Author: CoinMarketCap Research & Footprint Analytics; Translation: Plain-Language Blockchain

Bitcoin's role in DeFi (decentralized finance) is undergoing significant changes. From initially being just a simple peer-to-peer transfer, the world's first cryptocurrency is gradually rising to become a powerful force in the DeFi space, challenging Ethereum's long-held dominant position.

By comprehensively analyzing the current status and growth trajectory of the Bitcoin ecosystem through on-chain data, we have discovered a clear picture: BTCFi (the combination of Bitcoin and DeFi) is not just a technical shift, but may also lead to a paradigm shift in Bitcoin's role in DeFi. As we will delve into, the impact of this shift may redefine the entire landscape of the DeFi space.

01. The Rise of BTCFi

In 2008, Satoshi Nakamoto introduced Bitcoin with the initial aim of serving as a peer-to-peer electronic cash system. While this architecture is revolutionary in the field of crypto assets, it has clear limitations in more complex financial applications like DeFi.

02. Bitcoin's Original Design and its Limitations in DeFi

Core design elements and their limitations:

1) UTXO Model: Bitcoin uses the Unspent Transaction Output (UTXO) model, which is effective for simple transfers but lacks the flexibility required to support complex smart contracts.

Limited scripting language: Bitcoin's scripting language is designed to be restrictive primarily to avoid security vulnerabilities. However, this limitation also hinders its support for complex DeFi applications, as the number of executable opcodes is limited.

Lack of Turing completeness: Unlike Ethereum, Bitcoin's script is not Turing complete, making it difficult to implement complex smart contracts relying on state, which are crucial for many DeFi protocols.

Block size and transaction speed: Bitcoin's 1MB block size limit and 10-minute block generation time result in transaction processing speeds much lower than other blockchains focused on DeFi.

While these design choices enhance Bitcoin's security and decentralization, they also pose obstacles to directly implementing DeFi functionalities on the Bitcoin blockchain. The lack of native support for features like loops, complex conditions, and state storage makes it extremely difficult to build applications such as DEX, lending platforms, or yield farming protocols on Bitcoin.

03. Early Attempts and Development of DeFi on Bitcoin

Despite these limitations, Bitcoin's strong security and wide applications have driven developers to seek innovative solutions:

1. Colored Coins (2012-2013): One of the early attempts to expand Bitcoin's functionality. Colored coins represent and transfer real-world assets by 'coloring' specific bitcoins and attaching unique metadata. While not true DeFi, it laid the foundation for developing more complex financial applications on Bitcoin.

2. Counterparty (2014): This protocol introduced the ability to create and trade custom assets on the Bitcoin blockchain, including the first NFT. Counterparty demonstrated the potential of developing more complex financial instruments on Bitcoin.

3) Lightning Network (2015-present): The Lightning Network is a layer-two protocol designed to improve transaction scalability. By introducing payment channels, it opens up possibilities for more complex financial interactions, including some initial defi applications.

4) Discreet Log Contracts (DLC) (2017-present): Proposed by Tadge Dryja, DLC allows for complex financial contracts to be executed without altering the Bitcoin base layer, providing new possibilities for derivatives and other defi tools.

5) Liquid Network (2018-present): Developed by Blockstream, this is a sidechain-based settlement network that supports the issuance of crypto assets and more complex Bitcoin transactions, paving the way for DeFi-like applications.

6) Taproot Upgrade (2021): By introducing Merkleized Abstract Syntax Trees (MAST), Taproot compresses complex transactions into a single hash, reducing transaction fees and memory usage. While not a DeFi solution itself, it enhances Bitcoin's smart contract capabilities, making complex transactions simpler and more efficient, laying the foundation for future DeFi development.

These early developments laid the foundation for expanding Bitcoin's functionality from simple transfers to more applications. While introducing DeFi on Bitcoin faces challenges, these innovations also demonstrate the potential of the Bitcoin ecosystem. These foundations pave the way for the innovation wave of layer-two solutions, sidechains, and Bitcoin DeFi, and we will delve deeper into this area next.

04. Key Innovations: Implementing Smart Contracts on Bitcoin

In recent years, the Bitcoin ecosystem has seen several protocols aimed at introducing smart contracts and defi capabilities to the world's first global cryptocurrency. These innovations are changing the use cases of Bitcoin, making it more than just a store of value or medium of exchange. Here are some key protocols driving Bitcoin's smart contract implementation:

1) Rootstock: As a pioneer of Bitcoin smart contracts, Rootstock is the longest-running Bitcoin sidechain and has become a crucial foundation of the BTCFi ecosystem.

It utilizes 60% of Bitcoin's hashing power to support dual mining, and is compatible with the Ethereum Virtual Machine (EVM), allowing Ethereum's smart contracts to run on Bitcoin. Rootstock's unique Powpeg mechanism ensures seamless conversion between Bitcoin (BTC) and Rootstock Bitcoin (RBTC), and its "defense in depth" security model emphasizes simplicity and robustness.

Since the mainnet launch in 2018, Rootstock's on-chain activities have been steadily growing. Footprint Analytics points out that it has established a stable and scalable solution in the Bitcoin ecosystem.

2) Core: Core is a Bitcoin-based blockchain closely integrated with Bitcoin and compatible with the Ethereum Virtual Machine (EVM).

Core has attracted attention with its innovative dual pledge model, which combines Bitcoin and Core. Through non-custodial Bitcoin staking, Core establishes a risk-free yield for Bitcoin, effectively turning Bitcoin into an income-generating asset. Core reports that 55% of Bitcoin mining hash power is delegated to its network, enhancing its security in DeFi applications.

3) Merlin Chain: Merlin Chain is a relatively new Bitcoin Layer 2 network dedicated to unlocking the DeFi potential of Bitcoin, attracting increasing attention. It integrates ZK-Rollup technology, decentralized oracles, and an on-chain anti-fraud module, providing Bitcoin holders with a full set of DeFi functions. The M-BTC launched by Merlin is a packaged Bitcoin asset that can earn staking rewards, opening up new avenues for revenue generation and participation in DeFi.

4) BEVM: BEVM represents a significant advancement in bringing Ethereum's extensive DeFi ecosystem directly to Bitcoin. As the first fully decentralized and EVM-compatible Bitcoin Layer 2 network, BEVM uses Bitcoin as fuel, allowing seamless deployment of Ethereum's decentralized applications (DApps) on Bitcoin. BEVM is supported by mining giant Bitmain, introducing the concept of "hash power RWA," potentially unlocking new value dimensions for the Bitcoin ecosystem.

Key innovations in Bitcoin Layer 2 networks and sidechains:

• Tokenizing bitcoin assets;

• Smart contracts and EVM compatibility;

• Bitcoin with yield;

• Scalability and enhanced privacy.

These protocols are not just replicating Ethereum's DeFi strategies on Bitcoin, but are pioneering new directions by leveraging Bitcoin's unique features. From Rootstock's deep defense mechanisms, to Core's dual pledging model, to Merlin's comprehensive DeFi solutions and BEVM's proof of work RWA innovation, the BTCFi space is rapidly evolving.

As of September 8, 2024, the total locked value (TVL) of Bitcoin's Layer 2 solutions and sidechains has reached $1.07 billion, growing 5.7 times since January 1, 2024, and an astounding 18.4 times since January 1, 2023.

Core leads with 27.6% of the total locked value (TVL), followed closely by Bitlayer at 25.6%; Rootstock at 13.8%; Merlin Chain at 11.0%.

Current State of bitcoin DeFi

With the continuous development of the bitcoin DeFi ecosystem, some key projects have emerged as important participants, driving innovation and user adoption. These projects rely on bitcoin's layer 2 solutions and sidechains to provide various DeFi services:

1) Main BTCFi Projects

Pell Network (Multi-Chain)

Pell Network is a cross-chain re-collateralization protocol designed to enhance the security of the bitcoin ecosystem and optimize returns. Users earn rewards by staking bitcoin or Liquidity Staking Derivatives (LSD), while decentralized operators are responsible for running validation nodes to ensure network security. Pell offers a range of proactive validation services such as oracles, cross-chain bridges, and data availability, supporting a broader bitcoin layer 2 ecosystem. With its robust infrastructure, Pell aims to be a significant participant in providing liquidity and safeguarding crypto-economic security, driving sustainable growth in the bitcoin economy.

Avalon Finance (Multi-chain)

Avalon Finance is a multi-chain DeFi platform that spans Bitlayer, Core, and Merlin Chain, known for its comprehensive borrowing and trading services in the BTC DeFi ecosystem. Avalon's main services include overcollateralized borrowing for major assets and low-liquidity assets, with dedicated isolation pools. The platform also integrates derivative trading, enhancing the functionality of its borrowing services. In addition, Avalon has introduced an algorithmic stablecoin designed to optimize capital efficiency, making it a versatile and secure DeFi solution in the Bitcoin ecosystem. Its governance token AVAF adopts the ES Token model to incentivize liquidity provision and protocol usage.

Colend Protocol (Core)

Colend Protocol is a decentralized lending platform built on the Core blockchain, where users can securely borrow Bitcoin and other assets. By leveraging Core's dual collateral model, Colend seamlessly integrates with the broader DeFi ecosystem, enhancing Bitcoin's utility in DeFi. Its key features include decentralized and immutable transactions, liquidity pools with various dynamic interest rates, and a flexible collateral system.

MoneyOnChain (Rootstock)

MoneyOnChain is a comprehensive DeFi protocol built on Rootstock, allowing Bitcoin holders to increase asset yields while retaining full control of private keys. At the core of this protocol is the issuance of a stablecoin named Dollar on Chain (DoC), fully collateralized by Bitcoin, designed for users who wish to keep the value of their Bitcoin holdings pegged to the US dollar. Additionally, MoneyOnChain offers the BPRO token, enabling users to gain leverage exposure to Bitcoin for passive income.

The protocol's architecture is based on a risk-sharing mechanism, utilizing a proprietary financial model to combat extreme market volatility. Additionally, it includes a decentralized Token exchange platform (TEX), decentralized oracle (OMoC), and governance Token (MoC), allowing users to participate in protocol decisions, stake, and receive rewards.

Sovryn (multi-chain)

Sovryn is a DEX, also one of the most feature-rich DeFi platforms built on Bitcoin, enabling users to trade, lend, and earn yield with Bitcoin. Sovryn spans both BOB and Rootstock platforms, offering a variety of DeFi services including trading, swapping, liquidity provision, staking, and lending. The platform focuses on creating a permissionless financial layer for Bitcoin, integrating with other blockchains to become a unique multi-chain platform within the Bitcoin DeFi ecosystem.

Sovryn's governance Token SOV plays a crucial role in decentralized protocols managed through the Bitocracy system, representing voting rights and rewarding actively participating users.

Solv Protocol (Merlin Chain)

Solv Protocol is at the forefront of NFT financialization, allowing users to create, trade, and manage on-chain certificates. The protocol aims to tokenize and aggregate profits from various DeFi protocols in the Merlin Chain ecosystem. Its flagship product SolvBTC is a yield Token, enabling Bitcoin holders to earn yield while maintaining liquidity.

Solv Protocol is dedicated to establishing a strong liquidity layer through staking and other revenue-generating activities. This flexibility makes it an important DeFi project on Merlin Chain, helping unlock new financial opportunities in the bitcoin ecosystem.

These projects highlight the dynamic and rapid development in the Bitcoin DeFi space, each contributing unique features to expand the ecosystem's coverage. As of September 8, 2024, Core leads in the Bitcoin DeFi space with 25.2% of active projects, further solidifying its core role in the ecosystem. Rootstock and Bitlayer each support 13.0% of projects, reflecting their importance in enhancing liquidity and capital efficiency in the Bitcoin DeFi ecosystem. Merlin Chain also plays a key role with a 9.9% project share in expanding Bitcoin DeFi functionalities. Other platforms such as BOB (8.4%), BSquared (6.9%), and Stacks (6.1%) contribute to ecosystem diversity, while BEVM (5.3%), BounceBit (3.1%), and MAP Protocol (3.1%) drive overall growth with their specialized solutions.

Pell Network leads in DeFi projects with a total locked value (TVL) of 0.2608 billion USD, solidifying its leadership position in the NFT financial sector. Avalon Finance and Colend Protocol have TVLs of 0.2062 billion USD and 0.1155 billion USD respectively, also as significant participants. Other notable projects include MoneyOnChain and Sovryn, showcasing diversity in the BTCFi field, involving liquidity mining to stablecoins.

2) Key Narratives in Major BTCFi Projects

Security and Decentralization First: Bitcoin's DeFi ecosystem prioritizes security and decentralization as core principles. Bitcoin's unparalleled security framework is the foundation of the BTCFi ecosystem, ensuring all innovations adhere to these fundamental principles.

Bitcoin as a Programmable Token: BTCFi is reshaping Bitcoin's role, making it more than just a store of value, but a programmable token. This shift, enabled by smart contracts, unlocks possibilities for a new generation of complex financial applications. For example, Solv Protocol's SolvBTC is dubbed as the "first yield-bearing Bitcoin," leveraging neutral trading strategies in the revenue pool and providing returns in DeFi protocols like Ethereum, Arbitrum, and Merlin Chain.

Interoperability with Ethereum: BTCFi establishes a bridge with the Ethereum DeFi ecosystem through an EVM-compatible solution, fully leveraging the strengths of both networks. This interoperability creates a powerful synergistic effect, combining Bitcoin's security with Ethereum's flexible smart contract capabilities. For example, Core executes smart contracts via EVM, meaning decentralized applications (dApps) developed for Ethereum can easily migrate to the Core blockchain without significant modifications.

Unlocking capital for Bitcoin: The BTCFi ecosystem is unlocking a substantial amount of capital for DeFi purposes, providing yield opportunities while allowing users to maintain their Bitcoin exposure, thus expanding the practicality and attractiveness of Bitcoin in DeFi.

3) Comparative Analysis with Ethereum DeFi

As Bitcoin DeFi continues to evolve, it becomes increasingly important to compare it with Ethereum DeFi. In particular, attention should be paid to how Bitcoin operates in the Ethereum ecosystem using wrapped assets like wBTC and renBTC, as well as what lessons we can learn from Ethereum's development history.

4) Ethereum DeFi VS. Bitcoin and Native Bitcoin DeFi

The integration of Bitcoin with the Ethereum DeFi ecosystem is mainly achieved through wrapped assets like wBTC and renBTC. These tokens allow Bitcoin holders to convert BTC into ERC-20 tokens, granting access to Ethereum's extensive DeFi ecosystem, which can be utilized on platforms like MakerDAO, Aave, and Uniswap on Ethereum.

There are significant differences in the use of BTC in these two ecosystems. As of September 8th, the amount of BTC locked in Ethereum DeFi protocols is 0.1534 million, far exceeding the 0.00897 million in the Bitcoin-native DeFi ecosystem. This trend is due to Ethereum's mature and diverse DeFi infrastructure, offering a wider range of financial products, including borrowing, trading, and yield farming.

While wrapped Bitcoin tokens like wBTC can provide users with liquidity and more advanced DeFi features, they also rely on custodians and cross-chain bridges, which may increase risks. In contrast, native Bitcoin DeFi projects, although smaller in scale, operate within Bitcoin's own security framework, avoiding many risks associated with cross-chain transfers. However, Bitcoin DeFi is still in its early stages, and the range of financial services it offers is still limited compared to Ethereum.

06. Insights into Ethereum's development compared to Bitcoin and vice versa

1) Experiences Bitcoin can learn from Ethereum:

Product diversity: Ethereum's success in DeFi is largely due to its offering of various financial products and services, such as DEX and synthetic assets. To drive the development of Bitcoin DeFi, it is necessary to expand its product range, not limited to just lending and stablecoin services. Developing more complex financial tools and interoperability solutions may attract more users.

Developer ecosystem: Ethereum has nurtured an active developer community, constantly innovating and building new projects on the platform. Bitcoin DeFi projects can also promote a more active developer ecosystem, encouraging the creation of more new protocols and applications to leverage Bitcoin's advantages.

Interoperability: Ethereum's DeFi ecosystem performs well in terms of internal operations and interoperability with other blockchains. Enhancing Bitcoin DeFi's interoperability with other chains (including Ethereum) may bring new opportunities to users, allowing them to benefit from the advantages of both ecosystems.

2) Experiences Ethereum can learn from Bitcoin:

Security and decentralization: Bitcoin's emphasis on security and decentralization is unparalleled. Ethereum projects can gain insights from Bitcoin's conservative approach to ensure that these core principles are not sacrificed while innovating rapidly. This is particularly important as Ethereum transitions to more scalable solutions (such as Layer 2), as security issues must be handled carefully during this process.

Simplicity and robustness: Although the script function of Bitcoin is relatively simple and robust, its lack of flexibility means that it has fewer vulnerabilities than Ethereum's complex smart contracts. Ethereum developers can prioritize maintaining simplicity and robustness in smart contract design to reduce security risks.

Focus on value storage: While Ethereum is known for its smart contract capabilities, Bitcoin still maintains a strong position as a value store. The Ethereum ecosystem can explore ways to enhance its value storage function, possibly by integrating more Bitcoin-based assets to attract users who prioritize security and asset preservation.

Although Bitcoin's DeFi is still in its early stages, if it draws on the experience of Ethereum's mature ecosystem, it has significant growth potential. At the same time, Ethereum can learn from Bitcoin's advantages in security and decentralization to further strengthen its DeFi products. As these two ecosystems develop, their collaboration and mutual learning could drive the next growth phase of DeFi.

07. Challenges and Opportunities

As this field continues to evolve, it is necessary to address technological and regulatory barriers, while technological advancements and emerging growth areas also present significant expansion opportunities.

1) Technological Barriers

Developing DeFi on Bitcoin faces many technological challenges. Scalability is the primary issue, as Bitcoin's base layer has limited transaction processing capacity due to block size and block time constraints. Unlike Ethereum, which already has various mature Layer 2 solutions, Bitcoin's Layer 2 and sidechain ecosystems are still in their infancy, limiting the range of DeFi applications that can be effectively supported.

Secondly, interoperability is also a major challenge. Connecting Bitcoin with other blockchain ecosystems without compromising security or decentralization is quite complex and requires innovative solutions.

2) Regulatory Concerns

With the continuous development of bitcoin defi, it is expected that regulatory scrutiny will intensify. Governments and financial regulatory authorities may impose stricter regulations on defi services, especially in terms of AML and KYC. Bitcoin's decentralization and pseudo-anonymous features make compliance complex, which could affect the adoption and development of bitcoin defi. Therefore, finding a balance in these regulatory environments is crucial for the sustainable growth of bitcoin defi.

08. Future Opportunities

1) Technological Advancements

Bitcoin defi has significant room for technological advancements. Improving Layer 2 solutions, such as more efficient and secure sidechains, and developing more scalable and interoperable frameworks could significantly enhance the capabilities of the bitcoin defi ecosystem. Furthermore, advancements like discreet log contracts (DLCs) and privacy-enhancing technologies (e.g., zero-knowledge proofs) could make more complex and secure financial applications a reality.

2) Future Growth Areas Forecast

As the bitcoin defi ecosystem continues to mature, several areas show strong growth potential. Products that generate revenue, DEXs, and cross-chain liquidity pools are expected to attract increasing attention. Additionally, with institutions' growing interest in bitcoin, there is expected to be higher demand for defi products tailored to institutional needs, such as custody solutions, compliant financial instruments, and bitcoin-backed stablecoins. These developments provide early adopters and innovators in the bitcoin defi space with high investment return opportunities.

09. Conclusion

Looking ahead, the bitcoin DeFi ecosystem will continue to expand with the progress in technology and the growing interest of institutions. Developing more scalable Layer2 solutions, enhancing interoperability, and introducing more complex financial products are crucial for this expansion. As the ecosystem matures, income-generating products, DEXs, and institution-oriented DeFi services are expected to attract a lot of attention and funding.

However, this growth will also face challenges, especially in dealing with the evolving regulatory environment and overcoming technical challenges related to scalability and security. Addressing these issues is crucial to maintaining the growth momentum of bitcoin DeFi and ensuring its long-term success.

In conclusion, the future of bitcoin DeFi looks promising, with abundant innovation and growth opportunities. As the ecosystem continues to evolve, it has the potential to have a profound impact on the entire DeFi ecosystem and position bitcoin as a core participant in DeFi.