Analyzing BTCFi through on-chain data

CoinMarketCap Research and Footprint Analytics have researched the rise of Bitcoin Decentralized Finance (BTCFi), conducting a comprehensive analysis of its current status and future prospects using on-chain data.

Bitcoin's role in Decentralized Finance (DeFi) is undergoing significant changes. Once limited to simple peer-to-peer transfers, the world's first cryptocurrency is now becoming a powerful participant in the DeFi space, challenging Ethereum's long-standing dominance.

This report explores the rise of Bitcoin Decentralized Finance (BTCFi), using on-chain data to comprehensively analyze its current status, rise trajectory, and potential impact on the broader encryption ecosystem. We will explore:

• Technological innovation makes Decentralized Finance functionality on BTC possible.
• BTCFi is a key indicator of adoption rate and market influence.
• Native BTC Decentralized Finance compared with Ethereum-based Decentralized Finance analysis.
• The challenges and opportunities that shape the future of BTCFi.

As we delve into the data, a clear picture emerges: BTCFi represents not only a technological shift, but also a potential paradigm shift in the role of BTC in Decentralized Finance. As we will explore, the impact of this transformation could redefine the dynamics of the entire Decentralized Finance field.

The Emergence of BTC Decentralized Finance

Bitcoin was proposed by Satoshi Nakamoto in 2008 as a peer-to-peer electronic cash system. While its initial architecture was revolutionary for Digital Money, it had significant limitations for more complex financial applications such as Decentralized Finance.

The original design of BTC and the limitations of Decentralized Finance

Core design elements and their limitations:

• UTXO model: BTC uses the Unspent Transaction Output (UTXO) model, which, while very efficient for simple transfers, lacks the flexibility required for complex smart contracts.
• Limited Script: BTC's unique, stack-based script language is intentionally restricted to prevent potential security vulnerabilities, but this also limits its ability to support complex Decentralized Finance applications, as the set of operation codes (opcodes) that can be executed is limited.
• Lack of Turing Completeness: Unlike ETH, BTC's scripts are not Turing Complete, which makes it challenging to implement complex, state-dependent smart contracts that are necessary for many Decentralized Finance protocols.
• Block size and transaction speed: Compared to Blockchains centered around Decentralized Finance, BTC's 1MB Block size limit and 10-minute Block time result in lower transaction throughput.

These design choices enhance security and Decentralization, but also pose obstacles to implementing Decentralized Finance functionality directly on BTC Block on-chain. The lack of native support for features such as loops, complex conditions, and state storage makes it challenging to build applications like Decentralization exchange, lending platforms, or Liquidity Mining protocols directly on BTC.

Early Attempts and Progress of Introducing Decentralized Finance on Bitcoin

Despite these limitations, Bitcoin's strong security model and widespread adoption continue to drive developers to seek innovative solutions:

• Colored Coin (2012-2013): Colored Coin was one of the earliest attempts to expand the functionality of BTC, aiming to represent and transfer real-world assets by "coloring" specific BTC with unique Metadata. While not strictly Decentralized Finance, this sets the stage for more sophisticated financial applications on BTC.
• Counterparty (2014): The protocol introduced the ability to create and trade custom assets on the BTC blockchain, including the first Non-fungible Token (NFT). Counterparty demonstrated the potential for more complex financial instruments on BTC.01928374656574839201
• Lighting Network（2015-present）: Although Lighting Network is primarily designed for scalability as a second-layer protocol, the introduction of payment channels has opened up possibilities for more complex financial interactions, including basic Decentralized Finance applications.
• DLC (Discreet Log Contract) (2017-present): Proposed by Tadge Dryja, DLC allows for the execution of complex financial contracts on BTC without changing the underlying layer, opening up possibilities for derivatives and other Decentralized Finance tools.
• Liquid Network (2018-present): Developed by Blockstream, Liquid is a Settlement network based on sidechains that enables issuance of digital assets and more complex BTC transactions, paving the way for applications similar to Decentralized Finance.
• Taproot Upgrade (2021): Through Merklized Alternative Script Trees (MAST), Taproot compresses complex transactions into a single hash, dropping Money Laundering and minimizing memory usage. While Taproot itself is not a Decentralized Finance solution, the upgrade enhances BTC's Smart Contract capabilities, making the implementation of complex transactions simpler and more efficient, laying the foundation for future Decentralized Finance development.

These early developments laid the foundation for expanding BTC's functionality beyond simple transactions. While emphasizing the challenges of introducing Decentralized Finance to BTC, they also demonstrated the innovative potential of the ecosystem. This foundation work laid the groundwork for the emergence of Layer-2 solutions and sidechains, as well as the current wave of BTC Decentralized Finance innovations, which we will explore next.

Key Innovation: Enabling Smart Contract on Bitcoin

The BTC ecosystem has witnessed a surge in protocols aimed at bringing Smart Contract and Decentralized Finance functionality to the world's first cryptocurrency. These innovations are reshaping the practicality of BTC, extending its role beyond a simple store of value or medium of exchange. Here are some protocols that support BTC Smart Contracts:

• Rootstock: As a pioneer of BTC-based smart contracts, Rootstock is the oldest BTCSidechain and has become the cornerstone of the BTCFi ecosystem. It utilizes 60% of the BTChash power to provide dual mining and EVM compatibility for deploying ETH smart contracts. Its unique Powpeg mechanism ensures seamless conversion from BTC to RBTC, and its 'Depth Defense' security model prioritizes simplicity and robustness. According to Footprint Analytics, since its mainnet launch in 2018, Rootstock's on-chain activity has shown stable growth, consolidating its position as a stable and scalable solution in the BTC ecosystem.

Source: Footprint Analytics - Rootstock Overview

• CORE: Core is a layer 1 blockchain that is "BTC-driven, EVM-compatible, and consistent with BTC". With its innovative Double Staking model that combines BTC and CORE, it has become a powerful participant. This approach establishes a risk-free interest rate for BTC through non-custodial BTC stake, effectively turning BTC into a profitable asset. Core reports that 55% of BTC Mining Computing Power is delegated to its network, which may contribute to the security model of its Decentralized Finance applications.
• Merlin Chain: As a relatively new member, Merlin Chain is the second layer of BTC, focusing on unlocking the Decentralized Finance potential of BTC, and is causing a sensation. By integrating ZK-Rollup technology, Decentralized Oracle Machine, and on-chain BTC anti-fraud module, Merlin provides BTCholders with a complete set of Decentralized Finance functions. The launch of M-BTC (a packaged BTC asset that can earn stake rewards) opens up new ways to generate income and participate in Decentralized Finance.
• BEVM: BEVM represents a significant leap in bringing the vast Decentralized Finance ecosystem of Ethereum directly into BTC. As the first fully decentralized EVM-compatible layer 2 for BTC that uses BTC as gas, BEVM allows for seamless deployment of ETH-based DApps on BTC. With the support of mining giant Bitland, BEVM is pioneering the concept of 'Computing Power RWA,' which has the potential to unlock new dimensions of value in the BTC ecosystem.

Key Innovations of BTC Layer 2 and Sidechains

• Packaged BTC assets
• Smart Contract and EVM compatibility
• Profitable BTC
• Scalability and Privacy Enhancement

These protocols are not just copying Ethereum's Decentralized Finance script on BTC; they are leveraging BTC's unique properties to pave new paths. From Rootstock's Depth defense approach to Core's dual stake model, Merlin's comprehensive Decentralized Finance suite, and BEVM's Computing Power RWA innovation, the BTCFi field is rapidly evolving.

As of September 8, 2024, the Total Value Locked (TVL) of BTC Layer-2 solutions and sidechains has reached 1.07 billion USD, rising 5.7 times since January 1, 2024, and rising 18.4 times since January 1, 2023.

Source: Footprint Analytics - BTCscaling solution TVL

Leading the pack is CORE with a TVL of 27.6%, followed by Bitlayer (25.6%), Rootstock (13.8%), and Merlin Chain (11.0%).

Source: Footprint Analytics - BTCscaling solution TVL

BTC Decentralized Finance Status

As the BTC Decentralized Finance ecosystem continues to mature, several key projects have become key players, driving innovation and adoption. These projects are built on the strong foundations provided by BTC's layer 2 solutions and sidechains, providing various Decentralized Financial Services:

Main BTCFi Project

Pell Network (Multi-chain)

Pell Network is a multi-layer stake protocol designed to enhance the security and optimize returns within the BTC ecosystem. By staking BTC or Liquidity stake Derivatives (LSD), users earn rewards while decentralized operators run validation Nodes to ensure network security. Pell offers actively validated services such as Oracle Machine, cross-chain bridges, and data availability, supporting a broader BTC Layer 2 ecosystem. With its robust infrastructure, Pell aims to be a key participant in providing Liquidity and encryption security, driving sustainable rise in the entire BTC economy.

Avalon Finance (Multi-chain)

Avalon Finance is a multi-chain Decentralized Finance platform that operates across Bitlayer, Core, and Merlin Chain, known for its comprehensive lending and trading services in the BTC Decentralized Finance ecosystem. Avalon's main products include over-collateralization loans and dedicated isolation pools for major assets and low liquidity assets. The platform also integrates derivatives trading, enhancing the functionality of its lending services. In addition, Avalon has an algorithmic stablecoin designed to optimize capital efficiency, positioning it as a versatile and secure Decentralized Finance solution in the BTC ecosystem. Its governance token, AVAF, follows the ES Token model and incentivizes liquidity provision and protocol usage.

Colend protocol（Core）

Colend Protocol is a Decentralized lending platform built on Core Blockchain that enables users to securely borrow and lend BTC and other assets. By leveraging Core's dual-stake model, Colend seamlessly integrates with the wider Decentralized Finance ecosystem, enhancing BTC's utility in Decentralized Finance. Key features include Decentralization, tamper-proof transactions, multiple liquidity pools with dynamic Interest Rates, and a flexible collateral system.

MoneyOnChain（Rootstock）

MoneyOnChain is a comprehensive Decentralized Finance protocol built on Rootstock, allowing BTC holders to enhance the performance of their assets while retaining full control over their Private Key. The protocol centers around the issuance of Dollar on Chain (DoC), a stablecoin fully collateralized by BTC and designed for users who want to preserve the USD value of their held BTC. In addition, MoneyOnChain also offers BPRO, a token that provides BTC leveraged exposure for passive income.

The architecture of this protocol is built on a risk-sharing mechanism, using a proprietary financial model designed to withstand extreme market Fluctuation. It also features DecentralizationToken Exchange (TEX), Decentralized Oracle Machine (OMoC), and governance Token (MoC), allowing users to participate in protocol decision-making, stake, and rewards.

Sovryn (Multi-chain)

Sovryn is a Decentralized exchange and one of the most feature-rich Decentralized Finance platforms built on BTC, designed to enable users to trade, borrow, and earn income using BTC. Sovryn operates on BOB and Rootstock, offering a range of Decentralized Finance services including trading, swapping, Liquidity provision, staking, and borrowing. Sovryn focuses on creating a permissionless financial layer for BTC and integrating it with other blockchains, making it a unique multi-chain platform in the BTC Decentralized Finance ecosystem. The platform's governance token, 01928374656574839201, is called Token.SOV, plays a key role in managing the Decentralization protocol through its Bitocracy system, representing voting rights and rewarding active participants.

Solvprotocol (Merlin Chain)

Solv Protocol is at the forefront of financial Non-fungible Token, enabling users to create, trade and manage on-chain credentials. The protocol aims to tokenize and aggregate the earnings of various Decentralized Finance protocols in the Merlin chain ecosystem. Its flagship product, SolvBTC, as a revenue token, allows BTC holders to earn returns while maintaining liquidity. Solv Protocol aims to create a strong liquidity layer through staking and other revenue-generating activities. This flexibility makes it an important Decentralized Finance project in the Merlin on-chain and helps unlock new financial opportunities within the BTC ecosystem.

These projects highlight the pattern of BTC Decentralized Finance's dynamics and rapid development, with each project contributing unique features and expanding the ecosystem's scope of influence.

As of September 8, 2024, Core leads the BTC Decentralized Finance field in terms of the number of projects built on it, hosting 25.2% of active projects, which strengthens its core role in the ecosystem. Rootstock and Bitlayer are also important participants, supporting 13.0% of projects each, reflecting their importance in improving Liquidity and capital efficiency in the BTC Decentralized Finance field. Merlin Chain, with 9.9% of projects, also plays a key role in expanding BTC Decentralized Finance capabilities. Other platforms like BOB (8.4%), BSquared (6.9%), and Stacks (6.1%) contribute to the diversity of the ecosystem, while BEVM (5.3%), BounceBit (3.1%), and MAP Protocol (3.1%) add to the diversity of the ecosystem. Achieve overall rise with its professional solutions.

Source: Footprint Analytics - BTCscaling solution TVL

Pell Network (in 7 on-chain) has become the number one Decentralized Finance project ranked by Total Value Locked (TVL), reaching $260.8 million, highlighting its leadership position in the financial non-fungible token field. Avalon Finance (in three on-chain) and Colend Protocol (Core chain) have TVLs of $206.2 million and $115.5 million respectively, also significant contributors. Other noteworthy projects include MoneyOnChain and Sovryn, reflecting different focus areas in the BTCFi space - from Liquidity Mining to stablecoins.

Source: Footprint Analytics - BTC Decentralized Finance project Cross-Chain Interaction TVL

Key Description of BTCFi Projects

• Safety and Decentralization first: BTC Decentralized Finance ecosystem is built on the uncompromising principles of safety and Decentralization. BTC's unparalleled security framework is the foundation of the BTCFi ecosystem, ensuring that all development adheres to these core values.
• BTC as a Programmability currency: BTCFi is completely changing BTC's role, transforming it from a store of value to a Programmability currency. This transformation is achieved through the deployment of Smart Contracts, enabling a new generation of complex financial applications. For example, SolvBTC from Solv Protocol claims to be the "first ever profit-generating BTC", offering profits through a yield vault of Delta-neutral trading strategies and Decentralized Finance protocols on chains such as Ethereum, Arbitrum, and Merlin.
• Interoperability with Ethereum: By bridging the Decentralized Finance ecosystem of Ethereum through an EVM-compatible solution, BTCFi leverages the strengths of both networks. This interoperability creates a powerful synergy, combining the security of BTC with the flexible smart contract functionality of Ethereum. For example, Core utilizes the EVM to execute smart contracts, which means dApps developed for Ethereum can easily be migrated to the Core blockchain without major modifications.
• Unlocking capital for BTC: The BTCFi ecosystem is releasing a large amount of funds for Decentralized Finance, providing yield opportunities while allowing users to maintain their BTC exposure, thereby expanding the utility and attractiveness of BTC in Decentralization finance.

Comparison and Analysis of Decentralized Finance based on Ethereum

As BTC Decentralized Finance continues to be followed, it is crucial to compare its development with Decentralized Finance based on Ethereum, especially how followBTC is represented in the Ethereum ecosystem through wrapped assets such as wBTC and renBTC, and what lessons can be learned from the journey of Ethereum.

BTC on ETH Finance and native BTC Decentralized Finance

The integration of BTC and ETH in the Decentralized Finance ecosystem is mainly achieved through asset wrapping (such as Bitcoin and renBTC. These tokens allow BTC holders to access the vast Decentralized Finance space on Ethereum by converting BTC into ERC-20 tokens that can be used on platforms such as MakerDAO, Aave, and Uniswap based on Ethereum.

There are significant differences in the use of BTC between these ecosystems. As of September 8th, the amount of BTC locked in the Ethereum Decentralized Finance protocol is 153,400, far surpassing the 89,700 in the native BTC Decentralized Finance ecosystem. This trend is driven by the mature and diverse infrastructure of Ethereum's Decentralized Finance, which provides a wider range of financial products, including lending, trading, and Liquidity Mining.

Source: Footprint Analytics- Bitcoin Bridge BTC to Ethereum WBTC

While packaged BTC tokens like wBTC provide Liquidity and access to advanced Decentralized Finance features, they also introduce reliance on custodians and Cross-Chain Interaction bridges, which may add layers of risk. In contrast, native BTC Decentralized Finance projects, although smaller in scale, operate within the security framework of BTC itself, avoiding some of the risks associated with Cross-Chain Interaction transfers. However, the nascent state of BTC Decentralized Finance means that the available range of Financial Services is still limited compared to the Ethereum network.

The lessons brought to BTC by the development of Ethereum, and vice versa

What can BTC learn from the ETH network:

• Product Diversity: Ethereum's success in the field of Decentralized Finance is largely due to its support for a wide range of financial products and services, from DEX to synthetic asset. To foster the development of BTC Decentralized Finance, it needs to expand its products beyond the current lending and stablecoin services. Developing more complex financial instruments and interoperable solutions helps attract a broader user base.
• Developer Ecosystem: Ethereum has cultivated a vibrant developer community that continues to innovate and build on its platform. Decentralized Finance (DeFi) projects on BTC can benefit from nurturing a more participatory developer ecosystem, encouraging the creation of new protocols and applications that leverage the advantages of BTC.
• Interoperability: Ethereum's Decentralized Finance ecosystem has flourished due to its interoperability within its own ecosystem and with other blockchains. Enhancing the interoperability between BTC Decentralized Finance and other chains, including Ethereum, can unlock new opportunities for users to leverage the strengths of both ecosystems.

What can Ethereum learn from Bitcoin:

• Security and Decentralization: BTC's emphasis on security and decentralization remains unparalleled. The Ethereum project can learn from BTC's conservative security approach to ensure that rapid innovation does not come at the expense of these core principles. This is especially important as Ethereum transitions to more scalable solutions such as Layer 2, where security trade-offs must be carefully managed.
• Simplicity and Robustness: Compared to the complex smart contracts on Ethereum, BTC has simpler and more powerful script functions, although it is less flexible, it has fewer vulnerabilities. Ethereum developers can benefit from prioritizing simplicity and robustness in smart contract design to maximize the drop in security risks.
• Focused on store of value: While Ethereum is known for its smart contract functionality, Bitcoin's dominance as a store of value remains strong. Ethereum's ecosystem can benefit from exploring ways to enhance its store of value function, potentially integrating more BTC-based assets to attract users who prioritize security and store of value.

Although BTC Decentralized Finance is still in its early stages, it has tremendous rise potential by drawing on the experience and lessons of the more mature Ethereum ecosystem. At the same time, Ethereum can learn from BTC's advantages in security and decentralization to further strengthen its Decentralized Finance products. With the development of both ecosystems, their collaboration and mutual learning can drive the next stage of rise in Decentralized Finance.

Challenges and Opportunities

As the industry continues to develop, it is necessary to overcome technical and regulatory barriers, while technological progress and emerging rise areas bring huge expansion opportunities.

Technical and Regulatory Challenges

Technical Obstacles

Implementing Decentralized Finance on Bitcoin faces some technical challenges. Scalability is a major issue, as the base layer of BTC limits transaction throughput due to its block size and block time constraints. Unlike Ethereum, which has developed a wide range of Layer 2 solutions, BTC's Layer 2 and sidechain ecosystems are still in their early stages, restricting the effective support for a range of Decentralized Finance applications. Additionally, interoperability remains a significant challenge. Connecting BTC with other blockchain ecosystems without compromising security or decentralization is complex and requires innovative solutions.

Regulatory Issues

With the continuous rise of BTC Decentralized Finance, regulatory scrutiny is expected to strengthen. Governments and financial regulatory agencies may impose stricter regulations on Decentralization Financial Services, especially those related to Anti-Money Laundering (AML) and Know Your Customer (KYC) requirements. The Decentralization and Anonymity of BTC pose challenges to compliance and may slow down the adoption and development of BTC Decentralized Finance. It is crucial to address these regulatory environments for the sustainable rise of BTC Decentralized Finance.

Future Opportunities

Technological Progress

Technological advancements present significant opportunities to promote the development of Decentralized Finance (DeFi) for Bitcoin (BTC). Enhancements to Layer 2 solutions, such as more efficient and secure sidechains, as well as the development of more scalable and interoperable frameworks, can greatly enhance the functionality of the BTC DeFi ecosystem. Innovations like Discreet Log Contracts (DLC) and advancements in privacy protection technologies like Zero-Knowledge Proofs enable more complex and secure financial applications.

Predictions for the future rise field

With the maturity of the BTC Decentralized Finance ecosystem, multiple areas show significant potential for rise. Profit-generating products, Decentralization exchange (DEX), and Cross-Chain Interaction liquidity pools are expected to attract a large amount of interest. In addition, as institutional interest in BTC continues to rise, the demand for Decentralized Finance products that meet institutional needs (such as custody solutions, Compliance financial instruments, and BTC-backed stablecoins) may increase. These developments provide early adopters and innovators in the BTC Decentralized Finance field with opportunities for high Return on Investment.

Conclusion

Looking ahead, driven by technological advancements and increased institutional interest, the BTC Decentralized Finance ecosystem will continue to rise. Developing more scalable Layer 2 solutions, enhancing interoperability, and introducing more complex financial products are crucial for this expansion. As the ecosystem matures, opportunities for yield-generating products, Decentralization exchange, and institutional-grade Decentralized Finance services are expected to attract a large following and capital.

However, this kind of rise will be accompanied by challenges, especially in dealing with the constantly changing regulatory environment and overcoming technical barriers related to scalability and security. Addressing these challenges is crucial to maintaining the momentum of Bitcoin Decentralized Finance and ensuring its long-term success.

In short, the future of BTC Decentralized Finance looks promising, with a lot of innovation and rise opportunities. With the continuous development of the ecosystem, it has the potential to significantly change the broader Decentralized Finance landscape, positioning BTC as a core participant in Decentralization finance.

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