What Needs To Happen For Bitcoin-Based DeFi To Take Off

Bitcoin, the OG of cryptocurrencies, was described as a "peer-to-peer electronic cash system" that enabled "any two willing parties to transact directly with each other without the need for a trusted third party" in Satoshi Nakamoto's original whitepaper. You won't find terms like DeFi and dApps in the whitepaper that started it all.

However, DeFi is revolutionizing our financial systems. It enables anyone with an internet connection to access financial services without involving a centralized intermediary, giving you full control over your funds.

Bitcoin: Not-so-smart?

Most of the dApp developers have been flocking to Ethereum and other newer blockchains that support complex smart contracts and decentralized applications. They are faster than the Bitcoin base layer in processing transactions.

In December 2021, Eswar Prasad, a professor of economics at Cornell University, said the promise of DeFi using blockchain technology is a real one, but Bitcoin may not last much longer. The base layer of Bitcoin has scalability issues with a transaction taking up to 10 minutes to be validated.

Scalability is a problem we already have solutions for — Layer-2 and Layer-3 projects, sidechains, hard forks and whatnot. Hundreds of millions of dollars have been poured into projects expanding the functionality of Bitcoin's base layer. Their efforts have begun to bear fruit. These projects take some tasks away from the base layer but rely on it for security.

Now you can pay for small purchases in day-to-day life with Bitcoin, buy decentralized tokens that mimic the prices of real-world stocks, trade the tokenized versions of pre-IPO equities and do much more as developers continue to push the limits of what's possible with Bitcoin.

Defi Users Need Bitcoin; They Just Haven't Realized It Yet

So far, Bitcoin's effectiveness in providing censorship resistance through its unfairly cheap security model hasn't helped it gain a strong foothold in the DeFi space. Unlike other popular blockchains that wanted to be the jack-of-all-trades from the get-go, Bitcoin has built out a robust and secure foundation first. It has no counterparty risk or dilution risk.

Building out a thriving DeFi ecosystem on Bitcoin would require a multi-pronged approach with massive funding and development to make it irresistible for developers and users who are used to the EVM chains.

Besides the funding and incentives for dApp developers, here are a few things that could help accelerate the DeFi activity on Bitcoin:

1. Security Breaches and Censorship

Centralized cryptofinance platforms like Celsius Network, Voyager Digital and BlockFi were hit hard due to the crypto crash triggered by the collapse of Terra's UST stablecoin. Though they promised attractive returns to their users, they have not been fully transparent about how and where they were investing user assets to generate the returns.

Combine that with smart contract heists, security breaches and increasing censorship (remember the Canadian truckers?), and you'll realize that the low-security blockchains aren't that attractive. Amid all the turmoil, Bitcoin has held up its promise of decentralization and censorship resistance.

The hacking, censorship and failure of centralized DeFi platforms will drive cultural awareness of self-sovereign systems and encourage users to take "not your keys, not your coins" seriously.

Without feeling the risk of losing their money, most traders and investors won't realize the importance of Bitcoin's security and immutability. Today, the not-so-decentralized DeFi is full of third parties that hold user funds and opaque systems that hide serious vulnerabilities.

2. Real-world Assets on Bitcoin

Bringing DeFi to the masses would involve building real-world utility. It could be tokenizing stocks to enable people to get price exposure from anywhere in the world or tokenizing other assets such as gold, U.S. Treasuries and money-market funds to unlock massive potential. They could all be potentially used as collateral in DeFi pools.

When it comes to putting trillions of dollars' worth of real-world assets on the blockchain, security becomes the biggest concern for users as well as institutions. Whether it's individual users, banks or financial service providers, everyone would want their assets to be on the chain with the highest possible security, the kind of battle-tested security that Bitcoin provides.

Conclusion

DeFi on Bitcoin will be built in many different layers, even though the base layer has limited smart contract functionality. With the implementation of the Taproot upgrade, Bitcoin now boasts greater transaction privacy and efficiency besides unlocking the potential for smart contracts. Taproot makes smart contracts cheaper and smaller, in terms of the space they take up on the blockchain.

Bitcoin is the only blockchain that can claim to be the world's strongest decentralized network. The goal is not to bring DeFi to Bitcoin, but to ensure that DeFi has the best possible security — and that path would lead it to Bitcoin.

(U-Zyn Chua is the co-founder and CTO of Cake DeFi.)