Original Title: (BTCFi: An Innovative Journey to Unlock Bitcoin's Trillion-Dollar Market Value)
Original authors: Ac-Core, YBB Capital Research
TL;DR
● The broader context of BTCFi is: 1. The narrative of Ethereum and Ethereum killer chains is gradually weakening, and infrastructure construction has become saturated, leaving the industry lacking fresh narratives and merely superficial jargon; 2. Compared to other public chains, BTC has not formed a comprehensive resource monopoly.
● The main expansion solutions for BTC include state channels, sidechains, and Rollups, UTXO + client validation, larger blocks, and other asset protocols, but various expansion solutions must collectively face the technical challenges of meeting 'orthodox' verification.
● The prerequisites for BTCFi's development are: cross-chain interoperability, solutions for layer 2 expansion (Layer 2), smart contract functionality, and infrastructure and development tools that do not require one-click repeat construction.
● The main challenges faced by BTCFi are: the limitations of the Bitcoin protocol and liquidity issues, the security and trust issues of cross-chain bridges, the difficulty in accurately capturing prices with oracles, and finding a development path unique to BTCFi.
1. BTCFi
1.1 What is BTCFi?
The Bitcoin chain was once the least active public chain, with a market cap of trillions of dollars yet long in a 'dormant' state. Fi stands for Finance, and thus the purpose of BTCFi is to establish a decentralized financial market for Bitcoin within this trillion-dollar market, allowing BTC holders to directly use Bitcoin-related financial derivative tools such as staking, lending, and market-making to generate income, thereby introducing DeFi into the native Bitcoin ecosystem to activate more financial value.
1.2 Background
2023 is an important year for the Bitcoin ecosystem to officially reach its peak, with various tokens represented by BRC20 triggering noticeable wealth effects and sparking the market's FOMO sentiment. Looking at the industry status, aside from the engraved inscriptions, another reason the Bitcoin ecosystem can rise is that the narrative capabilities of Ethereum and Ethereum killer chains are gradually weakening, and infrastructure construction has become saturated. The industry overall lacks fresh narratives and is left with mere surface-level jargon. The Bitcoin ecosystem has also perfectly replicated the development path of Ethereum, but the essential challenge it faces is how to expand the block without destroying Bitcoin's native consensus or causing hard forks.
As of October 1, data statistics show that the Bitcoin ecosystem has experienced frequent financing situations, with 14 publicly disclosed financings totaling over $71.1 million. The current only opportunity for BTCFi is that, for both users and VCs, the Bitcoin ecosystem is still full of opportunities, and it has not formed a comprehensive resource monopoly compared to other public chains. Non-VC financing assets have also given rise to numerous protocol assets such as BRC20, ORC20, ARC20, SRC20, and CAT20. Our exploration from digital gold BTC to the controversial BTCFI raises the question of whether Bitcoin's Fi is a false proposition, with the core discussion point being how to ensure the security of assets and adopt effective expansion methods.
1.3 The First Explosion Point in the Market: Indexed Asset Protocols
Indexed assets can generally be divided into non-UTXO bound assets of BRC20 and UTXO bound assets of ARC20. The ARC20 fungible token standard is based on Bitcoin's smallest unit, 'Satoshi', where each token is equivalent to 1 Satoshi, ensuring that the minimum value of the token is 1 Satoshi. This standard is applied to the Bitcoin blockchain through the Atomicals protocol, allowing colored coin technology to be realized within the Bitcoin ecosystem, enabling these tokens to be split and combined like regular Bitcoin, paving the way for the potentially promising AVM in the future.
Other Asset Protocols
ORC20: A token standard based on the Ordinals protocol extension for Bitcoin. The Ordinals protocol allows users to assign unique markers to individual Satoshis (the smallest unit of Bitcoin) on the Bitcoin network. The goal of ORC20 is to create a token standard similar to Ethereum's ERC20, allowing users to issue and trade tokens on the Bitcoin network.
SRC20: Another Bitcoin token standard launched with a similar idea to ORC20, but unlike it, SRC20 emphasizes a simpler and more efficient token issuance and transfer mechanism. It aims to reduce transaction costs and improve efficiency by optimizing the complexity of token contracts and can be used to build token protocols on the Bitcoin blockchain.
CAT20: A similar token standard mainly used for issuing custom tokens (Custom Asset Token). Compared to ORC20 and SRC20, CAT20's functionality is more focused on creating custom tokens for individuals or businesses on the Bitcoin chain. It allows users to define the total supply, name, and other parameters of the token and circulate it within the Bitcoin network for creating and managing digital assets.
II. Layer 2 Expansion Solutions, Who Will Capture BTCFi's Market Potential?
The development of BTCFi cannot be separated from DeFi, while the further expansion of DeFi relies on blockchain scaling. However, the paths for blockchain scaling currently lack a unified and clear division; the trade-offs among different paths in terms of feasibility, decentralization, and security are still disputed, all facing a common technical challenge: the need to meet the 'orthodox' verification of Bitcoin.
Image source: DeFiLlama: Bitcoin Sidechains / Total Value Locked All Chains
By observing the relevant data from DeFiLlama on November 5, 2024, we can find that among the current sidechain-related projects, the four projects CORE, Bitlayer, BSquared, and Rootsock have the highest TVL, accounting for a total of 76.56%. Currently, BTCFi, compared to the same reliance on nested yield and 'ETHFi', shows the following similar characteristics:
● BTCFi's coin-based Buff yield comes from: Babylon+LRT rewards + BTC expansion chain rewards + ETH chain LRT bundled returns (similar to Pendle and Swell);
● The coin-based Buff yield of ETHFi comes from: POS interest + re-staking rewards + LRT rewards + ETH expansion chain rewards.
Image source: Pendle / BTC Bonanza
2.1 State Channels
State channels are an expansion solution that allows users to conduct multiple transactions off the mainnet, only submitting to the mainnet when the channel opens or closes. Currently, in Bitcoin, there are the Lightning Network and Ark, where users deposit BTC in a multi-signature address and use state channels for daily transactions, ultimately verifying transaction results through mainnet consensus to ensure security.
2.2 Sidechains and Rollups
From the perspective of developing the Bitcoin ecosystem from the market side, achieving fast transactions, Turing completeness, and interoperability, sidechains and Rollups are more suitable for Bitcoin's ecosystem development. Bitcoin's sidechains and Rollups have strong independence; Rollups aim to move complex operations to Layer 2, with the mainnet only responsible for verifying the proofs submitted periodically by Layer 2, thereby increasing throughput. This mechanism ensures that Layer 2's ledger remains secure and consistent with the mainnet. For sidechains, however, the mainnet cannot directly verify whether cross-chain actions on the sidechain are legitimate; cross-chain bridges lock mainnet assets and map them to the sidechain, often increasing decentralization through additional verification methods to ensure asset security. Meanwhile, in terms of releasing liquidity, both sidechains and Rollups have shown good market performance.
2.3 UTXO + Client Validation
From the perspective of native nature and security, the UTXO solution stands out and aligns better with the definition of 'orthodoxy'. UTXO + client validation is an off-chain solution based on Bitcoin's characteristics aimed at improving transaction efficiency and privacy while inheriting Bitcoin's security. Since Bitcoin natively adopts the UTXO (Unspent Transaction Output) model rather than the account model, the core idea of client validation is to shift transaction verification from the blockchain's consensus layer to off-chain, with transaction-related clients responsible for verification. Specifically, users need to verify the validity of transfer claims on their own clients, ensuring that transactions are secure and efficient. This off-chain verification reduces the burden on the blockchain and ensures user privacy by having each client store only the data relevant to themselves.
The RGB protocol is a concrete implementation of this concept, first proposed in 2016 by Peter Todd's ideas of 'one-time seals' and 'client validation'. RGB uses Bitcoin's UTXO as 'seal strips', binding the off-chain asset state changes to Bitcoin's UTXO, thereby ensuring safe off-chain state changes without double spending. In this way, RGB retains the strong security of the Bitcoin network.
Although this solution brings significant efficiency and privacy advantages, it still has some drawbacks. The client's only stores transaction data relevant to itself, leading to data island issues that hinder the development of applications like DeFi. UTXO + client validation achieves efficient and privacy-friendly off-chain transaction verification by inheriting Bitcoin's security, but there is still considerable room for improvement in terms of data transparency, operational convenience, and the completeness of development tools.
2.4 Changing the Original Consensus with Larger Blocks
Changing the original consensus also means changing today's Bitcoin, presenting hard issues such as consensus and ecological development in realizing the vision of BTCFi, which are only outlined here.
BCH (Bitcoin Cash) was a hard fork of Bitcoin due to Bitcoin's scalability issues at Block 478558 (August 1, 2017). The block size of Bitcoin Cash is 8M, while Bitcoin's block size was decided on the same day to increase from 1MB to 2MB within six months. The plan for Bitcoin Cash was first proposed by the Chinese Bitcoin mining machine company Bitmain, and another related hard fork token is BSV.
III. BTCFi's Fi Needs to Better Release Liquidity
Image source: pixabay.com
As mentioned at the beginning, Bitcoin's trillion-dollar market value cannot remain in a long-term dormant state like Ethereum, where interest is earned through borrowing; the storage method must choose secure hardware wallets or trusted centralized exchanges. How BTCFi can gradually circulate such a massive market value through on-chain financialization is a pressing concern.
3.1 Prerequisites for Development
1. Cross-Chain Interoperability
Unlike Ethereum and other smart contract platforms, the Bitcoin blockchain does not have native smart contract functionality. The primary task for BTCFi is to develop trusted cross-chain bridges so that Bitcoin can participate in DeFi applications on other blockchains with smart contract capabilities. These bridges can 'map' Bitcoin to other chains while preserving its value and enabling more functionalities.
2. Layer 2 Expansion Solutions
The second layer of Bitcoin is more difficult to balance among the triangular issues compared to Ethereum's second layer, as there will be a certain degree of sacrifice in decentralization. However, for the market, relatively centralized development tends to generate new wealth effects more easily, and how the project team can give the market more wealth effects to compensate for the lack of decentralization may be the primary consideration.
3. Smart Contract Functionality
To support DeFi applications, Bitcoin requires some form of smart contract functionality. Currently, the Bitcoin network does not have native smart contracts, and developers are exploring ways to provide smart contract support for Bitcoin through second-layer solutions (such as RSK, AVM, Bitvm) or sidechains. This would enable Bitcoin to directly support lending, liquidity provision, derivatives, and other DeFi functions.
4. Powerful Developer Tools and Infrastructure
Developers need robust tools and infrastructure to create and deploy BTCFi applications, but the Bitcoin ecosystem seems not to require one-click chain-like repetitive constructions.
3.2 Major Challenges Faced
1. Limitations of the Bitcoin Protocol
Bitcoin is designed to be a secure and reliable means of value storage and lacks the flexibility of Ethereum or other blockchains specifically designed for DeFi. Due to the lack of built-in smart contract functionality, developing BTCFi applications must overcome the limitations of the protocol itself, which may involve complex technological innovations.
2. Liquidity Issues
Even by introducing Bitcoin into Ethereum and other smart contract-supported blockchains through cross-chain bridges, Bitcoin's liquidity in DeFi remains far below that of Ethereum and other tokens, and the current liquidity shortage may limit the popularity of BTCFi.
3. Security and Trust Issues of Cross-Chain Bridges
Cross-chain bridge technology is key to the development of BTCFi, but such bridges themselves carry security risks. In recent years, cross-chain bridge attacks have been frequent, leading to significant financial losses. Ensuring the security of cross-chain bridges and preventing risks from centralization or technical failures remains an important challenge for BTCFi.
4. Difficulty in Accurately Capturing Prices with Oracles
Architectural limitations of the Bitcoin blockchain make it difficult to deploy oracle services as easily as projects like Chainlink on Ethereum. This limitation makes deploying oracle systems in the BTCFi ecosystem more complex, possibly requiring reliance on second-layer or sidechain solutions. Regarding the dependence on cross-chain bridges and the challenge of price synchronization, BTCFi may primarily rely on cross-chain bridges to map Bitcoin to other chains for cross-chain price synchronization in the future. Overall, it faces greater technical and security challenges in terms of oracle accuracy compared to Ethereum.
5. Can it find its own development path instead of merely imitating Ethereum?
The core goal of Bitcoin's design from the beginning was to prioritize security over functionality, and even more so in the design of BTCFi, where market acceptance and security will always take precedence over functionality. The adoption of Bitcoin globally is mainly focused on value storage and payments, so BTCFi may concentrate on financial products related to payments and value storage. The concept of PayFi is not only applicable to Solana but is also more suitable for Bitcoin.
Reference article: (Comparison of Four Mainstream Bitcoin Expansion Solutions: Who Will Truly Unlock BTCFi's Trillion-Dollar Market Potential?)
This article is from a submission and does not represent the views of BlockBeats.
