Bitcoin has arrived. Bitcoin Finance is next
Some thoughts on the rise of decentralized finance on Bitcoin
It’s been a while since my last post, and I’ve gotten the itch to start writing again. Here are some thoughts about finance on Bitcoin (BTCFi). This is based on my experience working in the ecosystem for the past 18 months supporting Stacks, a Bitcoin Layer that brings smart contracts to Bitcoin.
1. Institutional adoption of Bitcoin is here
Bitcoin adoption is going mainstream. And it’s not just individuals holding Bitcoin anymore — institutions are aggressively starting to acquire Bitcoin.
BitcoinTreasuries.net shows the breakdown of institutional holdings of Bitcoin.
Public and private companies are starting to adopt Bitcoin at serious levels. Public companies now own almost 1 million BTC (worth more than $100B).
Figma, for example, showed it held $70M in Bitcoin as a way to preserve capital ahead of its IPO.
But what comes after acquiring and holding Bitcoin as a treasury asset? I think it’s finance on Bitcoin.
The thesis is simple — if Bitcoin becomes money and a treasury asset, then institutions, companies, and individuals will want to use their money in creative ways (mostly to earn a yield on their BTC — similar to how people earn a yield on the dollars in their bank account).
Importantly, a portion of Bitcoin finance will be decentralized.
2. DeFi is real and here to stay
I’ll be honest, when I first learned about DeFi, I thought it was just another buzzword or fad. But there is real activity happening in decentralized finance.
Similar to stablecoins, DeFi is real and will have staying power because it is a better experience for users (primarily through reducing costs by cutting out middlemen). You can see this with centralized (CEX) vs decentralized exchanges (DEX). Volume is moving to decentralized exchanges because the fees are lower on DEXes.
Let’s look at some other numbers in DeFi.
On Aave, there is now over $5 billion worth of Wrapped Bitcoin (WBTC) supplied to the protocol. Why do people do this? It’s mainly so they can use their Bitcoin as collateral to get loans in stablecoins like USDC and USDT (so they don’t have to sell their BTC).
.
Similarly, BitcoinLayers.org shows that there are now almost 20,000 BTC supplied to Coinbase’s Base, most of it in cbBTC. That’s over 2 billion dollars. cbBTC users convert their BTC to cbBTC to put it to work.
These numbers are tiny in the grand scheme of global finance. However, they are growing. Total value locked in all DeFi was basically $0 in 2020. Now it’s around $150 billion. This entire concept is still very new.
3. How Bitcoin will be used in DeFi
The nuance with using Bitcoin in DeFi is that — based on technical limitations — users have to use a synthetic version of Bitcoin (like Wrapped Bitcoin, cbBTC, or sBTC) when using decentralized finance on Bitcoin.
With cbBTC, you’re essentially trusting that Coinbase does not steal your Bitcoin. In Bitcoin Layers review of cbBTC, they say that “the BTC backing of cbBTC is custodied by Coinbase.”
This isn’t necessarily a deal breaker. Many people trust Coinbase to custody their Bitcoin. They are a publicly traded company — if they stole your Bitcoin, it’d be a bigger financial scandal than Enron.
However, similar to how DEXes are gaining over CEXes, I’m confident there will be a demand for more decentralized versions of Bitcoin DeFi. There are many companies/projects working on this by creating their own version of wrapped Bitcoin (see the list below). Each of these wrappers requires the Bitcoin holder to assume a different level of trust and risk.
For example, you can make the argument that sBTC on Stacks is less risky than cbBTC on Coinbase because the BTC backing sBTC is secured by a federation of 14 signers. This aims to increase decentralization and remove single points of failure.
The risks of Bitcoin wrappers is a nuanced topic (bitcoinlayers.org is an entire website dedicated to breaking it down). However, the larger point is — Bitcoin is moving into Bitcoin wrappers because Bitcoin holders want to use their Bitcoin in DeFi.
Where’s it all going:
I’m closely watching a few trends.
Bitcoin — it’s becoming clearer everyday that Bitcoin has staying power and is a truly unique asset.
If #1 is true, more companies, institutions, individuals will hold Bitcoin as a treasury asset on their balance sheet.
If #2 is true, more companies, institutions, individuals will want to earn a yield on that Bitcoin.
If #3 is true, more companies, institutions, individuals will find the least risky way to earn this yield.
Thanks for reading!