What is Bitcoin DeFi, and How Does It Work? – Decrypt

In brief

  • Decentralized finance (DeFi) platforms are built on Ethereum, but Bitcoin holders are getting involved by “locking up” their coins.
  • Bitcoin DeFi involves locking Bitcoin into smart contracts that give them Ethereum-based tokens that represent the biggest cryptocurrency by market cap.
  • By locking up their Bitcoin on Ethereum, Bitcoiners are using DeFi to generate passive income.

You may have heard of decentralized finance (DeFi). It’s the newest craze to enter the cryptocurrency world, with billions of dollars having been invested in DeFi products in 2020 alone.  

Increasingly, Bitcoin holders are getting involved in DeFi by “locking up” their coins in exchange for tokens that can be used on DeFi platforms.

What is DeFi?

DeFi products are tools built predominantly on Ethereum that aim to revolutionize and replace the current methods of borrowing, lending and banking as seen with traditional finance.

The aim of DeFi is to make the world of finance available to all (or to anyone who has an Internet connection). 

Why would Bitcoin be involved? 

The majority of DeFi platforms are built on Ethereum. But there are a lot of people who own a lot of Bitcoin who want to get involved too. So it is becoming increasingly easy for those with Bitcoin to be able to invest in DeFi platforms with their funds. 

Bitcoin is the biggest cryptocurrency by market cap, so it makes sense for things to be moving in a direction that links the asset with DeFi products. 

How does Bitcoin DeFi work?

Bitcoin DeFi works by basically allowing Bitcoin—a currency on one blockchain—to run on Ethereum’s very different, separate blockchain. 

How? This is where things get a little complex. 

You can’t use Bitcoin directly on Ethereum platforms—as mentioned before, the blockchains are different. In order to do so, the Bitcoin needs to be converted into a currency that represents Bitcoin but is really an Ethereum-based token.

Then, the Bitcoin is essentially locked into a smart contract, (a piece of code that performs instructions to replicate agreements) and can be used on the network. Think of it like a swap.

Using Bitcoin DeFi to generate passive income

Why would someone want to put their Bitcoin in Ethereum smart contracts, you might ask, when they could just buy Ethereum tokens directly and get started from there? 

One good reason is to make your Bitcoin work for you in the form of passive income. We all know that a lot of people hold onto their Bitcoin as a store of value—not for purchasing things online (as was originally intended) or remittance payments. 

Besides, there are many other cryptocurrencies that serve that purpose now, some argue. So when Bitcoin is just sitting there as an investment in the hope that its value will one day skyrocket, why not use it to make money for you in the meantime?

One of the ways to generate passive income with Bitcoin is to utilize a DeFi platform to lend and earn interest with Bitcoin that would otherwise just be sitting around. It works like this: convert the Bitcoin into Ether or directly into Dai (a stablecoin, pegged to the US dollar) and put it in a platform where you could lend it out and receive loan back with interest. 

One way of doing this would be to use the MakerDAO platform. 

Who is leading the Bitcoin DeFi space?

A relatively new concept, there are a handful of companies currently leading this space. They include Wrapped Bitcoin (WBTC), RenVM, and RSK. 

  • 🤝 WBTC is a centralized collaboration between several DeFi protocols, including Maker, Compound, Kyber Network and Aave, among others. It works to lock Bitcoin on the Ethereum blockchain in exchange for ERC-20 tokens of the same value. 
  • 🖧 RenVM is a network that holds Bitcoin (among other cryptocurrencies) and mints a representation of that currency as an ERC-20 token.
  • 🏦 Global lending platform RSK works to help its users earn interest with their Bitcoins by converting them into a stablecoin before lending them out. 

What does the future hold for Bitcoin DeFi?

Right now, more Bitcoin than ever before is being sent over to Ethereum; nearly $1 billion worth, as of September 2020. This is undoubtedly due to the rise of DeFi. As the scene has grown in popularity, so have the methods of making Bitcoin run on such platforms. 

Companies in the space are reporting record amounts of Bitcoin being converted into ERC-20 tokens. 

As long as DeFi is popular, we will continue to see new companies work in this space to provide quick, easy and cheap ways to help Bitcoin work on DeFi platforms.

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