In-depth: Multi-dimensional data explains how Bitcoin embraces DeFi

As the DeFi market has been hot for several months, crypto users must be familiar with a picture from DEFI PULSE. As of October 20, 2020, the total locked funds (TVL) in the DeFi field have reached 11.2 billion US dollars, a record high. Ethereum is currently the most important underlying platform in the DeFi ecosystem, and its native token ETH is also worthy of being the underlying asset in DeFi, with a locked scale of 3.3 billion US dollars (accounting for 30%). However, what the market has not noticed or rarely discussed is that Bitcoin may be challenging this phenomenon. In the past 6 months, the number of BTC on Ethereum has increased from less than 3,000 to 140,000 today, with an annual compound growth rate of 276,498%. The current locked value is 1.6 billion US dollars, accounting for 15% of DeFi. In this article, the author will describe this phenomenon in detail and explore its causes and significance.

Figure 1: DeFi locked funds (TVL) growth, source: DEFI PULSE

Bitcoin in DeFi by the numbers

Bitcoin embraces DeFi, and at this stage it is mainly through two methods: tokenized Bitcoin and Lightning Network. The latter is an important attempt of Bitcoin in the field of payment, which consists of an off-chain transmission network based on Bitcoin. During the transaction, both parties will create a payment channel and apply it to the hash time lock contract. At present, about 12 million US dollars of BTC are locked in the Lightning Network, and the overall trend is steadily rising.

In contrast, tokenization is the main way for Bitcoin to enter the DeFi ecosystem by pledging and issuing anchor coins on Ethereum. Figure 1 depicts the changes in the number of Bitcoin anchor coins on Ethereum since 2018. The single large influx of Bitcoin anchor coins into the Ethereum network basically started in May this year. In less than half a year, the number of Bitcoin anchor coins on Ethereum has increased by 57 times, currently reaching 142,000, worth US$1.62 billion. What does 142,000 mean? It accounts for about 0.77% of the current circulation of BTC. Although this proportion is not very significant, it is enough to show that Bitcoin's interaction in the DeFi field cannot be ignored.

Figure 2: Number of Bitcoins on Ethereum, source: https://btconethereum.com/

Looking more closely, there are currently seven main types of Bitcoin-pegged coins on Ethereum, and Figure 2 depicts the specific composition ratios. It can be seen that WBTC is currently the Bitcoin-pegged coin with the highest proportion (74%), with a number exceeding 100,000, followed by renBTC (19%) and HBTC (4%), while TBTC and pBTC account for a negligible proportion.

Figure 3: Bitcoin on Ethereum, Chart: Cointelegraph Chinese

So, where did such a large amount of Bitcoin on Ethereum go? Taking WBTC, which has the largest number, as an example, of its current total supply of 105,132, the top 15 addresses hold more than 90%, and they are mainly the top DeFi platforms. The top 5 addresses are: Uniswap V2, Aave, Maker, Curve and Compound. This shows that there is already a large demand for Bitcoin lending, trading or transfer in the DeFi field.

Figure 4: WBTC quantity distribution, chart: Cointelegraph Chinese

How Bitcoin Tokenization Works

There are many ways to tokenize Bitcoin, and the platform is not limited to the Ethereum network. According to the standard of whether custody is required, the existing Bitcoin-pegged coins can be divided into two categories: centralized and decentralized. The former requires a centralized custodian to issue a mortgage, so it needs to be completed by a trusted, well-known institution with strong endorsement. The latter achieves trustlessness through an automated on-chain process, but it also increases contract security/technical risks.

Specifically, the issuance process of centralized (custodial) Bitcoin-pegged coins, such as WBTC, involves four roles: customers, merchants, custodians, and contracts. The process is actually very simple and easy to understand. Users first need to comply with KYC/AML terms and pledge Bitcoin to partner merchants such as Coinlist. After receiving the Bitcoin, the merchant sends it to the custodian, who usually stores the Bitcoin in a multi-signature cold wallet and issues the corresponding WBTC through the contract. This process is called mining, and the opposite is destruction.

Figure 5: WBTC generation process

Some major crypto exchanges are also experimenting with Bitcoin tokenization. Binance’s BTCB is one example, with a BEP2 token type currently available for trading on Binance DEX.

Decentralized (non-custodial) solutions run entirely on-chain without the involvement of any middleman. Most of the generation principles are similar to WBTC, but the execution process is completed by smart contracts or virtual machines. The most popular example in this category is renBTC (ERC-20), which is implemented through the Ren virtual machine, which uses a distributed network of nodes to store them. ERC-20 tokens are then minted based on the amount of bitcoin sent. In addition, sBTC and iBTC are also very interesting examples. They are both synthetic tokens generated by SNX instead of Bitcoin collateral. What is more special about the latter iBTC is that it tracks the price of Bitcoin in reverse and can be regarded as a means of shorting Bitcoin.

The significance of Bitcoin embracing DeFi

From the author's point of view, Bitcoin's entry into the DeFi ecosystem is a phenomenon that deserves special attention and discussion. It will have a positive impact on both Bitcoin itself and the DeFi ecosystem, forming a win-win situation. For Bitcoin, the Lightning Network and tokenization will increase its application, speed up transactions, reduce transaction costs, and enhance interchangeability and privacy. In particular, with the expected arrival of ETH2.0, the congestion of the Bitcoin network may be alleviated. For the DeFi ecosystem, the inflow of Bitcoin means that other underlying platforms (mainly Ethereum) have captured part of the value of Bitcoin. As the leading asset in the crypto market, the importance and value of the latter are self-evident. With more and more interactions between Bitcoin in the DeFi field, the richness, robustness and activity of the DeFi ecosystem will be greatly improved. Of course, objectively speaking, at the same time, we must also pay attention to whether Bitcoin's entry into other platforms may weaken the role of its own network.