Market landscape
1. What do you think of the state of BTC DeFi today?
Layer 2s come to market, and we have seen multiple protocols on Bitcoin that intend to enable DeFi on BTC. We want to highlight the following three pain points:
a. Layer 2 adds complexity and centralization risks, and the BTC block size and block interval limitation prevent all L2 transactions from being stored on L1.
b. Currently, the tech leveraged by L2 or other infra protocols are not native to BTC: Sidechains or ZK proofs L2 won’t be able to settle natively, not to mention that miners can’t verify ZK proofs, and other infra projects rely on centralized indexers built in-house
c. Liquidity segmentation: L2s have engaged in a TVL war that brings more harm than benefit to the whole ecosystem
Nowadays, the demand for yield from asset management companies, Bitcoin miners, and holders still needs to be satisfied as they are reluctant to trust centralized BTC yield systems via wrapping or bridging. The recent launch of the Ethena protocol showed the rising interest from BTC holders in experiencing alternative yield solutions, but dry powder remains to be invested in native and composable BTC DeFi protocols.
2. How and why will that change in the next 12 months?
a. For L2s: An immutable record of L2 transactions on L1 is required to achieve Bitcoin security, so the Data Availability piece will come into play.
-> Evolution: A modular approach similar to the modular blockchain narrative on Ethereum has already started. Avail has been actively sourcing partners to make its roll-up solution available on Bitcoin.
b. Privacy: BitVM is considered a good solution to enhance BTC functionality, but the cost of executing fraud proofs restricts its use.
-> Evolution: We have seen so far a trust-minimized narrative instead of a ZKP narrative that would solve the trust and centralization challenge raised by the community, but incoming updates on BTC would enable more secure and decentralized infrastructure (Decentralized indexer and oracle would be part of the landscape).
3. What are the missing pieces?
To establish a competitive edge on Bitcoin, we foresee the need for:
a native stablecoin: If you look at the summer DeFi in 2020, the backbone of this success is the stablecoin. Lending and borrowing wouldn’t be feasible without the emergence of such a tool, and stablecoin issuer firms flourished since. As a result, Bitcoin needs a native stablecoin that is not tied to any other ecosystem to offer composable liquidity.
lending and derivative protocols: Market participants could earn interest with attractive yield-generation opportunities. Additionally, these protocols enhance the liquidity of the cryptocurrency market by facilitating borrowing for various activities such as trading, liquidity provision in DeFi protocols, and leveraging investment positions.
a pool AMM platform: Similar to Curve on Ethereum, an AMM protocol would be required to minimize impermanent loss, fees, and slippage, ensuring a great user experience for BTC DeFi.
an insurance mechanism: Because of Bitcoin's latency of block production, price fluctuation could be a huge roadblock for users. Consequently, on-chain insurance modules are needed to hedge against the latter.
The Yala insurance module will lead the path. Alongside the MakerDAO framework, the insurance module addresses the unique challenges within the Bitcoin ecosystem, characterized by 10-minute block production times. This addition aims to safeguard Yala users from liquidation triggered by Bitcoin price volatility or engagement in higher-risk activities like restaking.
Note: The insurance module, Takaful, represents Yala's innovative approach to DeFi on Bitcoin, creating a cooperative framework where participants, insurers, and shareholders collectively manage risks and benefits. It details insurers' roles in fund management, contract formulation, and governance, incorporating qard hasan loans as a fallback for insufficient funds, thereby ensuring a resilient, compliant, and community-driven financial environment.
Once the above is established, more asset management firms and Bitcoin holders will actively contribute to the BTC-Fi ecosystem.
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