I recently shared some thoughts about DeFi in light of recent market turmoil. While I remain extremely bullish on p2p finance in the long run, I believe there are at least 3 major questions to answer in the short term: 1) what blockchain/layer is most appropriate for DeFi scalability, 2) what use cases can DeFi power beyond speculation, and 3) how can we bring Bitcoin’s superior collateral security and liquidity to the DeFi ecosystem? Today I will explore this final question.
First, I want to touch on why it’s important that we bring Bitcoin to DeFi or DeFi to Bitcoin. While I’ve become increasingly convinced that ETH has a number of interesting money-like properties, there is no question that Bitcoin is by far the most secure crypto-native form of money or collateral. Bitcoin is dominant on four axes:
2) Liquidity – Bitcoin market cap dominance remains >60%. And daily BTC volume has been at least 2-5x that of ETH over the last month (source: Messari). Bitcoin also dominates in p2p markets (localbitcoins, Bisq, etc.) which are the primary means of trading in countries like Venezuela (see this excellent study of bitcoin as a censorship resistant bridge currency).
3) Attack surfaces – By virtue of its intentionally limited, non Turing complete scripting language, Bitcoin has far fewer potential attack surfaces than Ethereum.
4) Monetary policy / governance – This is a hot button issue and perhaps a bit less clear than the first three points. But at least for the foreseeable future, Bitcoin has a hard coded supply cap of 21 million bitcoin. That cap has taken on an almost religious significance within the community. Ethereum meanwhile attempts to engineer scarcity via a “minimum necessary issuance” policy. So how many ETH will be issued in a block reward a year from now? The short answer: no one knows, because the community’s issuance requires active governance. And that’s to say nothing of whether or not we’ll be using ETH 2.0 by then. Short term, the certainty in Bitcoin’s issuance makes it substantially better collateral. Long term, legitimate questions remain around Bitcoin’s security budget once all miner rewards have been distributed – a subject for another post. At the very least, Bitcoin’s sound monetary policy provides a means of diversifying collateral risk.
Because of its impressive security and liquidity network effects, it’s not hard to imagine that Bitcoin’s ultimate killer app will be that of the most secure, liquid, bearer asset collateral in the world and thus the basis for a new financial system.
How then can DeFi markets access the >$100B in BTC collateral? There are essentially two options:
- Port Bitcoin to Ethereum
- Build a layer for more sophisticated financial contracts on top of Bitcoin
Both options have their pros and cons and will no doubt be tested by a number of smart teams. For option 1, the most obvious answer would be to have a centralized entity or group of entities custody bitcoin and mint corresponding tokens on Ethereum. This is effectively what Bitgo has done with wbtc. To date, there’s only about $7.5M locked up in wbtc. The risk of a centralized entity holding your funds is clearly high.
More interesting are projects that make use of trust minimized pegs (e.g. tbtc and Ren), atomic swaps (e.g. Atomic Loans), interoperable blockchains like Cosmos (e.g. Kava), or Bitcoin’s RSK sidechain (e.g. Money on Chain). Each of these projects have their own advantages and disadvantages, but I personally find the first 3 most intriguing.
Perhaps an even more interesting approach would be to build a native contracts for difference (CFD) platform directly on top of Bitcoin. The DEBNK proposal based on Dan Robinson’s Rainbow Network paper is the most interesting I’ve seen to date. Although still theoretical, I’m particularly excited about their proof of concept on top of the lightning network, which mitigates many of my scalability concerns as well.
While it’s not clear whether Bitcoin will eventually come to DeFi or DeFi to Bitcoin (or both), it is very clear that the best collateral in the crypto world (and perhaps eventually the world at large) will one day be core to a p2p financial system. If you or someone you know is working on novel solutions to this problem, particularly if you’re building DeFi solutions on top of Bitcoin, please do reach out!