BTCFi: The Financial Innovation Path of the Bitcoin Ecosystem

Summary

• The background for the rise of BTCFi: The narratives of public chains like Ethereum are weakening, infrastructure is becoming saturated, and the industry lacks fresh narratives; the Bitcoin ecosystem has not yet formed a resource monopoly, and there are still opportunities.

• The main scaling solutions for BTC include state channels, sidechains, Rollups, UTXO + client verification, etc., but they all face technical challenges to comply with Bitcoin's "orthodoxy."

• Key conditions for the development of BTCFi: cross-chain interoperability, layer two scalability, smart contract functionality, and a complete infrastructure and development tools.

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

1. Overview of BTCFi

Definition of 1.1 BTCFi

BTCFi aims to establish a decentralized financial ecosystem in the trillion-dollar Bitcoin market, allowing BTC holders to directly use financial tools such as staking, lending, and market making to gain profits, thereby activating the financial value of Bitcoin.

Background of the rise of BTCFi

In 2023, the Bitcoin ecosystem is thriving, with tokens such as BRC20 triggering a wealth effect. The reasons for the rise of the Bitcoin ecosystem include:

1. The narrative of public chains like Ethereum is weakening, and the infrastructure is becoming saturated.
2. The industry overall lacks fresh narratives
3. The Bitcoin ecosystem has not yet formed a resource monopoly, and there are still opportunities.

As of October 1st, the Bitcoin ecosystem has publicly raised funds 14 times, totaling over $71.1 million. The opportunity for BTCFi lies in the fact that for users and investors, the Bitcoin ecosystem is still full of opportunities.

1.3 BTCFi asset agreement

The Bitcoin ecosystem has given rise to various asset protocols, such as BRC20, ORC20, ARC20, SRC20, CAT20, etc. Among them, index-type asset protocols were an early hotspot, mainly including:

• BRC20: Non-UTXO bound assets
• ARC20: UTXO bound assets, based on Bitcoin's smallest unit "Satoshi"
• ORC20: Token standard based on the Ordinals protocol
• SRC20: Emphasizes a simple and efficient token issuance and transfer mechanism
• CAT20: Focus on issuing custom tokens

2. The Expansion Plan of BTCFi

The development of BTCFi needs to address the scalability issue. Currently, mainstream scaling solutions include:

2.1 State Channel

Allows users to conduct multiple transactions off the mainnet, submitting to the mainnet only when the channel is opened or closed. Representative projects include Lightning Network and Ark.

2.2 Sidechains and Rollups

Sidechains and Rollups are more suitable for the development of the Bitcoin ecosystem, enabling fast transactions, Turing completeness, and interoperability. Rollups move complex operations to Layer 2, with the mainnet only responsible for validation. Sidechains, on the other hand, need to ensure asset security through other verification methods.

2.3 UTXO+ client verification

This is an off-chain solution based on the characteristics of Bitcoin, aimed at improving transaction efficiency and privacy. The RGB protocol is its specific implementation, using Bitcoin UTXO as "seals" to bind off-chain asset state changes.

2.4 Large Block Solution

By changing the original consensus to expand capacity, such as BCH(Bitcoin Cash) increasing the block size to 8M. However, this plan faces issues related to consensus and ecological development.

3. Liquidity Release of BTCFi

3.1 Prerequisites for Development

1. Cross-chain interoperability: Develop reliable cross-chain bridges to enable Bitcoin to participate in DeFi applications on other chains.

2. Layer 2 expansion solutions: seeking a balance between decentralization and efficiency, while considering how to create wealth effects.

3. Smart Contract Functionality: Providing smart contract support for Bitcoin through second-layer solutions or sidechains.

4. Complete development tools and infrastructure: Provide developers with the necessary tools while avoiding redundant construction.

3.2 Major Challenges Faced

1. Limitations of the Bitcoin protocol: Lack of built-in smart contract functionality, developing BTCFi applications requires overcoming protocol restrictions.

2. Insufficient liquidity: Bitcoin's liquidity in DeFi is far lower than that of tokens like Ethereum.

3. Cross-chain bridge security issues: How to ensure the security of cross-chain bridges, prevent attacks and fund losses.

4. Oracle Problem: The architecture limitations of Bitcoin make the deployment of oracles complex and price synchronization difficult.

5. Development Path: How to carve out a unique route, not just imitating Ethereum, but possibly focusing more on financial products related to payment and value storage.