of liquidity. Reducing risks and increasing the rewards, as could potentially be the case with this application, is one way to get more Bitcoin users excited about decentralized finance.
Although there is no mention of native BTC support in the whitepaper, the idea could be implemented in a Bitcoin sidechain such as RSK.
But does Bitcoin even need DeFi?
Since Bitcoin is a significant long-term investment on its own, one has to wonder if people are willing to take risks with their BTC holdings. That said, sitting idly and waiting for the price to go up doesn’t suit everyone, either. Enabling users to explore by providing “investment options” will always prove beneficial to some.
On the other hand, the DeFi industry in its current form is still characterized by uncertainty, trust problems and greed. Most people are looking for ways to get rich quick through high-yield farming, which is an unsustainable approach. I think AMM DEXes have a far better chance of success in the long run, especially when compared to services with no obvious use cases. Creating a DeFi token for agricultural yield with no long-term use cases for the asset is a business model that will eventually be forgotten.
There is also an obvious surge in institutional demand for Bitcoin exposures to deal with. It took companies a decade to become aware of Bitcoin. With this wave now slowly gaining traction, it may not be the best opportunity to launch DeFi on Bitcoin. The world’s leading cryptocurrency has gained recognition as an investment and store of value rather than play money. The introduction and widespread use of DeFi products for Bitcoin could potentially undermine this image.
While I find certain aspects of DeFi fascinating, I am not convinced that the Bitcoin ecosystem today needs any of these solutions. Granted, doing more with my BTC holdings could be useful, but for now I’m more than happy with keeping the money in a private wallet and playing the long-term game.
Should AMM DEXes ever integrate support for Bitcoin in its native form, I will be happy to examine the options. That is, assuming the smart contracts are adequately audited, the approach is non-custodial and the revenues justify the effort. If these three conditions cannot be met, Bitcoin does not have to be financed on a decentralized basis – as we know it today.
This is a guest post by Alex Zha. The opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.