In recent years, decentralized finance (DeFi) has been a key aspect of the crypto ecosystem, especially challenging the limitations of traditional finance. Since DeFi was introduced on the Bitcoin blockchain, multiple protocols have launched DeFi functionalities on the Bitcoin blockchain, but we are still in the early stages.
This article discusses the different protocols for launching DeFi projects on Bitcoin and their status in providing DeFi functionalities on the Bitcoin blockchain.
Understanding how Bitcoin's blockchain operates
The Bitcoin blockchain operates using a proof-of-work consensus algorithm, which requires solving complex mathematical problems to verify transactions and secure the network.
This consensus mechanism ensures high security for Bitcoin; however, unlike similar blockchains such as Ethereum and Solana, it does not support smart contracts – a cornerstone of DeFi – which Bitcoin lacks.
Due to the lack of smart contract functionality, Ethereum gained an advantage, leading it to dominate the DeFi race, currently accounting for 55% of the total locked value (TVL); Ethereum remains the king of DeFi.
But if this situation doesn't last long for many, Bitcoin must first overcome the limitations that hinder its development to join the DeFi race and support its functionalities and various applications.
The original design of Bitcoin and its limitations related to DeFi
Bitcoin's initial design as a decentralized digital currency includes several elements that do not support the vision of DeFi. These core elements include:
UTXO Model
UTXO stands for Unspent Transaction Output, and this model is effective for simple transfers but lacks the flexibility required for complex smart contracts.
Imagine the UTXO model as cash: when you spend part of a bill, you receive change. While this is effective for simple transactions, it is inefficient for DeFi since smart contracts need to manage multiple states and conditions in a transaction.
Bitcoin's UTXO system was not designed for this complexity, limiting its ability to support advanced DeFi functionalities.
Limited Scripting
Bitcoin's scripting language is intentionally limited to maintain security; however, this means it cannot handle the complex logic required for advanced DeFi applications.
Bitcoin's scripting language consists of a set of simple instructions used to verify and execute basic transactions on the Bitcoin network.
But as Bitfinity connects Ethereum's knowledge with the Bitcoin ecosystem, solutions to the scripting limitations have been found.
Lack of Turing Completeness
Unlike Ethereum, Bitcoin cannot natively support complex, state-dependent smart contracts.
In this case, 'state dependence' means that the outcome of a smart contract relies on the current state or conditions of the system, which can change over time. Bitcoin cannot effectively track these changing states.
Block Size and Transaction Speed
The 1MB block size limit and 10-minute block time reduce Bitcoin's transaction throughput, which is too slow for rapid Dapps; this is the largest objection to the effectiveness of large-scale applications like DeFi so far. That said, it has even caused a split among the Bitcoin tribes, perhaps leading to the emergence of 'extremism.'
The lack of these core elements makes it very difficult to build platforms such as decentralized exchanges, lending platforms, or yield farming protocols directly on Bitcoin. We collectively refer to these platforms as DeFi.
So what exactly is Bitcoin DeFi?
As the name suggests, Bitcoin decentralized finance, or Bitcoin DeFi, sometimes referred to as BTCFi, refers to DeFi developed on the Bitcoin blockchain, simple and straightforward.
Due to Bitcoin's core limitations (as mentioned earlier), the functionality of DeFi can be enhanced by introducing additional layers of Bitcoin that benefit from certain upgrades to the Bitcoin protocol.
Some Bitcoin functionalities or Layer 1 upgrades that need to be made include changes like Schnorr signatures and Taproot. While you can read about them in previous articles, these upgrades improve transaction privacy and scalability, introduce more complex smart contract functionalities, and pave the way for innovations like Ordinals and BRC-20 tokens, which mimic the well-known and widely used Ethereum ERC-20 standard.
Exploring the building blocks of Bitcoin DeFi
Similar to core functionalities, the three elements are the main components of Bitcoin DeFi, which will be explained in detail below.
Bitfinity as the 'Driver' of DeFi
You may know, but you are reading a Bitfinity blog post, and from this, you know that we are actively committed to promoting the development of DeFi in a manner similar to Ethereum. We are about to achieve this as we connect the functionalities of the mainnet with some new features (such as the ICP technology ChainFusion), which essentially means different blockchains can interact with each other, certainly combined with the robustness of the Bitcoin blockchain.
In short, Bitfinity is an auxiliary protocol aimed at significantly increasing transaction speed and making it more scalable. Of course, this is what we need when we want to run DeFi applications in a good, clean version, and it is efficient without compromising the security and decentralization of the Bitcoin network.
What applications can run on top of us? Our ecosystem comprises multiple Bitcoin DeFi applications, each with different functionalities. Here are some brief descriptions.
DotSwap
DotSwap is a Bitcoin-based DeFi platform that ensures secure, trustless exchanges of BTC and BRC20 assets within the Bitcoin ecosystem. As the first native BRC20 exchange, it combines simple AMM trading with strict adherence to Bitcoin principles.
The daily trading volume of DotSwap is $8.8696 million, and the scale is still small, but there is hope for large-scale creation of DeFi on Bitcoin.
Bitcoin Virtual Machine (BVM)
The Bitcoin Virtual Machine (BVM) is a development platform that introduces decentralized applications for DeFi and gaming into the Bitcoin network. It also supports Solidity smart contracts and is EVM-compatible.
BiHelix
BiHelix is also an application framework layer for Bitcoin, built on the Bitcoin blockchain's Lightning Network and RGB protocol, designed to support the development of any type of dApp on the Bitcoin blockchain, from AI and gaming to DeFi.
BitStable Finance
BitStable is a decentralized protocol based on Bitcoin's capabilities, offering DAII (a Bitcoin-backed stablecoin pegged to currencies and commodities) and BSSB (a token for governance decisions). For more information about Bitcoin stablecoins, please check its blog post.
BitSmiley Protocol
The BitSmiley protocol is built on the Bitcoin blockchain through the Fintegra framework and integrates over-collateralized decentralized stablecoins (bitUSD), trustless lending platforms (bitLending), and derivatives protocols (bitCredit) to create a unified ecosystem of stablecoins, lending, and credit needed for DeFi.
Liquidum
Liquidum is the first peer-to-peer, non-custodial Bitcoin DeFi application that allows users to borrow and lend Bitcoin or Bitcoin-based assets, such as inscriptions, Ordinals, runes, and BRC-20 tokens, using discrete log contracts (DLC).
Final Thoughts
At the end of this article, we see that many will attempt to create Bitcoin DeFi, many may fail, but as we seek ways to break through Bitcoin's limitations and become game changers, we may help others succeed by bridging the gap between old finance and new finance (i.e., cryptocurrency).
By leveraging Ethereum's capabilities, it has been proven that Ethereum's functionality plays a significant role in usability and inclusivity, meaning developers can deploy Ethereum-based applications directly on Bitcoin using Solidity through Bitfinity, thus giving Bitcoin access to Ethereum's rich DeFi application ecosystem and expanding its functionality.
This also means that the necessity of building new applications from scratch will decrease, allowing developers and users to use their favorite Ethereum DeFi applications on Bitcoin without reinventing the wheel, thus improving the experience and adoption rate.
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