Original Title: (BTCFi: The Innovative Journey to Unlocking Bitcoin's Trillion Market Value)
Original Author: Ac-Core, YBB Capital Research
TL;DR
● The background of BTCFi is: 1. The narrative of Ethereum and Ethereum killer chains is gradually weakening and infrastructure development has become saturated, with the industry overall lacking fresh narratives, only superficial jargon remains, 2. Compared to other public chains, BTC has not formed a comprehensive resource monopoly.
● The main expansion solutions for BTC include state channels, sidechains, rollups, UTXO+ client verification, large blocks, and other asset protocols, but all types of expansion solutions face the technological difficulties of meeting the 'orthodoxy' verification.
● The prerequisites for the development of BTCFi are: cross-chain interoperability, solving Layer 2 expansion solutions, smart contract functionality, and infrastructure and development tools that do not require one-click repetitive construction.
● The main challenges facing BTCFi are: limitations of the Bitcoin protocol and liquidity issues, security and trust issues of cross-chain bridges, the difficulty of oracles accurately capturing prices, and carving out a development path unique to BTCFi.
I. BTCFi
1.1 What is BTCFi
The Bitcoin chain was once the least active public chain, with a market value of over a trillion dollars but remained in a 'dormant' state for a long time. Fi stands for Finance, so BTCFi aims to establish a decentralized financial market for Bitcoin within this trillion-dollar market, allowing BTC holders to directly use financial derivative tools related to Bitcoin such as staking, lending, and market-making to generate yields, thus bringing 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. Various tokens represented by BRC20 have triggered a significant wealth effect, igniting market FOMO. Looking at the current industry situation, apart from the inscriptions that are a broken horse, another reason the Bitcoin ecosystem can thrive is that the narrative capabilities of Ethereum and Ethereum killer chains are gradually weakening, and infrastructure development has become saturated, with the industry overall lacking fresh narratives and only superficial jargon remaining. The Bitcoin ecosystem has also perfectly replicated Ethereum's development path, but the fundamental problems faced are how to expand blocks without destroying Bitcoin's native consensus or causing hard forks.
As of October 1, data statistics show that there have been frequent financing situations in the Bitcoin ecosystem, with 14 public financings totaling over $71.1 million. The only opportunity for BTCFi currently is that, for both users and VCs, the Bitcoin ecosystem is still full of opportunities, and unlike other public chains, it has not formed a comprehensive resource monopoly. Non-VC financing asset categories have also given birth to numerous protocol assets such as BRC20, ORC20, ARC20, SRC20, and CAT20. We explore from digital gold BTC to the controversial BTCFi, questioning whether Bitcoin's Fi is a pseudo proposition, with the core discussion point being how to ensure asset security and adopt effective scaling methods.
1.3 The First Trigger Point in the Market: Index Asset Protocols
Index 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', with each token 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, enabling colored coin technology to be realized in the Bitcoin ecosystem, allowing these tokens to be split and combined like regular Bitcoin, and paving the way for the future potential of AVM.
Other Asset Protocols
ORC20: A token standard based on the Ordinals protocol extended from Bitcoin. The Ordinals protocol allows users to assign unique identifiers 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 introduced with a similar concept to ORC20, but unlike it, SRC20 emphasizes a simpler and more efficient token issuance and transfer mechanism. It attempts to lower transaction costs and enhance efficiency by optimizing the complexity of token contracts, making it suitable for building tokens on the Bitcoin blockchain.
CAT20: A similar token standard primarily used for issuing custom tokens (Custom Asset Token). Compared to ORC20 and SRC20, CAT20 focuses more on creating custom tokens for individuals or enterprises on the Bitcoin chain. It allows users to define the total supply, name, and other parameters of the token, circulating within the Bitcoin network for creating and managing digital assets.
II. Layer Two Expansion Solutions, Who Will Capture the Market Potential of BTCFi
The development of BTCFi cannot be separated from DeFi, and the further expansion of DeFi relies on blockchain scalability. However, there is currently no unified and clear division of the paths for blockchain scalability, and the trade-offs between feasibility, decentralization, and security among different paths still exist. They all face a common technical difficulty: compliance with Bitcoin's 'orthodoxy' verification.
Source: DeFiLlama: Bitcoin Sidechains / Total Value Locked All Chains
By observing the relevant data from DeFiLlama on November 5, 2024, we can see that among the current sidechain-related projects, CORE, Bitlayer, BSquared, and Rootsock have the highest TVL share, totaling 76.56%. Currently, BTCFi, compared to similar strategies of nested profits and 'ETHFi', shows the following similar characteristics:
● The currency-based Buff returns of BTCFi come from: comparable to Babylon + LRT rewards + BTC expansion chain rewards + ETH chain LRT bundled returns (similar to Pendle and Swell).
● The currency-based Buff returns of ETHFi come from: POS interest + re-staking rewards + LRT rewards + ETH expansion chain rewards.
Source: Pendle / BTC Bonanza
2.1 State Channel
State channels are an expansion solution allowing users to conduct multiple transactions off the mainnet, only submitting to the mainnet when the channel is opened or closed. Currently, there are the Lightning Network and Ark in Bitcoin, where users deposit BTC into a multi-signature address and conduct daily transactions through state channels, ultimately verifying the transaction results through mainnet consensus to ensure security.
2.2 Sidechains and Rollups
From the perspective of developing the Bitcoin ecosystem at the market level to achieve fast transactions, Turing completeness, and interoperability, sidechains and rollups are more suitable for the ecological development of Bitcoin. Bitcoin's sidechains and rollups have strong independence, with rollups aimed at moving complex operations to Layer 2, where the mainnet only verifies periodic proofs submitted by Layer 2, thereby increasing throughput. This mechanism ensures the security of Layer 2 ledgers and their consistency with the mainnet. For sidechains, the mainnet cannot directly verify the legality of cross-chain activities on the sidechain, so cross-chain bridges lock mainnet assets and map them on the sidechain, often increasing other verification methods to enhance the decentralization of the chain to ensure asset security. Currently, both sidechains and rollups have shown good market performance in releasing liquidity.
2.3 UTXO+ Client Verification
In terms of native characteristics and security, the UTXO solution stands out and aligns more closely with the definition of 'orthodoxy'. UTXO+ client verification 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 instead of an account model, the core idea of client verification is to transfer transaction verification from the consensus layer of the blockchain to off-chain, with the clients related to the transaction responsible for verification. Specifically, users need to verify the validity of transfer declarations on their clients to ensure transactions are secure and efficient. This off-chain verification reduces the burden on the blockchain and ensures user privacy by allowing each client to store only data relevant to itself.
The RGB protocol is a concrete realization of this concept, first proposed in 2016 by Peter Todd's concepts of 'one-time seals' and 'client verification'. RGB uses Bitcoin's UTXO as 'seal strips', binding the state changes of off-chain assets to Bitcoin's UTXO, thus ensuring secure 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 flaws. Users' clients only store transaction data relevant to themselves, leading to data isolation issues that hinder the development of applications like DeFi. UTXO + client verification achieves efficient and privacy-friendly off-chain transaction verification by inheriting Bitcoin's security, but there is still considerable room for improvement in data transparency, operational convenience, and the completeness of development tools.
2.4 Large Blocks Changing Existing Consensus
Changing the existing consensus also means changing today's Bitcoin, which presents hard issues in realizing the vision of BTCFi, such as consensus and ecological development, which are only briefly outlined here.
BCH (Bitcoin Cash) is a hard fork of Bitcoin conducted 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 China's Bitcoin mining machine company Bitmain, with related hard fork tokens including BSV.
III. The Fi in BTCFi Needs to Better Release Liquidity
Source: pixabay.com
As mentioned at the beginning, the trillion-dollar market value of Bitcoin cannot remain in a dormant state like Ethereum, generating interest on borrowed coins. The only storage methods available are secure hardware wallets or trusted centralized exchanges. How can BTCFi gradually circulate such a massive market value through on-chain financialization?
3.1 Prerequisites for Development
1. Cross-chain Interoperability
The Bitcoin blockchain differs from Ethereum and other smart contract platforms in that its architecture does not have native smart contract functionality. BTCFi's primary task is to develop trusted cross-chain bridges so that Bitcoin can participate in DeFi applications on other blockchains with smart contract capabilities. These bridges would enable Bitcoin to be 'mapped' onto other chains, retaining its value while achieving more functionality.
2. Layer Two Expansion Solutions
Layer Two solutions for Bitcoin are more difficult to balance among the triangle problem compared to Ethereum's Layer Two, often sacrificing decentralization to some extent. However, for the market, more centralized development often generates new wealth effects more easily. How project teams can provide the market with more wealth effects to compensate for the lack of decentralization may be a primary consideration.
3. Smart Contract Functionality
To support DeFi applications, Bitcoin needs 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 (like RSK, AVM, Bitvm) or sidechains. This would enable Bitcoin to directly support DeFi functionalities such as lending, liquidity provision, and derivatives.
4. Strong Developer Tools and Infrastructure
Developers need comprehensive tools and infrastructure to create and deploy BTCFi applications, but the Bitcoin ecosystem seems not to require the repetitive construction of one-click chain deployments.
3.2 Major Challenges Faced
1. Limitations of the Bitcoin Protocol
Bitcoin is designed to serve as a secure and reliable means of storing value 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 when Bitcoin is brought into Ethereum and other smart contract-supported blockchains through cross-chain bridges, its liquidity in DeFi is still far lower than tokens like Ethereum. The current lack of liquidity may limit the adoption 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 pose security risks. In recent years, cross-chain bridge attacks have become frequent, leading to substantial financial losses. Ensuring the safety of cross-chain bridges and preventing risks arising from centralization or technical failures remains an important challenge for BTCFi.
4. The Challenge of Oracles Accurately Capturing Prices
The architectural limitations of the Bitcoin blockchain make deploying oracle services on it more complex than projects like Chainlink on Ethereum. This limitation makes it more complicated to deploy oracle systems in the BTCFi ecosystem, possibly requiring reliance on second-layer or sidechain solutions. In the reliance on cross-chain bridges and price synchronization challenges, BTCFi may primarily depend on cross-chain bridges to map Bitcoin to other chains for cross-chain price synchronization. Overall, it faces greater technical and security challenges regarding the accuracy of oracles compared to Ethereum.
5. Can it carve out its own development path, rather than blindly imitating Ethereum?
The core goal of Bitcoin's design is security over functionality. In the design of BTCFi, the market's acceptance of security will always take precedence over functionality. The adoption of Bitcoin globally primarily focuses on value storage and payment; therefore, BTCFi may concentrate on financial products related to payments and value storage. The concept of PayFi is not only applicable to Solana but also more suitable for Bitcoin.
Reference Article: (Comparison of the Four Major Bitcoin Expansion Solutions: Who Will Truly Unlock the Trillion Market Potential of BTCFi?)
This article is contributed and does not represent the views of BlockBeats.
