Decentralized Finance (DeFi) applications are now the primary focus within the crypto space. Many believe this might be the killer use case of blockchain technology—an opportunity to deliver all financial services on a peer-to-peer arrangement, and not just payments.
The volumes in the DeFi markets are already telling a story of possible massive success in a short time. For example, Uniswap, the most used of the DeFi exchanges, facilitates over US$ 400 million worth of transactions daily. Meanwhile, over US$ 3 billion value of assets is held on Compound Finance at any time. According to CoinMarketCap, the total DeFi market cap is over US$15 billion.
Some reports have indicated that while the amount of Bitcoin-related transactions reduced in the third quarter of 2020, those related to DeFi increased significantly. This could be an indicator of what to come.
Indeed, investors are buying, HODLing, lending, and borrowing on the many platforms launched. In particular, the platforms have created new ways to margin trade crypto without going through a central entity.
Even more, they have created a possibility of leveraging a small amount of crypto capital to generate an amount of revenue several times what is possible on centralized exchanges and trading platforms.
However, it turns out that you are locked out if you intend to play with Bitcoin either as your capital, collateral, or opportunity. If you want to trade crypto with margin, you can’t do it on a DeFi platform. In the meantime, you still have to go to centralized exchanges like Binance and Coinbase.
While DeFi Decentralized exchanges like Uniswap support hundreds of coins, Bitcoin is not one of them. You can’t use Bitcoin as collateral or borrow funds to trade it on any of the DeFi exchanges or platforms.
But why is that so?
The root cause of this alienation of Bitcoin from the ongoing DeFi craze is the infrastructure. For DeFi to function, they rely on smart contracts, and more importantly, the assets and applications involved sharing the same or a common infrastructure.
The transactions on DeFi are implemented through smart contracts, coded agreements that self execute when launched. It is not like a Bitcoin transaction can’t be programmed into a smart contract.
Indeed, Bitcoin is compatible with smart contracts. The RSK is one of the dev projects dedicated to building smart contract capacity on the Bitcoin blockchain. That means that it is possible to do everything that is happening on DeFi with Bitcoin.
However, right now, the activity is with the smart applications built on top of the Ethereum blockchain. While Bitcoin was the first on the scene, Ethereum was the first to see smart contracts’ potential and prepare for it.
Unlike Bitcoin, from its inception, Ethereum launched as a platform that would support and run all kinds of applications, including those by independent developers and companies.
This has given it a considerable advantage, and almost 70 percent of tokens and cryptocurrencies listed on exchanges are domiciled on the Ethereum blockchain.
The fact that all these assets share the basic infrastructure, along with the DeFi applications, has made it easy for them to interoperate through smart contracts on the Ethereum blockchain. Meanwhile, that has alienated Bitcoin.
It is important to point out that all tokens that are traded and processed through DeFi platforms also meet the ERC-20 standards put in place by the Ethereum community.
Interestingly ETH does not meet this standard, and to have it as part of transactions on the DeFi platforms, it is usually locked and replaced with wrapped ETH (wETH), an ERC-20 token.
Will Bitcoin be on a DeFi application?
It is very much possible. The easier way that could happen is if RSK, the Bitcoin smart contract platform, is embraced by many and indeed tokens like those on Ethereum created there. This could easily be achieved through what is known as colored coins, which could even give Bitcoin an advantage over Ethereum, especially because it could be a platform to manage real-world assets.
It might seem like it is too late for Bitcoin to achieve this, but we are still in the early days of blockchain.
The more challenging way this can be achieved is by implementing the interoperability protocol between different blockchains. Of course, there is a lot of work going on in this area. Examples include the side chain and Plasma projects.
An option will be to create an ERC-20 token that is pegged on Bitcoin. Traders who need to use Bitcoin as collateral or borrow to margin trade might have to lock the cryptocurrency and get an equivalent amount in tokens.
It might take long before Bitcoin is part of the DeFi environment, but we are highly likely to reach there. It might not even be the same way, but Bitcoin started the peer-to-peer experience, and it can deliver even more.