The curious relationship between Bitcoin and Defi
Being the leading digital decentralized medium of exchange and storage of value, Bitcoin acquires almost 40% of the accounts in the crypto-financial world.
Shifting financial services to Defi has been a hot topic of debate for some time now. However, it requires a hold-holding from the Bitcoin protocol for mass adoption.
Although building Bitcoin Defi projects could be equally beneficial, it can develop the bitcoin economy and increase the capital productivity of bitcoin as an asset. Adopting innovations like Defi is mandatory for bitcoin to become a Web 3.0 settlement layer.
In this article, let us explore the following facets of the relationship between Bitcoin and Defi.
- Does Defi require Bitcoin for its existence?
- What is Bitcoin Defi?
- How does it work?
- Bitcoin Defi on other blockchain protocols
- How to introduce stability in Bitcoin Defi?
- Introduction of Fixed-rate bonds
- Dynamic Collateral rebalancing pool
- Sum Up
- About ImmuneBytes
Does Defi require Bitcoin for its existence?
Undoubtedly, Ethereum has strongly supported a decentralized financial system. But, it does need the support of bitcoin for mass adoption.
Smart contracts are at the heart of Decentralized finance. However, it has been impossible to build extensive smart contracts on the core bitcoin blockchain due to the security trade-offs.
Defi applications to increase scalability and impart smart contracts capabilities to bitcoin require sidechain support.
Bitcoin sidechains allow you to move BTC to another autonomous blockchain for trading and then to move back to the core bitcoin blockchain. Sidechains are independent blockchains that can interact with other blockchains.
What is Bitcoin Defi?
Defi applications are nothing but smart contracts majorly built on Ethereum, the leading smart contract blockchain platform. Bitcoin wasn’t designed in a way to support extensive smart contracts. But, with the scale of adoption and trust in bitcoin, it is imperative for Defi must have a role in it.
Being the most significant cryptocurrency of the times, Bitcoin users demand a solution to enter the world of Defi.
How does Bitcoin Defi work?
Bitcoin Defi working depends on the different blockchain protocols it operates on. Following are a few protocols on which Bitcoin Defi has been deployed.
Stack’s new venture, Trust Machines, seeks to build the largest community of bitcoin applications, including Defi applications.
Stack entered as a solution to two major issues in the Bitcoin core chain- scalability and smart contract compatibility.
Stack uses its layer-1 Blockchain and BTC for transaction settlement instead of deploying a smart contract on the bitcoin core chain.
It uses a Proof of Transfer consensus mechanism that utilizes the mining energy consumed on the bitcoin chain to deploy smart contracts on the Stacks blockchain.
Stack ensures scalability along with bitcoin’s security.
Stack uses its own smart contract language, CLARITY, that ensures decidability and interpretability.
Till now, Stack is the most prominent Web 3.0 landscape on Bitcoin.
The leading smart contract blockchain protocol, Ethereum, dominates over 50% of the entire Defi ecosystem. For bitcoin users to use BTC on the Ethereum protocol, Wrapped Bitcoins(WBTC) need to be deployed.
WBTC is ERC 20 tokens representing Bitcoin on the Ethereum blockchain protocol. It intends to bring new use cases of bitcoin such as DAO and Defi on Ethereum.
The wrapped tokens can be used on the Ethereum platform like any of its native tokens. Firstly, convert your bitcoin to WBTC, then borrow stablecoins to be reinvested in the Defi ecosystem.
RootStock majorly works as a Bitcoin sidechain that utilizes smart bitcoin(RBTC) as its utility token. RBTC is pegged to the price of bitcoin and is used to pay the transaction amount using a smart contract.
Being a sidechain, the stack can utilize RBTC and BTC interchangeably on the two blockchain platforms.
Now that we know ways to use Defi on bitcoin. Let us see how we can reduce the volatility in price fluctuations in Bitcoin Defi.
How to introduce stability in Bitcoin Defi?
Undeniably, fluctuations in BTC pricing have been a significant distraction for investors to shift their banking system to crypto.
Deposit, lending, and borrowing on Defi today bring in their own set of uncertainty. Defi on bitcoin is no different. Although it enables sovereign collectibles to determine their interest rate yield curve, bitcoin as collateral is a highly risky asset.
Here are ways to reduce instability in the Bitcoin Defi ecosystem.
- Introduction of fixed-rate bonds
This implies mimicking the traditional banking system and, for instance, introducing fixed-rate bonds like zero-coupon bonds to impart a static interest rate to the lenders. Thus, providing safe haven to users having a lesser risk appetite.
2. Dynamic collateral rebalancing pool
Lending and borrowing in BTC bring a fair share of uncertainty themselves. Bitcoin being collateral is a risky asset. If the price of BTC drops below the minimum threshold of the loan-to-value ratio, then you tend to liquidate almost 50% of your collateral amount.
In a situation like this, a dynamic collateral rebalancing pool is required as the bitcoin goes up, and the pool shifts to a risky asset to capture the game. While, in the case of downward bitcoin, the pool will shift to a minor risk condition saving the collateral from being liquidated.
The Crypto world has the potential to change the traditional financial system. Indeed, bitcoin is the most popular and secure blockchain protocol. Defi needs bitcoin for it to scale. In February 2022 Indian Government, in its budget, introduced a 30% tax on income earned from digital assets.
Although it seems a lot, it gives a positive message that governments recognize the existence of blockchain assets. Hopefully, the future financial world will run on Blockchain.
Stay tuned with ImmuneBytes, to be in the known with more such information about Bitcoin, Defi, and Web 3.0 security updates.
ImmuneBytes, a blockchain security company, offers enterprises and startups comprehensive smart contract auditing solutions for their applications to have a secure commencement. Our journey begins with an aim to foster security in the upcoming blockchain world, improving the performance of large-scale systems.
However, Blockchain fosters a secure transactional environment, and applications built on this technology come with their own set of vulnerabilities. As there is no scope for alterations in blockchain transactions, smart contracts need to be thoroughly evaluated to prevent further loopholes from turning your project into an extravagant exploit.
ImmuneBytes administers stern smart contract audits, employing both static and dynamic analysis, alongside examining a contract’s code and gas optimization, leaving no escape route for bugs.