Will the DeFi ecology on BTC become the next outlet?
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Financial instruments on Bitcoin, however, took a completely different path. As of today, most activity around BTC relies on large"encrypted bank"text
These crypto banks require you to deposit BTC with them, and typically, we don’t know much about what happens to those funds once they’re deposited. As some have astutely noted, centralized lending platforms are even free to rehypothecate, trade, and perform other profitable activities with the Bitcoin collateral users provide them.
The rise of DeFi
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Part of this may be due to the many challenges of building on Bitcoin. Bitcoin Script is a simple, primitive, secure, stack-based contract language. But it is not Turing complete and has no concept of state. This makes it easy to securely lock up your bitcoins without worrying about"Smart Contract Hacked"text
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why?
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Other types of exchanges
One of the more unique projects is Summa, which offers cross-chain auctions. They use SPV proofs to prove BTC transactions that happen on Ethereum.
This allows users to download a desktop application and then use bitcoin to purchase ethereum assets at an auction.
While this is a great and unique solution, it doesn't get a lot of use. This may have something to do with it requiring users to download an app, or because the auction's liquidity hasn't gained much traction.
Tokenized Bitcoin
Wouldn’t it be great if you could use a BTC represented by ERC20 to work with all existing DeFi protocols?
There is no need for a custom Bitcoin wallet, and no need for a liquidity provider to be constantly online.
On the surface, this sounds like a perfect solution. But each version of tokenized bitcoin has pros and cons.
WBTC
The first is WBTC or known as"wrapped bitcoin". This solution allows users to deposit BTC with a custodian and receive an ERC20 BTC in return. Of course, this is more similar to CeFi, because users need to pass the KYC procedure and trust a third-party custodian.
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Source: btconethereum.com (BTC locked in WBTC)
tBTC
Next up is tBTC, or “Trustless BTC.”", which allows users to deposit BTC by pledging ETH equity through the custodian, and obtain ERC20 BTC. The ETH equity held by the custodian is greater than the locked BTC value (1.5 times initially). If a custodian misbehaves, their ETH stake can be forfeited.
The trustless nature of tokens makes them more censorship resistant and a better option for DeFi. However, the large amount of ETH collateral makes it difficult to scale, because each person who wants to lock 1 BTC and mint 1 tBTC must have an ETH custodian holding 1.5 times the value of BTC.
renBTC
Finally, let’s talk about renBTC, a protocol similar to tBTC that allows users to deposit BTC, which is then held by a trustless custodian (RenVM), but with REN as collateral (instead of ETH).
Again, the trustless nature makes it resistant to censorship, and its design assumption is that as more and more assets are locked in the system, the value of REN will also increase, which makes it more scalable than tBTC .
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Bitcoin sidechain
Bitcoin sidechains such as RSK provide an underlying platform for building DeFi on top of Bitcoin. In fact, Money on Chain has been working on building stablecoin solutions on this platform.
RSK works by letting users lock their BTC in a federated sidechain that runs the EVM and receives RBTC. This means that applications on RSK can create smart contracts with BTC.
However, this requires users to trust the federation and a proper bridge into RSK. But so far, this approach has had limited traction. Most likely due to the lack of a proper bridge, and the lack of applications built on top of it.
Our experience in building Atomic Loans V1
cryptocurrency bank"cryptocurrency bank"We were frustrated with taking BTC-backed loans, so our team set out to build a protocol that would allow bitcoin holders to get liquidity in a way that minimizes trust and doesn't liquidate bitcoin sex.
Our goal is to allow users to secure loans in Ethereum stablecoins by locking up BTC as collateral.
Why not use tokenized Bitcoin?
At the time of construction, tokenized bitcoins did not exist on Ethereum. We considered going this route, but realized that due to the high collateral requirements for custodians/pledgers, it is not scalable and requires escrow to mint an ERC20 BTC.
Lock BTC
We chose a P2P lending model (easiest to build for V1) that allows users to lock BTC in a custom Bitcoin contract that can be unlocked upon repayment or liquidation.
The repayment is implemented using a mechanism similar to that in atomic swaps (a password is obtained after repayment, which is used to allow the borrower to unlock BTC). For liquidation, a multi-signature mechanism (with borrower, lender, and arbitrator) is used, allowing lenders and arbitrators to liquidate collateral if the debt position falls below the minimum collateralization rate.
trust model
The different trust characteristics of arbitrators and oracles are adopted. In a typical DeFi protocol, if one oracle fails, all debt positions in the protocol could be liquidated. But if there is an arbitrator, even though it is easy to collude with a particular lender or borrower, it is very difficult to bring down the whole system together.
lender
capital efficiency
capital efficiency
Additionally, we quickly learned that the P2P lending model is very inefficient with regard to capital. Pooling of funds is hard to do in Bitcoin (unless you tokenize Bitcoin). Our V1 model means you can have a lender lend to multiple borrowers, but not the other way around.
This naturally leads to a demand for unspent funds from both large lenders and small lenders.
Compatibility of wallets
On top of that, using a custom bitcoin contract (P2SH) means most bitcoin wallets don't support unlocking BTC.
attraction
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Despite these limitations, we managed to reach a TVL of ~500,000 before the suspension after samczsun's vulnerability disclosure on June 21, 2020. Building and launching V1 was a great learning experience and taught us a lot about what users really care about.
Building for Bitcoin is hard
Users will only appreciate the unmanaged approach if the experience is simple
If users are required to install some basic applications, it will reduce the possibility of providing liquidity.
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The Future of DeFi on Bitcoin
Most of the solutions mentioned so far involve the EVM in some sense. It's hard to say if this will last, although there are projects in the works that take advantage of Bitcoin's native capabilities"DeFi"。
Simplicity
Blockstream has been working on a blockchain smart contract programming language called Simplicity, which aims to make code execution more easily formally verifiable.
This is currently a work in progress and is expected to be completed by the end of this year. At that time, Simplicity will likely be deployed on the Liquid sidechain. There are currently no plans or intentions to incorporate this into Bitcoin Core anytime soon.
DLC (Discrete Logging Contract)
DLCs are basically bitcoin oracle contracts. They enable users to sign a"real life"The protocol executed by the event and settled in BTC.
This is achieved by having participants lock their funds in a 2-of-2 multi-signature and follow an exit method similar to the Lightning Network (i.e. cooperative and non-cooperative closures with oracle signatures).
These contracts enable financial derivatives and prediction markets to be created on top of Bitcoin.
DLC can be transferred on the chain and Lightning Network, and users can enter and exit warehouses outside the chain. However, DLC via the Lightning Network suffers from the same financial inefficiencies as routed payments.
RGB
RGB is a smart contract system that allows assets to be issued on top of the Lightning Network.
This is achieved by anchoring assets to specific Bitcoin UTXOs and addresses, and by using single-purpose seals (cryptographic primitives that ensure a specific message can only be sent once) to prevent double spending.
Tether plans to issue USDT on RGB before the end of the year.
Combining the capabilities of RGB with the ongoing work on DLC will enable more uses for financial derivatives and prediction markets.
Summarize
Summarize
Bitcoin is digital gold. But that doesn't mean it has to be a shiny stone.
From DLCs to tokenized BTC, more and more infrastructure is being built to allow Bitcoin stalwarts to use their BTC for new financial applications.
Whether these applications will be built on Ethereum using cross-chain bridges, on sidechains like Liquid, or on the Lightning Network — only time will tell.
