Decentralized finance (defi) describes blockchain-based protocols and applications that power a suite of monetary tools that are open to everyone. Defi takes services that are common to the established financial system – lending; borrowing; trading; synthetics – and recreates them on-chain. The difference between the two realms – traditional and crypto – owes less to the architecture supporting defi applications – a distributed ledger instead of a central database – and more to the parties who can participate.
Defi applications are, by their nature, open-source and open to everyone. Anyone can participate in the decentralized finance ecosystem, be it as a market maker, borrower, or trader, without requiring permission. This is a marked difference to the old world of finance, where inclusion is based on geography, social status, creditworthiness, and other markers that can be arbitrarily altered or removed at any time, denying access to individuals.
Much of the development that has occurred within defi to date has revolved around Ethereum, which hosts an array of dApps, lending platforms, and stable coin issuance protocols tailored to this purpose. However, in many respects, Bitcoin is the blockchain ecosystem that is better suited to defi, boasting greater liquidity, global adoption, and security guarantees. Defi may have gained its moniker on Ethereum, but it has now transcended that network and found a home on Bitcoin, where a number of smart contract platforms and protocols have been developed to leverage BTC’s defi capabilities. In this guide, we’ll look at some of these products and what they offer to developers and end-users.
The Case for Bitcoin Defi
Defi belongs to no single blockchain. In fact, the very ethos of defi entails being free from financial constraints that limit products to single ecosystems and siloed databases. Composability – the concept of creating defi components that slot together like Lego blocks to create new financial applications – is a key tenet of the defi doctrine. It, therefore, makes sense for defi developers to want to connect the world’s largest distributed computing network – Bitcoin – to the heart of the defi movement.
A lot of the heavy lifting within Bitcoin’s burgeoning defi sector has been done by RSK. The first smart contract platform centered around Bitcoin and powered by it, RSK provides tools for developers looking to create defi applications. These include:
- Distributed storage, payments, oracles, and naming services courtesy of RIF
- Smart contract development that mirrors Ethereum’s capabilities on RSK
- A federated token bridge to Ethereum and its defi dApps
RSK’s smart contract infrastructure can be deployed for creating defi wallets, exchanges, stablecoins, lending and borrowing platforms, and much more. Why build all this on Bitcoin? Well, for one thing, BTC is the cryptoconomy’s best store of value and the asset that hodlers are likeliest to, well, hodl. But locking away all this bitcoin does not provide a yield to its owners. Defi has the potential to put this capital to work, through lending and liquidity provision, giving holders a chance to earn a return on their BTC.
Using RSK’s defi framework, bitcoin holders can:
- Earn interest on their BTC
- Borrow stablecoins so they can unlock the value of their BTC without having to sell
- Leverage trade with their BTC to earn more
- Stake BTC to earn other tokens
Defi Is a Team Game
Collaboration underpins decentralized finance. More than any other crypto vertical, defi is characterized by a spirit of collaboration, partnership, and integration between defi projects. The same is true within Bitcoin’s defi sector; while RSK is the bed for a lot of the decentralized finance innovation occurring, it’s not being created in a vacuum. For example, the first bitcoin-collateralized stablecoin came courtesy of Money On Chain, built, of course, on the RSK platform. It is through the creation of consumer-facing applications such as BTC-based stablecoins that users can actively participate in the defi economy.
RSK has created the framework for Bitcoin defi to flourish. It’s now up to third-party developers to leverage these tools to create applications that solve real-world problems, from efficient escrow to decentralized margin trading, prediction markets, secure messaging, and insurance.
Defi Makes Bitcoin Payments Possible
One of the most bullish cases for marrying Bitcoin with defi is that it makes BTC spendable again. Rising network fees, coupled with a lack of on-chain privacy, have limited bitcoin’s ability to serve as fungible cash as suited to micropayments as it is to move billions of dollars at a time. Enter Lightning Network (LN). If RSK is a Bitcoin layer two for smart contracts, LN is its monetary analog.
With $9 million of BTC locked into the Lightning Network, LN has gained a strong foundation for supporting a global payment network. There is still work to be done in refining the user experience so that Lightning can become accessible to the masses and not just the tech-savvy early adopters. However, its value proposition of near-instant transactions at near-zero cost and with full fungibility is compelling.
The endgame of defi is a permissionless financial system that operates in parallel to the traditional financial system, providing access to anyone who requires it – complete with on-ramps from the old world. For this to occur, defi developers need to refine the UX, usability, and integration of base layer, middleware, and application-level components, to create products that deliver genuine utility and that have a gentle learning curve.
At the moment, the foundations of defi are still ossifying, which means a lot of the development work is still occurring at the base layer and on layer two. The next phase will see closer synergies between defi ecosystems such as Bitcoin and Ethereum, and new applications formed from the defi primitives that have taken shape through the efforts of projects like MakerDAO, Compound, RSK, and Lightning Labs. Bitcoin is already the most decentralized crypto network in the world. If its proponents have their way, it will become the home of the largest decentralized finance experiment the world has ever seen.