As of early February, more than $1 billion U.S. dollars of assets reside in decentralized finance protocols, commonly called DeFi protocols. DeFi protocols and platforms offer crypto holders sophisticated financial tools that were unavailable to them just a year or two prior, but the rapid evolution and speedy adoption of DeFi has left some observers wondering about the ecosystem’s future.
Skeptics and supporters alike want to know when Bitcoin (BTC) — the first and most popular cryptocurrency — will receive adequate DeFi support. Decentralized finance with Bitcoin is on the way, but there are good reasons that it’s relatively late to the market.
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Bitcoin, as any longtime cryptocurrency trader knows, suffers limitations in terms of speed and transaction fees. There’s a long history of people attempting to extend the capabilities of the Bitcoin blockchain, but today, more and more are developing cross-chain solutions that move Bitcoin onto other chains for use in DeFi. One such protocol, Wrapped Bitcoin, has many strengths, but still requires third-party-intervention and Know Your Customer checks for its users. While some may accept these tradeoffs as necessary for doing business, others will conclude that such concessions are overly centralizing and contrary to the spirit of crypto.
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The tBTC protocol also looks promising, taking inspiration from protocols such as Maker and uses bonded deposits to secure Bitcoin on other chains. Ensuring that the decentralized custodians are properly incentivized to keep the system running smoothly while providing “no KYC, no middlemen.” It remains in early days, however, and there are substantial limits to its current feasibility. To take an obvious example, the project’s website acknowledges that for the moment, “deposits are only possible in fixed-sized lots of 1 Bitcoin.” While there are compelling reasons for this limit, tBTC participation requires significant faith and significant funding.
Many DeFi users are projects or investors, rather than individuals. What does this mean for Bitcoin DeFi? They have substantial chunks of crypto to move around, convert, and invest: They’re not making transactions akin to buying a coffee on the way to work, and are rather more likely make deals closer in size to buying the coffee shop. This tendency to large transactions may make relatively high per-transaction fees acceptable to DeFi users, but large fees may deter smaller holders, particularly individuals with limited holdings. Is Bitcoin DeFi fated to be the sole province of institutions, groups and the occasional “whale” tycoon?
The advent of Bitcoin DeFi requires would-be users and supporters to face some difficult truths. The first truth is that, although some technologies are more robust and less compromised than others, it’s likely that any technological solution to the impasse will require tradeoffs. One DeFi Bitcoin implementation might increase centralization as wrapped Bitcoin does — will ideological purists be able to accept this? Another version of Bitcoin DeFi might be less centralized, but still require substantial collateralization from participants, which might deter certain kinds of investors.
Cryptocurrency in general is a young industry, and DeFi is even younger. Mass adoption remains a ways off for crypto, and standard practices are still coalescing in associated fields like DeFi. What tradeoffs will prove most palatable (or rather, the least unpalatable) for investors? Will one protocol or solution corner the market, or will several viable tools peacefully coexist? We shall see in the days ahead, but whatever happens, we can be sure it will be interesting.
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