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Ethereum's vast developer ecosystem and advanced smart contract capabilities have put it at the forefront of decentralized finance (DeFi). Solana and some Ethereum L2 blockchains have also established themselves as major players. Bitcoin is catching up. It's becoming increasingly attractive for DeFi integration, a process facilitated by protocols like Sumer Money.
A suite of DeFi services on the Bitcoin blockchain and its L2 protocols enables users to trade, lend, borrow, or engage in other financial activities using Bitcoin while maintaining the network's decentralization and security. This evolution has made it possible for Bitcoin holders to use their assets more effectively, taking part in DeFi protocols that only users of other L1 chains could access in the past.
The 2021 Taproot upgrade has been pivotal to this development. Taproot improved Bitcoin's scripting capabilities, augmenting efficiency and privacy. More importantly, it set a basis for the creation of decentralized applications on Bitcoin. This advancement has enabled intricate financial interactions and widened the scope of decentralized services users can access.
A mission to enhance the largest crypto's DeFi utility
Sumer Money, a DeFi liquidity infrastructure protocol, is on a mission to enhance Bitcoin's utility within DeFi. The platform recently surpassed $100 million in Total Value Locked (TVL), demonstrating its growth as a capital-efficient synthetic asset and lending protocol. Its role in supporting Bitcoin's expanding presence in DeFi has been crucial. It lets Bitcoin holders take advantage of opportunities to generate cross-chain yield, but not at the expense of their assets' native security.
Sumer is now preparing for deployment on Berachain, a dynamically growing platform with TVL deposits in excess of $3 billion. The expansion will emphasize Berachain-native assets such as BERA, BERA LSTs, HONEY, and NECT to facilitate leveraged strategies and deeper liquidity.
How Bitcoin brings interoperability, resilience, and liquidity to DeFi
Bitcoin facilitates interoperability with other blockchains in DeFi, building a more efficient and connected ecosystem. Solutions like the Stacks blockchain allow decentralized applications (DApps) and smart contracts to operate on Bitcoin, enhancing its functionality and interoperability with other platforms. Offering DeFi services on Bitcoin will diversify the range of financial services available in the digital asset ecosystem. This will appeal to more users, with many drawn by Bitcoin's reliability and security.
It's estimated that as much as a trillion of Bitcoin liquidity is idling away in cold wallets. Bitcoin DeFi can help unlock this liquidity. Bitcoin may be well-established as "digital gold," but proponents of Bitcoin DeFi believe holders could use the idle Bitcoin more productively.
Bitcoin DeFi even has the potential to address issues with the flagship crypto's security budget. Every four years, its inflation rate is cut in half, reducing mining rewards. This was effective for early growth but raises concerns that its security budget will be depleted unless transaction fees increase. As demonstrated by the surge of BRC-20 tokens and ordinals, Bitcoin DeFi could generate more activity on the network, raising fees and augmenting the security budget.
Use cases include Bitcoin-native assets, wrapped Bitcoin, and L2 solutions. Bitcoin DeFi makes it possible to issue fungible and non-fungible assets on the blockchain, which users can transfer via L2s or the Bitcoin mainnet. Initiatives like Taproot Assets have helped advance the native creation of fungible tokens on Bitcoin.
The use of wrapped Bitcoin in DeFi improves Bitcoin's utility and liquidity, and Bitcoin L2 networks expand the possibilities and bring advanced smart contract functionality to Bitcoin.
There is also potential in terms of borrowing and lending. Bitcoin DeFi is no exception to the rule of decentralized money markets being a core element of DeFi networks. Users can borrow assets or earn interest by leveraging Bitcoin as collateral, which unlocks novel financial opportunities.
Risks are being addressed or declining
The benefits and use cases are growing along with efforts to reduce the risks inherent to the niche, such as smart contract vulnerabilities. Bitcoin L2s and wrapped assets can introduce bugs and exploits in the code. Reentrancy attacks are one of the most common vulnerabilities. These are addressed by implementing a security pattern known as CEI, or checks-effects interactions. They make sure that the contract deploys state changes before calling external contracts.
Other risks include governance attacks, flash loan attacks, oracle manipulation, signature verification exploits, and access control issues. The good news is that all of these can and are being addressed. To mitigate governance attacks, you enforce a time-lock security pattern. The community then has enough time to react to malicious proposals.
Flash loan attacks can be countered by setting transaction slippage limits to neutralize significant price deviations.
To avoid oracle manipulation, using multiple oracles to cross-verify data is advised.
EIP-712 or another secure signature scheme reduces the likelihood of signature verification vulnerabilities. Enforcing reliable input validation checks for signatures is recommended. You can use nonces to prevent replay attacks.
Guarding protocol functions with access controls is crucial. Stakeholders must ensure roles and role-based permissions are labeled properly and use the onlyOwner modifier. Tests and code reviews will reveal whether critical functions are secured.
Bitcoin uses the UTXO model, which means people who regularly receive small amounts of Bitcoin will accumulate UTXOs in excess. They end up accruing Bitcoin dust: BTC that they can't spend, hurting their portfolio. The definition of dust changes based on network activity, but holding at least 500,000 Satoshi as a UTXO is a common rule of thumb.
Finally, governments may impose strict regulations on Bitcoin-based DeFi due to money laundering, taxation, and consumer protection concerns. With Donald Trump's victory, draconian regulations are becoming a thing of the past in the US, and the crypto market may be on the verge of a deregulation-fueled bonanza. One related prospect is classifying cryptocurrencies as commodities rather than securities, meaning the Commodity Futures Trading Commission would govern them, not the SEC. The CFTC has been crypto-friendlier, advocating for deregulatory measures.
Disclaimer: This article is provided for informational purposes only. It is not offered or intended to be used as legal, tax, investment, financial, or other advice.
