Overview of Bitcoin DeFi

Key Takeaways

• Bitcoin DeFi aims to enhance Bitcoin’s utility beyond a store of value, unlocking BTC for DeFi apps via layer-two (L2) networks.
• Stacks (STX) is widely considered the most well-known Bitcoin DeFi project. Dozens more are in development and should go live in 2025.
• These developments promise to integrate Bitcoin into a broader financial ecosystem without altering its core protocol.

What Is Bitcoin DeFi?

While Bitcoin (BTC) has historically been viewed as a store of value, decentralised finance (DeFi) has the potential to greatly expand its utility mainly by allowing BTC to be used as collateral for borrowing and lending. In many ways, this would allow Bitcoin to foster a DeFi ecosystem similar to other blockchains such as Ethereum (ETH).

Currently, there are BTC derivatives on Ethereum, such as Wrapped Bitcoin (WBTC), which allow BTC holders to participate in Ethereum-based DeFi platforms. However, WBTC introduces new risks because BTC holders need to trust third parties. When using WBTC, Bitcoin is handed over to a custodian who holds it and issues a tokenised version of BTC. This introduces counterparty risk because trust is placed in these entities to manage the Bitcoin securely and return it when requested.

If these custodians were compromised or acted maliciously, user funds could be lost. This reliance on third-party custodians contradicts the decentralised ethos of Bitcoin and DeFi, which is why DeFi projects are attempting to build on Bitcoin.

Where Is Bitcoin DeFi Being Built?

Bitcoin DeFi is being developed on several L2 solutions, which improve Bitcoin’s scalability and lower transaction costs. L2 networks can enhance Bitcoin’s utility by adding greater smart contract functionality without jeopardising its security. This approach allows Bitcoin to handle more transactions and interact with various DeFi projects.

At the time of writing, the total value locked (TVL) on Bitcoin L2s is $886M ($598M USD). This pales in comparison to Ethereum, which has over $93B ($63B USD) in TVL. However, given that Bitcoin's total market cap is nearly $1.8T, compared to Ethereum’s $444B, there is a significant amount of collateral potentially waiting to be unlocked.

Current Bitcoin L2 Projects

Stacks (STX)

Stacks (STX) is a network that extends the capabilities of Bitcoin, making it possible to build DeFi apps using BTC without changing Bitcoin’s underlying protocol. It anchors transactions to the Bitcoin blockchain for security, allowing users to engage with dapps directly using BTC. This platform is central to Bitcoin DeFi’s growth.

In the second half of 2024, Stacks underwent an upgrade called ‘Nakamoto’, which had been in development for multiple years. The Nakamoto upgrade delivered a variety of network performance enhancements to Stacks, setting the stage for greater adoption of Bitcoin DeFi.

BOB (Build on Bitcoin)

BOB is a hybrid L2 solution that integrates Ethereum's EVM (Ethereum Virtual Machine) to enable smart contracts on Bitcoin. It supports DeFi apps, allowing developers to use Bitcoin’s security while benefiting from Ethereum’s versatility. BOB already has a mainnet launch with over 40 dapps, making it a promising hub for DeFi activities on Bitcoin.

Botanix (Spiderchain)

Botanix Labs is building Spiderchain, an EVM-equivalent L2 solution on Bitcoin. Spiderchain aims to offer seamless DeFi services using Bitcoin for both security and transaction gas, creating a truly Bitcoin-native DeFi environment. Its innovative cryptography and decentralised multisigs ensure secure fund transfers between Bitcoin and the Spiderchain.

Potential Challenges for Bitcoin DeFi

While the future of Bitcoin DeFi is promising, several challenges can hinder its adoption. One of the main hurdles is scalability. Although L2 solutions help reduce transaction costs and improve speed, these networks are still in their early stages compared to Ethereum’s DeFi ecosystem. Relatedly, the limited developer infrastructure around Bitcoin-based smart contracts can also hinder innovation.

Another challenge is liquidity. Bitcoin DeFi lacks the deep liquidity seen on Ethereum. For DeFi on Bitcoin to thrive, more participants must provide liquidity to decentralised exchanges and lending platforms. Without sufficient liquidity, users may face issues like high slippage and limited borrowing capacity, hindering the growth of DeFi protocols on Bitcoin.

Lastly, user adoption remains a crucial factor. Bitcoin has a strong reputation as a store of value, but many of its users are not as familiar with DeFi services as Ethereum users. Convincing Bitcoin holders to engage with DeFi protocols may take time, especially when dealing with the risks and complexities of smart contracts and decentralised platforms.

Conclusion

Bitcoin DeFi is a fast-growing ecosystem spearheaded by projects such as Stacks. Projects building in this space aim to let people borrow and lend their BTC in a decentralised manner that does not jeopardise the Bitcoin blockchain itself. As with any category in the crypto market, Bitcoin DeFi faces certain growth challenges.