Everything You Need to Know about DeFi on Bitcoin

Sep 4, 2019 · 5 min read
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Entrepreneurs in the Bitcoin and blockchain industry want to decentralize finance. Bitcoin is the first example of a DeFI project with global impact. And then there’s Ethereum with its crowdfunding features, illustrated by the fleeting ICO boom.

DeFi is a portmanteau of two words central to Bitcoin — decentralized and finance. DeFi refers any financial activity facilitated by blockchains. For example, dapps, some of which could be labeled DeFi, are apps that run on decentralized or distributed blockchains.

Maker, based in Santa Cruz, California, is another example of a DeFi project. Dai, its native stablecoin, provides price stability compared to Bitcoin. 1 Dai token is always worth 1 USD. Since its value is pegged to the U.S. dollar, it is less volatile — making it more sensible for everyday purchases.

While Maker’s collateralized lending system and stablecoin (DAI) are decentralized, and therefore DeFI, stablecoins like Tether and Gemini dollar, in which funds are held in traditional banking arrangements, are not DeFI projects.

What is DeFi?

Everything from ICOs to decentralized exchanges are considered DeFi. Compelling uses of DeFi on a blockchain include decentralized exchanges, decentralized prediction markets and other forms of decentralized gambling, decentralized lending, decentralized bandwidth markets, and more. In past years, the most famous and infamous DeFi experiments and failures have been attempted on the Ethereum blockchain.

But, Bitcoin has grown exponentially since its inception in the twilight of the naughts, and could provide a more secure foundation upon which to build DeFi applications. The total power of all the computers mining Bitcoin is over 1000 times more powerful than the world’s top 500 supercomputers combined.

Hundreds of thousands of Bitcoin transactions, furthermore, take place per day. Hundreds of thousands of Bitcoin change hands at a time, too. In 2013, 194,993 bitcoins were sent between addresses — 1.6% of all bitcoins in circulation at the time or $147 million on that day. Today there are more than one million Redditors subscribed at r/Bitcoin, the first Reddit community for Bitcoin, and there have been days when Bitcoin has been tweeted about hundreds of thousands of times.

It has long been theorized, dating back to the days of Bitcoin’s mysterious founder Satoshi Nakamoto, that Bitcoin could support sophisticated and decentralized financial services.

“The design supports a tremendous variety of possible transaction types that I designed years ago,” wrote Satoshi on BitcoinTalk in 2010. “Escrow transactions, bonded contracts, third party arbitration, multi-party signature, etc.”

He added: “If Bitcoin catches on in a big way, these are things we will want to explore in the future, but they all had to be designed at the beginning to make sure they would be possible later.”

Current R3 lead developer Mike Hearn, and former Bitcoin core developer, gave talks on Bitcoin smart contracts as early as 2012.


In the talk, which is called “the future of Bitcoin and rebuilding the financial system,” Hearn highlights the ways in which smart contracts might be implemented by using the Bitcoin blockchain.

Bitcoin software has features that are not in use today, he said. Hearn learned about contracts on Bitcoin from Satoshi himself. But, then Satoshi vanished. Hearn said we’d need to learn about the “dormant” features that are implementable today. His talk, he underscores, is not a talk of wishes, but a talk of real potential Bitcoin functionalities.

He discusses micropayment channels, dispute meditation, automated mediation, assurance contracts (Kickstarter-style funding), smart property (property controlled via Bitcoin), and more.

Smart property on the Bitcoin blockchain, according to Hearn, reduces trust needed in physical transactions, enables P2P investment funds (send money to a Bitcoin key), p2p currency exchange (he suggests to use the Ripple concept), and can be used as collateral in loans

“Lenders and borrowers construct Bitcoin transactions that the car understands,” reads one of Hearn’s slides. “If borrower defaults the car automatically changes ownership to the lender.” The contract is trustless.

“Bitcoin’s future is bright,” Hearn concluded.

How Does it Work?

Projects today are exploring sidechains to create Bitcoin-based smart contracts. ‘Sidechains’ are separate blockchain that is attached to its parent blockchain. They could enable asset-issuance, stateful smart-contracts, scaling, faster settlement finality, and higher privacy.

Liquid, an inter-exchange settlement network linking together cryptocurrency exchanges and institutions around the world, and a good example of DeFi on the Bitcoin blockchain, enables faster Bitcoin transactions and the issuance of digital assets.

“Through Liquid’s Issued Assets feature, members can tokenize fiat currencies, securities, or even other cryptocurrencies,” writes cryptocurrency security consultant Sergio Lerner on RSK.co. “Liquid peg and consensus is managed by a Federation of functionaries. The native token in the Liquid sidechain is LBTC.”

RSK is a smart contract platform secured by the Bitcoin network. As the most secure proof-of-work smart contract network, RSK adds value by broadening the uses and usability of Bitcoin as a currency.

“Also, it enables scaling Bitcoin payments with more on-chain space and off-chain transactions provided by the RIF Lumino payment channel network,” writes Lerner. The native token in the RSK sidechain is RBTC.

There are other technological approaches to implementing DeFi on the Bitcoin blockchain. Hash Time Locked Contracts (HTLCs) could make cross-chain atomic swaps — that is, transactions between blockchains with no third-party — possible. And, with cross-chain atomic swaps possible, decentralized exchanges could be built atop Bitcoin. Cross operability such as cross-chain atomic swaps between blockchains is an enduring pursuit in Bitcoin development circles.

In addition, layers on top of Bitcoin, such as Lightning Network, could pave the way for DeFi with Bitcoin. To be sure, most technologies designed to implement smart contracts on Bitcoin are a work in progress.

Once the Bitcoin blockchain features smart contract functionality, DeFi on the Bitcoin blockchain would be aided by Bitcoin’s brand recognition and the broad tradition of literature, podcasts, and video documentation, created by diverse sources, helping the public consciousness to conceptualize Bitcoin and its uses.

The Bitcoin blockchain is the most secure blockchain because of its well-developed mining industry. As many experts have said about Bitcoin mining and proof-of-work, it’s a feature not a bug. A stablecoin built on top of Bitcoin would be more secure than a stablecoin built upon any other network

Early on, Bitcoiners touted the crypto asset as a tool for financial inclusion and to empower people. While that sentiment is perhaps less universal today — its hyperbolic price movement makes for good headlines and appeals to our basest emotions, after all — DeFi has restored these visions to the Bitcoin blockchain. It could bank the billions who are unbanked.

Learn more today about how we are building the future of DeFI with Bitcoin.

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