The Bitcoin Taproot upgrade opened up the possibility of creating DApps on the Bitcoin blockchain, improving the long-term scalability of the blockchain by accelerating DeFi traffic on the Bitcoin network.
Decentralized Finance (DeFi) has seen massive success since 2020, with almost all of that growth being fueled by Ethereum. Ethereum paved the way for new financial services and tools, including decentralized exchanges (DEXs), automated loan platforms and non-perishable tokens (NFTs).
On the contrary, the development of smart contracts running decentralized applications (DApps) was not possible on the Bitcoin blockchain until the Taproot upgrade, which opened the door to DeFi for the world’s first cryptocurrency. In this context, Bitcoin DeFi refers to the development of innovative decentralized applications on the Bitcoin network, which was not possible before due to the scalability issue of transactions.
Because each digital signature must be verified against a public key before implementing the Taproot upgrade, Bitcoin transactions have been relatively slow. Thanks to Taproot, the network can now collect multiple digital signatures and validate them all at once. As a result, less space is required on each block, allowing the Bitcoin blockchain to support the development of DeFi applications.
How does Bitcoin DeFi work?
Wrapped tokens like Wrapped Bitcoin, Layer 1 blockchains like Stacks, and sidechains like Rootstock enable DeFi on Bitcoin.
The scripting language used by Bitcoin, called Script, is not Turing-complete, which means that it is deficient in many logical operations, such as loops. As a result, the Bitcoin network supports limited programmability despite the Taproot upgrade, which means that Bitcoin DeFi platforms rely on Layer 2 scaling and sidechain solutions to host their smart contracts.
DeFi on Bitcoin is made possible by wrapped tokens like Wrapped Bitcoin (wBTC), layer 1 blockchains like Stacks, and sidechains like Rootstock. For example, wBTC, an Ethereum token introduced in January 2019, is backed by Bitcoin (BTC), which means that 1 WBTC is always equal to 1 BTC. Users can transact various Ethereum DApps using the wBTC token.
An independent, first-tier blockchain called Stacks provides hundreds of billions of dollars in capital in BTC and provides Bitcoin holders with new ways to use and earn from cryptocurrency. It uses a Proof-of-Transfer consensus mechanism, which secures its own blockchain through the use of Bitcoin’s Proof-of-Work blockchain.
DeFi products such as Stackswap DEX leverage the Stacks blockchain to allow users to trade, mint NFTs, borrow stable algorithms, launch and exchange tokens on the Bitcoin network. Additionally, because Stacks and Bitcoin are linked, NFTs created on Stacks are stable and protected by the Bitcoin blockchain.
Full smart contracts are made possible on the Bitcoin blockchain by Rootstock, which runs parallel to the blockchain. When BTC is sent to Rootstock, it converts into RBTC, which is a smart contract-activated Bitcoin. Based on two-way communication, this protocol acts as a bridge to connect both chains. For example, Sovryn, one of the first unauthorized financial applications, uses RSK technology to connect to the Lightning Network, Ethereum, Bitcoin, and BNB Smart Chain.
What DeFi projects are part of the Bitcoin ecosystem?
Along with wBTC, Stacks, and Rootstock, BadgerDAO, RenVM, and Liquid Network are promoting various use cases for Bitcoin DeFi.
A decentralized autonomous organization (DAO) called BadgerDAO makes it possible to use BTC as collateral across various DApps. BadgerDAO uses the Ethereum-based token BADGER for protocol governance and incentive distribution.
Users can earn income from their synthetic BTC assets using Sett Vaults, the first product offered by Badger. Users can lock their tokens into SETTs, which are pools of tokens, and let smart contracts manage their holdings to produce a return in the form of bTokens.
Badger’s second product, called Digg, is the software that controls a flexible supply cryptocurrency called the DIGG token, which is pegged to the BTC price in US dollars. Like any other token, DIGG can be deposited into SETTs to provide return to holders and used in DeFi protocols.
The decentralized Ethereum protocol Ren creates tokens that monitor the value of non-Ethereum assets such as Bitcoin and provide liquidity to projects on many blockchains. However, Bitcoin owners may use Ren (needed to pay the contract) to access Ethereum’s suite of DeFi products without selling BTC or moving their assets across blockchains.
The Ren virtual machine keeps the original funds in storage, accepts tokens from the blockchain, and generates new tokens over another through its own RenBridge to exchange assets between the blockchains. For example, a user can send BTC to RenVM, which will issue renBTC, a