As of August 27th, 2024, there are ten times more wrapped bitcoin than Bitcoin TVL.
Bitcoin’s market cap is $1.24 trillion, but most of it is idle because there’s no easy way for holders to use their assets without giving up custody.
Faced with that choice, most abide by the rule ‘not your key, not your coin’. But not all do. Blockfi and Celsius, two centralised lender services, managed respectively $10b and $3b, offering 5-7% on Bitcoin before collapsing in the FTX aftermath.
It’s a cautionary tale of the worst, but also a market signal that there is demand for productive uses of bitcoin. This has led to the creation of an ecosystem of 90+ blockchains built on top of the main bitcoin blockchain, offering ways to make it productive, while trying to reduce the risks and maintaining self-custody.
It’s a worthwhile effort, but most are recreating what already exists on Ethereum, with a technology that’s worse.
Market economies thrive on specialisation. Ethereum specialises precisely on what’s needed for a successful decentralised finance ecosystem. Bitcoin focuses on making its asset a type of asset that is resistant to inflation and censorship. Bitcoin for storage, Ethereum for usage.
The point is, for most financial products using Bitcoin, you can build a faster to market, more scalable, and easier-to-use version on Ethereum rather than on a Bitcoin L2. Ethereum is the best place to build bitcoin defi because it has the most primitives, assets, and liquidity.
The major DeFi building blocks and primitives are already on Ethereum. You can create a trading pair with bitcoin on Uniswap. The simplest method to create a money market using Bitcoin as collateral is to create a market on Morpho, a decentralized lending platform, using any asset as borrowed and your preferred oracle.
As a consequence, Ethereum hosts the most liquid DeFi ecosystem. Technical fitness is just one factor for the success of a financial rails. Liquidity is more crucial.
Traditional financial rails demonstrate the inertia of liquidity impeding technological change. Players who innovate too much move away from the liquidity flows and isolate themselves. Indeed, most innovation in finance over the past decade has been in improving frontends and customer service.
With over $50b in TVL in Ethereum L1, the Bitcoin ecosystem needs to 10x - twice - before catching up. This is while dealing with a slower rate of development due to the protocol not being designed for the use case, and not particularly developer-friendly.
On scalability, it is not an issue if you’re building directly on Bitcoin, but for most intents and purposes, it’s not possible because Bitcoin script is just not expressive enough and the chain not meant for high throughput. The alternative is building on one of the numerous L2s, but since the ecosystem is early, it’s a gamble on their longevity.
Bridging the gap
Going back to the first line, my expectation is for this ratio to widen. For this to happen, the main thing needed is a low-friction, high security option to bridge assets from Bitcoin to Ethereum.
The current offering isn’t good enough because it’s too centralised and managed by institutions reminiscent of the past cycle’s centralised lenders.
With all the DeFi building blocks ready to use Bitcoin as an asset & collateral, what’s needed is a mechanism that allows bitcoins to be moved to Ethereum with low trust assumptions. One key element is retaining self-custody of the asset. Another is the segregation of risks from one user to the other. The third element will be the smooth bridging to Ethereum.
There is progress in the space, with products like dlcBTC and Hemi, but I expect more in the coming months.
Reach out if you’re building in the space!