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DeFi ecology on BTC will be next?

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Bitcoin is digital gold. But that doesn't mean it has to be a shining stone.

Original title: "Perspective | The rise of DeFi will Push Stabilisation Currency Beyond BTC?"

原文作者：Ryan Sean Adams & Matthew Black

Source: Encrypted Valley Live

DeFi on Bitcoin: Our experience

Electronic cash? Cheap P2P payments? Digital gold against censorship?

Either way, Bitcoin is designed to replace the existing financial system. The aim is to create a system without Banks to replace the old system and thus eliminate dependence on intermediaries.

The financial instruments on Bitcoin, however, took an entirely different path. To date, most of the activity around BTC relies on large "encrypted Banks", such as centralized exchanges and centralized lending platforms, which largely dominate their respective verticals.

These encrypted Banks require you to deposit BTC with them, and very little is known about what happens when you deposit that money. As some have keenly noted, centralised lending platforms are even free to re-mortgage, trade and other profitable activities with the bitcoin collateral that users give them.

DeFi ecology on BTC will be next? Users of these products are exposed to both hosting risks and their opaque internal risks and management system failures. Centralized platforms also have restrictions on who can access them due to jurisdictional requirements, and they often require an "application" process to obtain a loan.

The rise of DeFi

While bitcoins have had to use centralized cryptocurrency Banks for their financial needs, projects like MakerDAO and Compound have been busy building transparent, open, unmanaged solutions for Ethereum users, creating an entire ecosystem from a stable currency resistant to censorship to a transparent money market.

Source: DeFi Pulse July 21, 2020

But why aren't these types of applications built on bitcoin?

Part of the reason may be the challenges of building on bitcoin. Bitcoin scripting is a simple, primitive, secure, stack-based contract language. But it's not Turing complete, there's no state. This makes it easy to lock down your bitcoin securely without worrying about "smart contracts being hacked," as we often see in Ethereum. But it also makes it much harder to build on bitcoin.

Another challenge is the lack of an ecosystem to build financial applications on top of Bitcoin. Without an ecosystem like MetaMask or Web3, the barriers to building on Bitcoin and DeFi would be even more difficult.

Atoms swap Atomic Swaps

Bitcoin DeFi's earliest attempts focused on Swaps, specifically Atomic Swaps of atoms. Summa, Liquality, SparkSwap, Swap Online and other teams started to set up experiments to realize cross-chain switching methods from 2017 to 2018.

Some of these atomic exchange schemes developed into the main network and gained traction. But most of them fade away, or change.

Why is that?

It's hard to build on bitcoin, and even harder to build across chains. Before signing up, you need to know the bitcoin address of the participant. You can't create a liquidity pool on bitcoin. This means that without automated market maker AMM, liquidity providers must be online 24 hours a day to guarantee any type of bitcoin DeFi interaction by participants.

Nevertheless, Liquality has been working hard to overcome many of these UI/UX challenges (thanks to their new Liquality Wallet) and has recently gained increasing traction in swapping BTC, ETH, DAI, and USDC.

Liquality swap trading volume 2020

Other types of exchanges

One of the more unique items is Summa, which offers cross-chain auctions. They used THE SPV to prove that the BTC transaction occurred on Ethereum.

This allows users to download a desktop application and then use Bitcoin to buy Ethereum assets at auction.

While this is a great and unique solution, it hasn't been widely used. This may have something to do with the fact that it requires users to download an app, or because the liquidity of the auction has not gained much traction.

The bitcoin as a token

Wouldn't it be nice if you could use one BTC for ERC20 with all the existing DeFi protocols?

There is no need for a customized Bitcoin wallet or a liquidity provider to be constantly online.

On the face of it, this sounds like a perfect solution. But each version of bitcoin has its pros and cons.

WBTC

The first is WBTC, or "packaged Bitcoin." This solution allows the user to deposit the BTC with a custodian and receive an ERC20 BTC in return. Of course, this is more like CeFi, because users need to go through KYC programs and trust third-party custodians.

On the plus side, each WBTC has 1:1 BTC support, so it's easy to scale.

Source: btconethereum.com(BTC locked in WBTC)

tBTC

Then there is tBTC, or "De-trusted BTC", which allows users to obtain BTC of ERC20 by deposing it in BTC by custodian as a pledge of ETH equity, which is greater than the value of the locked BTC (initially 1.5 times) and forfeits their ETH equity if the custodian misbehaves.

The de-trusting nature of tokens makes them more resistant to censorship and a better option for DeFi. However, the large number of ETH collateral makes it difficult to expand, as each person who wants to lock in one BTC and cast one tBTC must have an ETH trustee holding one and a half times the value of the BTC.

renBTC

Finally, renBTC, a protocol similar to tBTC, allows the user to deposit into BTC, which is then held by a detrusted trustee (RenVM), but with REN as collateral (not ETH).

Thirdly, the trustless nature makes it resistant to censorship. Its design assumes that as more and more assets are locked in the system, REN's value will increase, which makes it more extensible than tBTC.

However, since REN is a relatively new asset, using it as collateral would increase the fear of bankruptcy if users lost confidence in the agreement.

Source: btconethereum.com(BTC locked in renBTC)

Bitcoin side chain

Bitcoin side chains such as RSK provide an underlying platform to build DeFi over bitcoin. In fact, Money on Chain has been committed to building solutions of stable currency on this platform.

RSK works by letting users lock their BTC into a joint side chain that runs EVM and receives RBTC. This means that applications over RSK can create smart contracts using BTC.

However, this requires users to trust the alliance and a proper bridge into RSK. But so far, the traction has been limited. It is most likely due to the lack of a proper bridge and the lack of applications to build upon.

Let's build our experience of Atomic Loans V1

We were frustrated that we could only get bTC-backed loans from the Cryptocurrency Bank until 2018, so our team then set out to build a protocol that would allow bitcoin holders to access liquidity in a way that minimised trust and would not liquidate bitcoin.

Our goal is to allow users to secure a loan by locking in BTC as collateral and then using Ethereum stabilization currency.

Why not use bitcoin as a token?

At the time of construction, there were no tokens on Ethereum. We considered going this route, but realized that due to the high collateral requirements for custodians/pledges, it was not scalable and required a custodial approach to cast an ERC20 BTC.

Lock the BTC

We chose the P2P lending model (easiest to build for V1), which allows users to lock THE BTC into a custom Bitcoin contract that can be unlocked in the event of repayment or liquidation.

Repayment is made using a mechanism similar to atomic swap (repayment is then given a password that allows the borrower to unlock the BTC). For liquidation, a mechanism with multiple signatures (borrowers, lenders and arbitrators) is used, allowing lenders and arbitrators to liquidate collateral if debt positions fall below the minimum collateral rate.

The trust model

It adopts the different trust characteristics of arbitrator and prophetic machine. In a typical DeFi protocol, all debt positions in the protocol can be liquidated if a prediction machine goes wrong. But if you have an arbitrator, even if it is easy to collude with one lender or borrower, it is hard to bring the whole system down together.

lenders

However, using this model means lenders need to be online 24 hours a day to provide passwords for clearing. To solve this problem, we set up agents so that lenders could set up and not worry about their money. But even with these agents, the process can be cumbersome compared to Compound agreements.

The efficiency of capital

In addition, we soon learned that the P2P lending model is very inefficient. In Bitcoin, a pool of money is hard to achieve (unless you have a bitcoin token). Our V1 model means that you can have lenders lend to multiple borrowers, but not the other way around.

This has naturally led to a demand for unused capital from large lenders and small lenders.

Wallet compatibility

In addition, the use of custom bitcoin contracts (P2SH) means that most bitcoin wallets do not support unlocking BTC.

We initially chose to use The Ledger Nano to allow the borrower to unlock their BTC because Ledger supports the specific unlock feature we needed (signP2SHTransaction). But surprisingly, many early customers did not have Ledger, and even customers with Ledger were not necessarily willing to connect their devices to the web interface for fear that the Web interface would record their transactions.

attractive

Despite these limitations, we managed to reach about 500,000 TVL before suspending it on June 21, 2020 after samczsun's vulnerability was disclosed. Building and rolling out V1 was a great learning experience and taught us a lot about what users really care about.

The biggest harvest

1. Building bitcoin is hard

2. Users will only like the unmanaged approach if the experience is simple

3. Requiring users to install basic applications reduces the likelihood of providing liquidity.

4. The capital pool is more efficient

The future of DeFi on Bitcoin

Most of the solutions mentioned so far involve EVM in some sense. It's hard to say if this will continue, although there are some projects in the works that have implemented DeFi using bitcoin's native features.

Simplicity

Blockstream has been working on a programming language for smart blockchain contracts called Simplicity, which aims to make it easier for code execution to be formally validated.

This is a work in progress and is expected to be completed by the end of the year. By then, Simplicity is likely to be deployed on the Liquid side chain. There are no plans or plans to bring it into bitcoin's core anytime soon.

DLC(Discrete Log Contract)

The DLC is basically a Bitcoin prediction machine contract. They enable users to sign an agreement that is executed in accordance with "real life" events and is settled at BTC.

This was achieved by having participants lock their money into 2-OF-2 multi-signatures and follow a lightning network-like exit approach (co-close and non-co-close with predictive machine signatures).

These contracts allow derivatives and prediction markets to be created on top of Bitcoin.

DLC can be transferred on the chain and lightning network, and users can enter and exit the warehouse outside the chain. However, DLC over lightning networks can run into the same inefficiencies as routing payments.

RGB

RGB is a smart contract system that allows assets to be issued over a lightning network.

This is achieved by anchoring the asset to a specific Bitcoin UTXO and address, and preventing duplexes by using single-purpose seals (encryption primitives that ensure that a particular message can only be sent once).

Tether plans to release USDT on RGB by the end of the year.

Combining the functions of RGB with the ongoing work of DLC will enable more USES for financial derivatives and forecast markets.

RGB also plans to implement more advanced smart contract features when it consolidates with Simplicity by the end of the year.

conclusion

Bitcoin is digital gold. But that doesn't mean it has to be a shining stone.

From DLC to scrip BTC, more and more infrastructure is being built to allow hardened bitcoin holders to use their BTC for new financial applications.

Whether these applications will be built on ethereum using cross-chain Bridges, on side chains such as Liquid, or on lightning networks -- only time will tell.