Bitcoin-Backed DeFi: An Introduction
Published by Tycho Onnasch and Claire Topalian on January 17, 2023
Bitcoin-Backed DeFi (Decentralized Finance) refers to a financial system that is built on top of the Bitcoin blockchain. This type of DeFi utilizes Bitcoin as collateral or financial asset, allowing users to access a range of financial services in a decentralized manner, without having to rely on centralized financial institutions.
One of the benefits of Bitcoin-Backed DeFi is that it allows users to earn passive income by lending their Bitcoins to other users.
Another popular use case for Bitcoin-Backed DeFi is the creation of stablecoins. Stablecoins are cryptocurrencies that are pegged to the value of another asset, such as the US dollar. By using Bitcoin as collateral, stablecoins can be created in a decentralized manner, offering users a stable store of value that is not subject to the volatility of the cryptocurrency market.
Bitcoin-Backed DeFi also allows for the creation of decentralized exchanges (DEXs), which enable users to trade cryptocurrencies without having to rely on centralized exchanges. By using smart contracts to facilitate trades, DEXs offer users a more secure and transparent way of trading cryptocurrencies.
DeFi on Bitcoin offers a range of benefits, including greater financial autonomy, access to passive income opportunities, and the ability to create stablecoins and decentralized exchanges.
One of the benefits of Bitcoin-Backed DeFi is that it allows users to earn passive income by lending their Bitcoins to other users.
Another popular use case for Bitcoin-Backed DeFi is the creation of stablecoins. Stablecoins are cryptocurrencies that are pegged to the value of another asset, such as the US dollar. By using Bitcoin as collateral, stablecoins can be created in a decentralized manner, offering users a stable store of value that is not subject to the volatility of the cryptocurrency market.
Bitcoin-Backed DeFi also allows for the creation of decentralized exchanges (DEXs), which enable users to trade cryptocurrencies without having to rely on centralized exchanges. By using smart contracts to facilitate trades, DEXs offer users a more secure and transparent way of trading cryptocurrencies.
DeFi on Bitcoin offers a range of benefits, including greater financial autonomy, access to passive income opportunities, and the ability to create stablecoins and decentralized exchanges.
DeFi Use Cases
Yield
Bitcoin DeFi will enable decentralized ways to earn yield on BTC. Yield is generated by putting idle capital to work, for example through lending or securing a network or application.
Let’s say Bob owns 50 BTC, which he bought in 2018. This 50 BTC has become a nice nest egg but has been sitting idle in Bob’s wallet. Bob wasn’t very keen on putting his BTC on centralized yield platforms like Blockfi since he had no insight into how these platforms generated a yield. With a decentralized Bitcoin yield platform, Bob can generate more BTC with his holdings while knowing exactly how the yield is generated with the ability to withdraw his funds at any time (as specified by the platform’s public smart contracts).
Let’s say Bob owns 50 BTC, which he bought in 2018. This 50 BTC has become a nice nest egg but has been sitting idle in Bob’s wallet. Bob wasn’t very keen on putting his BTC on centralized yield platforms like Blockfi since he had no insight into how these platforms generated a yield. With a decentralized Bitcoin yield platform, Bob can generate more BTC with his holdings while knowing exactly how the yield is generated with the ability to withdraw his funds at any time (as specified by the platform’s public smart contracts).
Collateral
With Bitcoin DeFi, it will become much safer to use BTC as collateral to borrow against. Bitcoin is a digitally native scarcity asset. Its limited supply and near instantaneous transferability makes it a perfect asset to borrow against.
Let’s say Bob bought 10 BTC in 2016 while he was a student. What he saw as a little internet experiment has turned into a nice financial windfall. Now that Bob has grown a bit older he’s looking to buy a home. However, Bob doesn’t want to sell his BTC as he believes it will appreciate in value. Using Bitcoin DeFi, Bob can borrow USD against his Bitcoin. Bitcoin DeFi is superior to centralized platforms that offer loans against Bitcoin, since Bob remains in control of his Bitcoin collateral as it sits in a publicly auditable smart contract (as opposed to an opaque lending entity).
Let’s say Bob bought 10 BTC in 2016 while he was a student. What he saw as a little internet experiment has turned into a nice financial windfall. Now that Bob has grown a bit older he’s looking to buy a home. However, Bob doesn’t want to sell his BTC as he believes it will appreciate in value. Using Bitcoin DeFi, Bob can borrow USD against his Bitcoin. Bitcoin DeFi is superior to centralized platforms that offer loans against Bitcoin, since Bob remains in control of his Bitcoin collateral as it sits in a publicly auditable smart contract (as opposed to an opaque lending entity).
Swapping
Bitcoin DeFi will make it much easier for users to swap in and out of BTC.
Today, users rely almost exclusively on centralized exchanges to buy/sell BTC. However, this comes with challenges as we’ve recently seen with FTX’s collapse.
Let’s say Carlos owns 10 BTC and lives in Paraguay. He bought the BTC from his friend in a cash transaction, way back in 2014. Carlos doesn’t have access to any crypto exchanges if he wants to sell his Bitcoin, as there are no exchanges with licenses in Paraguay. A Bitcoin DEx is the only way that Carlos can sell his BTC (for a stablecoin like USDT for example).
Today, users rely almost exclusively on centralized exchanges to buy/sell BTC. However, this comes with challenges as we’ve recently seen with FTX’s collapse.
Let’s say Carlos owns 10 BTC and lives in Paraguay. He bought the BTC from his friend in a cash transaction, way back in 2014. Carlos doesn’t have access to any crypto exchanges if he wants to sell his Bitcoin, as there are no exchanges with licenses in Paraguay. A Bitcoin DEx is the only way that Carlos can sell his BTC (for a stablecoin like USDT for example).
Zest Protocol + sBTC = Frictionless yield-earning on BTC
We’re currently building a Bitcoin DeFi app called Zest Protocol. Zest Protocol will enable users to earn a real Bitcoin yield without relying on a centralized intermediary for the first time.
While working on the first version of Zest Protocol, we quickly realized that a native Bitcoin integration on the Stacks layer would be required for Zest Protocol to reach scale. This led us to table a range of proposals to the technical minds in the ecosystem, which eventually led to sBTC. When users come to earn Bitcoin yield on Zest Protocol, they will send native Bitcoin to the app - which Zest Protocol will turn into sBTC under the hood before moving the asset back into native BTC to pursue yield bearing activity.
sBTC helps us to make the process of earning yield on BTC a seamless and frictionless experience. - Tycho
While working on the first version of Zest Protocol, we quickly realized that a native Bitcoin integration on the Stacks layer would be required for Zest Protocol to reach scale. This led us to table a range of proposals to the technical minds in the ecosystem, which eventually led to sBTC. When users come to earn Bitcoin yield on Zest Protocol, they will send native Bitcoin to the app - which Zest Protocol will turn into sBTC under the hood before moving the asset back into native BTC to pursue yield bearing activity.
sBTC helps us to make the process of earning yield on BTC a seamless and frictionless experience. - Tycho
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