Galaxy's November report on second-layer (L2) solutions based on the first cryptocurrency raised questions about the prospects of DeFi on Bitcoin. Analysts estimate the segment's TVL at $50 billion by 2030 (2.3% of the annual supply of digital gold at the current rate).
Oleg Cash Coin figured out who and how will provide an influx of liquidity into L2 solutions based on Bitcoin in the coming years.
Banking Bitcoin maximalism
In December 2010, the recipient of the first Bitcoin transaction, Hal Finney, presented the concept of a banking system based on Bitcoin. In a post on the BitcoinTalk forum, he referred to the book by American economist George Selgin, The Theory of Free Banking:
«Different banks may have different policies. Some are more aggressive, while others are more conservative. Some will have partial reserves, while others may be 100% backed by Bitcoin. Interest rates may vary. And money from some banks may trade at a discount compared to cash from others.»
In Selgin's book, a theoretical justification for a decentralized financial system free from centralized regulation and government intervention is outlined. He provides numerous examples from different eras when the economy managed to operate without regulatory bodies.
Finney believed that Bitcoin could become a reserve asset intended for banks to issue their own currency. Some of the largest and most influential crypto companies have taken this path.
Thus, Adam Back and his Liquid Network launched a clearing service for cryptocurrency exchanges in 2015. They effectively created a settlement system based on Bitcoin, offering one of the first banking use cases for digital gold in settlements.
It turned out that Bitcoin and cryptocurrencies, in general, are optimally suited for the realization and development of the free banking system described by Selgin. Primarily due to the absence of a central issuer and an authority that sets or controls interest rates.
The foundation of trust in such banks will likely be the development of Proof-of-Reserve technologies and ZKP. These mechanisms are already successfully used by cryptocurrency exchanges, allowing anyone to verify the current state of their assets.
A turn towards a free DeFi market on Bitcoin
The prospects of DeFi on Bitcoin are beginning to take shape with Tether, which issues USDT. Formally, the issuance of stablecoins may be regulated by the state, but under normal circumstances, the issuance and burning of coins are not controlled by supervisory authorities.
Tether has long been taking Bitcoins as collateral for issuing USDT. A telling example is the situation with the bankrupt company Celsius, which pledged at least 57,428 BTC in exchange for stablecoins.
Celsius was ultimately liquidated, but Tether was not harmed by this. The very fact of demand for loans in stablecoins is interesting. This means there will be a need for such services even in a decentralized format.
In fact, Tether has already become one of the 'free banks' according to Selgin and Finney: USDT is no longer a speculative asset, but a currency used for payments and settlements around the world.
Despite widespread criticism, Paolo Ardoino's company has penetrated the very heart of the financial system, highlighting the viability of a new DeFi model. For example, Howard Lutnick, a candidate for the position of U.S. Secretary of Commerce and CEO of financial company Cantor Fitzgerald, is negotiating close cooperation with Tether regarding the launch of a credit platform. The essence of this new direction lies in creating a credit line secured by Bitcoin — initially set at $2 billion.
Cantor Fitzgerald is one of two dozen authorized organizations that trade directly with the Federal Reserve Bank of New York. It is also the custodian of U.S. government bonds owned by Tether. These securities (approximately $100 billion) are what back USDT to the dollar.
At the end of November, it turned out that Cantor Fitzgerald owns 5% of Tether's shares. Additionally, according to Bloomberg, Lyutnik's son, Brandon, works as a trader at Cantor and previously interned at Tether's Swiss branch.
From this, one can assume that the trend toward crypto banking and issuance bypassing the state may only strengthen.
How much can Bitcoin hold
Given the possibilities of partial reserves, as is the case in the traditional banking system, the capacity of DeFi on Bitcoin could easily exceed the capitalization of gold.
Even rough estimates show that synthetic versions of digital gold in the Ethereum network amount to about $20 billion in WBTC, cbBTC, and L2 Bitcoin. This already represents about 17% of the entire DeFi market. And if we add that Tether accounts held over 75,000 BTC as of the end of September 2024, it comes to even more. We should also add WBTC held in contracts, for example, securing DAI.
Thus, even in the absence of 'live' L2 on Bitcoin, there is about $30 billion TVL in a conditional 'banking' system based on the first cryptocurrency. And this is based on the most superficial calculations, even without decentralized exchanges.
Moreover, it is unknown how much actually flows through the Liquid Network and which organizations are involved in market formation. In an interview with Forbes, Back mentioned such 'hidden' processes. He stated that the company has already created an accounting system for credit institutions and their clients based on Bitcoin. And that capital for such operations is provided by several public banks in the U.S., with 'hundreds' of individuals and legal entities already as clients.
One of the most well-known advocates of Bitcoin among institutions, Michael Saylor, thinks along the same lines. The head of MicroStrategy noted that large banks like JPMorgan and Citi could benefit from issuing loans secured by digital gold. Of course, this is not the same as reserving Bitcoin, but overall, the direction could prove to be correct in the long run.