How to Put Bitcoin to Work in DeFi

Bitcoiners, the original holders of the cryptocurrency, are hesitant to engage with decentralized finance (DeFi) due to past negative experiences and inherent risks. Many are fearful of moving their "native" Bitcoin from the secure Bitcoin blockchain to other protocols or Layer 2 solutions, which they perceive as adding layers of risk to an asset they consider to be in its purest, untouchable form. This caution is understandable, as less than 1% of the total Bitcoin supply is currently active in DeFi. Bitcoiners have witnessed the implosion of centralized finance (CeFi) lenders like Genesis and Celsius, where they entrusted their Bitcoin, and have also seen significant hacks occur on the very infrastructure used for bridging and wrapping Bitcoin. Despite these challenges, the technology for Bitcoin DeFi is evolving, and the ecosystem is beginning to function, albeit with more trust assumptions and less liquidity than ideal. Currently, Bitcoin's total market capitalization is substantial, around $1.3 trillion, yet the total value locked (TVL) in Bitcoin DeFi is only about $4.5 billion. This TVL is distributed across various protocols. The staking protocol Babylon holds a significant portion, around $3.5 billion. The payments protocol Lightning Network has approximately $300 million in TVL. For context, the widely used wrapped Bitcoin, WBTC, alone has over $7.7 billion in custody, highlighting that most Bitcoin holders access DeFi by wrapping their BTC and deploying it on other chains, primarily Ethereum. Bitcoin sidechains, which offer various functionalities, collectively hold about $300 million in TVL. The hesitancy among Bitcoiners stems from a desire for more trustless financial applications. Developers, including those at Starkware, are working on creating more secure ways to integrate Bitcoin into programmable chains. Starkware's technology, for instance, aims to enhance Bitcoin's expressibility, allowing users to do more with their Bitcoin beyond simple holding and transferring. Co-founder Ellie Ben Sassan notes that the demand for Bitcoin financialization, borrowing, and other economic transactions is significant, but the current options involve compromises in trust, liquidity, or decentralization. Despite the caution, Bitcoin is already being utilized in DeFi in at least three major ways: borrowing against it, earning yield on it, and spending it. The most popular use case is holding Bitcoin as collateral to borrow against it, enabling holders to access liquidity without selling their BTC and potentially missing out on future price appreciation. The crypto collateralized lending market is substantial, with a significant portion in DeFi lending applications. Many individuals, like Bitcoin OG Matt Longo, have used Bitcoin-backed on-chain loans to finance major purchases, such as homes, often securing better terms and avoiding taxes and capital gains by not selling their Bitcoin. Borrowing against Bitcoin typically involves using wrapped Bitcoin (like WBTC) on Ethereum and its Layer 2 solutions, or on Bitcoin sidechains. Protocols like Aave and Spark on Ethereum allow users to deposit wrapped Bitcoin and borrow stablecoins, often with high loan-to-value ratios (70-90%). Newer ecosystems like Starknet are also developing BTC-backed lending markets. Bitcoin sidechains like Rootstock and Stacks offer similar borrowing functionalities, though often with slightly higher rates and lower loan-to-value ratios. There are also emerging native Bitcoin alternatives that aim to eliminate the need for wrapping and bridging altogether, though these may have thinner liquidity. The trade-off across all these options is consistent: greater liquidity and composability often come with more trust assumptions, while more Bitcoin-native solutions tend to have less liquidity. The second major use case is earning yield on Bitcoin, often referred to as "stacking sats." Similar to borrowing, options range from highly liquid but low-yield environments on Ethereum to more native but potentially less liquid solutions. While lending wrapped Bitcoin on Ethereum is possible, yields are currently very low due to limited demand for borrowing BTC. Starknet offers slightly better yields, boosted by incentives. Bitcoin Layer 2s and sidechains like Stacks provide yield denominated in their native tokens, introducing token risk. The most Bitcoin-native approach is staking native Bitcoin directly, as offered by Babylon, which allows users to secure other blockchains. This method is trustless, as Bitcoin is not deposited into a third-party wallet. However, the yield is typically lower, around 4%, reflecting the cost of staying fully aligned with the Bitcoin mainnet. Projects like Lombard are creating liquid staking tokens for staked Bitcoin, enabling users to deploy them across DeFi. The third use case, spending Bitcoin, is the oldest but remains the smallest in terms of volume. The Lightning Network has seen growth in monthly volume and merchant adoption, but it still faces friction and has a limited scope. For many Bitcoiners, spending BTC means letting go of their prized asset, and the potential for opportunity cost is a significant deterrent. A fourth, less discussed use case is providing liquidity on decentralized exchanges (DEXs). Users can pair their Bitcoin with other assets to earn trading fees. This is happening on Ethereum DEXs using wrapped Bitcoin, but it carries the risk of impermanent loss if prices move unfavorably. More native Bitcoin options exist on chains like Thundercore, offering lower yields but with less wrapping. Newer ecosystems on Stacks and Merlin are building their own DEX environments with higher yields, often boosted by incentives. More sophisticated users can also engage in structured Bitcoin yield strategies, which combine lending, trading, and staking to generate higher returns. These multi-strategy vaults can target yields ranging from modest to over 20%, often by combining DeFi yields with incentives or structured products. However, these strategies introduce more complexity, more layers, and consequently, more trust assumptions. In summary, Bitcoin DeFi is no longer just a future promise; it is a present reality, though still in its nascent stages. The ecosystem is growing, with innovations aiming to reduce trust assumptions and increase utility for Bitcoiners. While bridging and wrapping Bitcoin currently offers the most liquidity and access to advanced DeFi options, the focus is shifting towards building more trustless and secure bridges. Starknet, in particular, is making a significant investment in Bitcoin DeFi, aiming to transform Bitcoin from a static asset into the infrastructure for the global economy. The journey involves addressing challenges related to programmability, scalability, and privacy, with ongoing research and development in areas like BitVM and Zero-Knowledge proofs to enhance the security and functionality of Bitcoin DeFi. The ultimate goal is to expand Bitcoin's GDP by making it more productive and integrated into the broader financial landscape, while respecting the core ideals of decentralization and self-custody that Bitcoiners cherish.