BTCFi: Innovative Exploration to Activate Bitcoin's Huge Market Capitalization

Summary

• Background of BTCFi's rise: The narrative of public chains like Ethereum has weakened, the industry lacks fresh concepts, and the Bitcoin ecosystem has not yet formed a resource monopoly.

• BTC scaling solutions include state channels, sidechains, Rollups, UTXO + client validation, large blocks, etc. Each solution must meet "authenticity" validation.

• Key conditions for the development of BTCFi: cross-chain interoperability, layer two scaling, smart contract functionality, and comprehensive development tools.

• The main challenges faced by BTCFi: limitations of the Bitcoin protocol, insufficient liquidity, cross-chain bridge security, oracle problem, finding a unique development path.

1. Overview of BTCFi

Definition of 1.1 BTCFi

BTCFi aims to build a decentralized financial market within the Bitcoin ecosystem, allowing BTC holders to directly use financial derivatives such as staking, lending, and market making to generate profits, activating the financial attribute value of Bitcoin.

1.2 Development Background

2023 is an important milestone for the Bitcoin ecosystem. Tokens like BRC20 have triggered a significant wealth effect, igniting market enthusiasm. Another reason for the rise of the Bitcoin ecosystem is the weakening narratives of other public chains, the saturation of infrastructure, and the lack of fresh concepts in the industry. The core issue facing the Bitcoin ecosystem is how to achieve block expansion without undermining the native consensus.

As of early October, the Bitcoin ecosystem has publicly raised funds 14 times, totaling over 71.1 million USD. For users and investors, the Bitcoin ecosystem is still full of opportunities and has not formed a resource monopoly. On the asset side, various protocol assets such as BRC20, ORC20, and ARC20 have also emerged. The core discussion point of BTCFi is how to ensure asset security and achieve effective scalability.

1.3 Early Hotspots: Index Asset Protocol

Indexed assets are mainly divided into non-UTXO bound BRC20 and UTXO bound ARC20. ARC20 is based on the smallest unit of Bitcoin, "satoshi", with each token equivalent to 1 satoshi, ensuring a minimum value. This standard is implemented on the Bitcoin chain through the Atomicals protocol, paving the way for the future AVM.

Other asset protocols also include:

• ORC20: Based on the Ordinals protocol, similar to the Ethereum ERC20 standard
• SRC20: Emphasizes a simple and efficient token mechanism
• CAT20: Focused on issuing custom coins

2. BTCFi's Expansion Plan and Market Potential

The development of BTCFi relies on blockchain scalability, but there is no unified standard for the scalability paths. Each path involves a trade-off between feasibility, decentralization, and security, and must meet the "orthodoxy" verification of Bitcoin.

In current sidechain projects, CORE, Bitlayer, BSquared, and Rootsock have the highest TVL share, totaling 76.56%. BTCFi exhibits similar characteristics to "ETHFi":

• BTCFi yield: analogous to Babylon + LRT rewards + BTC extended chain rewards + ETH chain LRT yield
• ETHFi yield: POS interest + re-staking rewards + LRT rewards + ETH expansion chain rewards

2.1 State Channel

State channels allow users to conduct multiple transactions off the main network, interacting with the main network only when opening and closing the channel. In Bitcoin, there are Lightning Network and Ark, where users deposit BTC through multi-signature addresses, trade within the state channel, and ultimately have the results validated by the main network.

2.2 Sidechains and Rollups

Sidechains and Rollups are more suitable for the rapid development of the Bitcoin ecosystem. Rollups move complex operations to Layer 2, while the mainnet only verifies the proofs submitted by Layer 2, increasing throughput. Sidechains have a strong independence from the mainnet, locking mainnet assets through cross-chain bridges and mapping them on the sidechain, requiring additional verification methods to ensure security. Both perform well in releasing liquidity.

2.3 UTXO+ client validation

The UTXO+ client validation scheme conforms to Bitcoin's "orthodoxy". This scheme is based on the Bitcoin UTXO model, transferring transaction validation off-chain, with the client responsible. The RGB protocol is a specific implementation that uses Bitcoin UTXO as a "seal" to achieve secure off-chain state changes.

The advantages are high efficiency and privacy-friendly, while the disadvantages may lead to data silos, hindering DeFi development. Improvements are still needed in terms of data transparency, ease of operation, and the completeness of development tools.

2.4 Large Block Solution

Changing the existing consensus means altering Bitcoin itself, facing issues related to consensus and ecological development. BCH( Bitcoin Cash) is a representative that forked due to scalability issues, with the block size increased from 1MB to 8MB.

3. Liquidity Release of BTCFi

3.1 Prerequisites for Development

1. Cross-chain interoperability: Develop a reliable cross-chain bridge to enable the mapping and functional expansion of Bitcoin on other chains.

2. Layer 2 Expansion: Seeking a balance between decentralization and efficiency, compensating for the shortcomings of decentralization through the wealth effect.

3. Smart Contracts: Explore Layer 2 solutions or sidechains to provide smart contract support for Bitcoin

4. Development Tools and Infrastructure: Improve the toolchain, avoid redundant construction.

3.2 Main Challenges Faced

1. Bitcoin protocol limitations: the lack of built-in smart contract functionality, developing BTCFi applications requires overcoming technical barriers.

2. Insufficient liquidity: The liquidity of Bitcoin in DeFi is much lower than that of other tokens, limiting its adoption.

3. Cross-chain bridge security: It is necessary to ensure the security of cross-chain bridges and prevent centralization risks and technical failures.

4. Oracle Problem: The architecture limitations of Bitcoin restrict oracle deployment, and price synchronization faces greater challenges.

5. Unique Development Path: BTCFi needs to focus on financial products related to payments and value storage, and should not simply mimic Ethereum.