New shoots from old trees? Bitcoin is making inroads into Ethereum's DeFi space
Decentralized Finance (DeFi) began as a playground for developers and app players building decentralized financial applications on the Ethereum network. Developers and young project teams are using ethereum's open-source tools to create "permissionless" financial applications that replace rent-collecting intermediaries.
These decentralized applications allow anyone with an internet connection to access a wide range of financial products and services covering the exchange of encrypted assets, margin trading, financial derivatives, synthetic assets, algorithmic trading, and lending markets.
Two killer cases for DeFi include high-yield savings accounts and access to credit. Holders of Ether, Dai, USDC, Tether, and other crypto assets can lend their assets out and realize high single-digit annual returns. On the other side of the transaction, borrowers can put their crypto assets as collateral and receive stablecoins tied to fiat currencies for leveraged trades or access to lines of credit.
In addition to being built on top of Ethereum (the protocol), DeFi projects primarily use Ether (the protocol’s native monetary unit) as the underlying asset and primary source of collateral.
But now, the industry is working hard to inject Bitcoin into the DeFi ecosystem. These "bitcoin anchors" attempt to bridge bitcoin and ethereum by combining bitcoin's superior liquidity, transaction volume, and user base with ethereum's composability and open-source financial application ecosystem. Some of the projects bringing Bitcoin to DeFi include WBTC, imBTC, tBTC, sBTC, renBTC, and pBTC.
A common approach is to create ERC-20 (Ethereum standard) tokens that are collateralized by Bitcoin and pegged to Bitcoin’s market cap. In a nutshell, the process involves a user depositing bitcoin into a smart contract, which then spits out a newly minted bitcoin-pegged token that the user can access in an Ethereum wallet.
The smart contract utilizes Bitcoin's price information to monitor the value of the underlying Bitcoin collateral, which is equal to the value of the new ERC-20 token. More centralized solutions (i.e. WBTC and imBTC) involve third-party custodians who hold Bitcoin, mint new tokens, and monitor the value of Bitcoin collateral.
WBTC surged as the MakerDAO community voted to add the token as collateral in the Maker system. MakerDAO’s Dai is the largest decentralized stablecoin pegged to the U.S. dollar and accepts various crypto assets as collateral, starting with Ethereum, later joined by BAT, USDC and now WBTC.
In order to open a vault and access Dai, users need a well-collateralized position in these crypto assets. The addition of WBTC sent WBTC’s cumulative on-chain value soaring above $22 million.
Despite WBTC’s significant growth, Ether remains the largest form of collateral in DeFi, with 2.6 million ETH locked in DeFi protocols, worth $520 million at the time of writing. However, this trend has declined significantly in recent months with the arrival of alternative assets.
Despite WBTC’s recent success, Ethereum purists have criticized MakerDAO for including centralized tokens WBTC and USDC. Because WBTC and USDC rely on third-party custodians to hold the underlying Bitcoin and USD, these entities would have counterparty risk if they were to be attacked or coerced by regulatory pressure. Another issue is the ability of these entities to censor and process transactions, which is a nuisance to the ethos of the DeFi space.
Since DeFi applications need to lock up crypto collateral, they create demand for the asset and reduce its supply in the market. Naturally, this leads to an increase in the price of the underlying asset. Cryptoassets emerging as primary collateral assets in DeFi stand to benefit the most from these supply and demand dynamics. Users need to purchase and lock assets to access DeFi products and services.
It appears that Bitcoin and Ethereum are in direct competition to serve as the primary reserve asset for DeFi. However, even if Bitcoin dominates the market, Ethereum will also benefit due to the fact that DeFi applications require users to spend transaction fees and therefore require Ethereum to process transactions.
Assuming that Ethereum remains the dominant platform for decentralized applications, other competing platforms such as Blockstream's Liquid, Algorand, Cosmos, and Tezos fail to capture meaningful market share.
It’s still early days for Bitcoin’s introduction into Ethereum’s DeFi ecosystem, and it remains to be seen whether Bitcoin will emerge as the leading reserve asset powering decentralized applications. The market will decide which crypto asset is the most desirable and deserves a monetary reward: the value generated by tokens when users ask to hold or lock them.
The original text comes from the English version of Forbes, compiled by the Bluemountain Labs team, and the English copyright belongs to the original author. For Chinese reprint, please contact the compiler.
The original text comes from the English version of Forbes, compiled by the Bluemountain Labs team, and the English copyright belongs to the original author. For Chinese reprint, please contact the compiler.
