Without question, the DeFi movement is revolutionizing the financial sector. Decentralized finance is well on its way to changing the world of finance as we know it by transforming traditional financial components into open, transparent protocols across a decentralized network.
In fact, the total value locked in DeFi assets stands at a phenomenal $54.56 billion, and it appears that this figure is only going up. From making basic financial services like loans and insurance readily available for all, to promoting financial inclusion for the larger population, Decentralized Finance use cases are many.
While the most popular use cases for DeFi applications include borrowing and lending within a peer-to-peer network, there are also other use cases, such as becoming a liquidity provider for a decentralized exchange. Interest rates in DeFi are much lower and more appealing when compared to regular bank loans. Also, you can’t overlook the fact that DeFi provides extremely low barriers to entry. Taking out DeFi loans is a relatively straightforward process, and all you have to do is offer collateral in the form of crypto assets. Depending on the DeFi protocol they’re using, users also have the option to provide their non-fungible tokens (NFTs) as collateral.
While DeFi is still in its infancy stage and regulation is almost absent, several DeFi applications are already making big waves across various sectors. Bitcoin in Decentralized Finance is one concept that has been gaining a lot of traction recently.
Typically, most DeFi applications are built on Ethereum (ETH) due to its advanced smart contract functionality. However, there has been a noticeable rise in the number of DeFi applications built on top of Bitcoin. According to DeFi Prime, an analytics firm, out of the 223 DeFi projects that they have listed, at least 26 of them are active Bitcoin-based.
Specifically speaking, there’s Taproot, which will be a substantial update to Bitcoin’s technology architecture and bring about a host of new features. While the activation path of Taproot remains unclear, it is expected to be activated in the near future. In addition to the effect this new upgrade will have on privacy, security and scalability, Taproot will impact opportunities in smart contracting and thereby lay the foundation for future upgrades. Interestingly, these technological developments in Bitcoin come at the same time when Bitcoin adoption is also significantly increasing with each new day.
Another concern about Bitcoin is that anyone can monitor transactions because it is based on public blockchain. With the Taproot upgrade, Bitcoin will convert from its current ‘elliptic curve digital signature’ algorithm, which takes up more space, to Schnorr signatures, which can potentially make basic transactions indistinguishable from complex transactions. As a result, there will be more anonymity and transparency in transactions.
With a specific focus on Decentralized Finance on Bitcoin, discreet log contracts (DLCs) is another area that has seen a lot of progress recently. Essentially, a DLC is a type of Bitcoin transaction that executes a smart contract using an oracle. As a result, DLCs enable the formation of smart contracts and a variety of other financial contracts, including options and futures.
A DLC typically allows multiple parties to put bets on the Bitcoin blockchain. To construct a DLC, it is required that two parties lock the funds in a multi-sig address. And these funds can only be used if the oracle provides the requested information at the requested time. To put it simply, DLCs operate by using the signature of a message from an oracle as a private key. This permits the bet winner to sign a transaction using the funds committed to the contract by the two counterparties at the start.
Looking forward Decentralized Finance
Recently, Jack Dorsey, CEO and co-founder of Twitter, announced that his mobile payments company Square will be launching a platform that will allow developers to create ‘decentralized finance’ projects built on Bitcoin. In an attempt to make the creation of non-custodial, permissionless and decentralized financial services much easier, this is expected to be one of the first big projects of its kind in the nascent market.
Another reason why Decentralized Finance on Bitcoin is becoming immensely popular is that Bitcoin is the best type of collateral in the entire world. Bitcoin is highly secure, transactions are super quick, the markets never close and Bitcoin is high in liquidity. This has been the primary driver behind the case for adopting DeFi on Bitcoin. And not to forget the fact that the security of Bitcoin has been developed to a wartime security level.
Indeed, this is only one among the several big DeFi on Bitcoin projects expected to come out. As more Bitcoin-based DeFi projects launch, and with the Taproot upgrade, there is certainly a lot of growth potential to look out for.