∞Evolving Bitcoin: DeFi Opportunities and Scalability Solutions

Greythorn Asset Management
10 min readApr 22, 2024

Opening Remarks

As the original and largest blockchain by market cap, Bitcoin not only led the way for digital assets but continues to dominate the market in terms of capitalization. Historically perceived as ‘digital gold,’ Bitcoin is mostly recognized for its role as a store of value rather than for its use in decentralised applications.

However, recent developments indicate that Bitcoin’s potential to develop an active DeFi ecosystem is greater than previously anticipated. This shift occurs as both interest in and technological capabilities of Bitcoin are aligning like never before.

Source: X

The coming years could be pivotal for Bitcoin as it might transform from a passive store of value into an active ecosystem filled with innovation and investment opportunities.

We believe this represents an opportunity worth exploring, especially since most people have not yet invested in this ecosystem as it’s new, and some features like Runes are about to get released.

This will be the first bull market where people can directly invest in protocols and assets on the Bitcoin blockchain, which stand to gain as Bitcoin’s price rises and profits filter down when people sell their BTC.

This article seeks to highlight the potential opportunities that await in Bitcoin’s future.

Bitcoin Ecosystem

The core code of the Bitcoin protocol has undergone minimal changes over the years, primarily serving as a medium for transactions.

In 2017, the Bitcoin protocol received the SegWit upgrade, which detached digital signatures (the “witness”) from transaction data. This separation effectively freed up space, allowing more transactions to be included in the blockchain.

Following this, in 2021, the Taproot upgrade was introduced. This enhancement allowed multiple signatures and transactions to be combined, facilitating the aggregation of signatures. Essentially, this meant that multiple signatures could be grouped together for validation. Despite these upgrades, Bitcoin continues to face challenges with scalability, slow transaction speeds, and high costs.

Currently, the Bitcoin network consists of miners, nodes, stakeholders, developers, and a diverse array of layer 2 solutions, sidechains, and DApps. Miners and nodes maintain the network by validating transactions and ensuring consensus, achieved through a Proof of Work mechanism. The developer community contributes by expanding the native ecosystem and implementing occasional updates to the core protocol, although reaching consensus on these upgrades can be challenging, resulting in rare changes. Here’s a brief look at the ecosystem:

Layer-2 Solutions

Several solutions have been proposed to tackle Bitcoin’s scalability issues, but the vast majority of Bitcoin users view the PoW system as a fundamental part of Bitcoin’s identity and are generally reluctant to support major changes to the protocol.

Nevertheless, Layer-2 solutions present a more practical approach that seems to be gaining traction since they do not involve any major alterations to the core blockchain. These operate as separate blockchains layered on top of the main Bitcoin network, making them easier to implement and more realistic for addressing scalability efficiently.

Three prominent players have been taking a step forward here:

Introduced in 2016, was the first Layer-2 payment protocol developed on the Bitcoin blockchain. Designed to enhance transaction speed and reduce costs, it utilises Bitcoin’s smart contract functionality to enable near-instant payments. Although the Lightning Network has successfully increased transaction efficiency, attracting a significant TVL of over US $287 million, it has not provided the advanced smart contract capabilities needed for a diverse ecosystem of DApps to develop. Instead, it focuses on its peer-to-peer network capabilities for payments.

Source: The Lighting Network

Is the current market leader and has the Nakamoto upgrade coming soon, which will bring significant improvements to both security and speed. It was founded in 2013 at Princeton by computer scientist Muneeb Ali, who worked on the technology for four years. Stacks enables smart contracts and decentralised applications to use Bitcoin as an asset and to settle transactions on the Bitcoin blockchain. All transactions on the Stacks layer are automatically hashed and settled on Bitcoin. It boasts an extremely qualified team, and the technology has been peer-reviewed by experts from Stanford and Princeton.

Is addressing Bitcoin’s smart contract and scalability limitations through its Layer 2 meta-protocol. BVM enables the creation of DApp, smart contracts, and facilitates the expansion of Bitcoin L2 blockchains. Currently, BVM is emerging as a leading solution on-chain, particularly noticeable during the recent market downturn. Its relative strength demonstrates potential growth, especially with the rising interest in BTC L2 solutions. As a Rollup-as-a-Service (RaaS) protocol, BVM allows users to effortlessly launch new Bitcoin L2 blockchains, with all value accruing back to BVM token holders, as new L2s continuously pay their dues in $BVM tokens. Notable developments include the launch of ecosystems such as the Tuna chain and Naka chain utilising the BVM SDK. Furthermore, plans to integrate Runes functionality suggest further growth for BVM.

Source: BVM

Several other scaling solutions have been developed to enable smart contracts on Bitcoin:

  • RGB: An off-chain layer that uses Bitcoin’s UTXOs to create digital assets like tokens and NFTs, fully compatible with the Lightning Network.
  • Counterparty: Allows token creation and crowdfunding; revitalised with innovations like Ordinals.
  • Rootstock (RSK): A merge-mined sidechain with EVM-compatible smart contracts, using a Bitcoin-pegged token, RBTC.
  • Liquid Network: A sidechain by Blockstream that supports decentralised trading and asset issuance, including NFTs and stablecoins.
  • Omni Layer: Supports token minting and decentralised exchanges; enhanced by Omni Bolt for faster transactions via the Lightning Network.
  • Mintlayer: Combines Proof of Stake with Bitcoin’s Proof of Work in a sidechain supporting smart contracts and cross-blockchain transfers.

DeFi on Bitcoin

Ethereum has been the premier layer-1 blockchain for DeFi. However, recent developments may position Bitcoin as a significant player in mainstream DeFi adoption. With regulatory changes in the US and anticipation for Bitcoin’s halving in 2024, along with the introduction of Bitcoin ordinals, Bitcoin is gaining momentum.

The Bitcoin network is expanding beyond basic transactions with various scaling solutions, leading the way for a rich DeFi ecosystem. This has led to the emergence of projects that enable more complex financial applications, challenging Ethereum’s dominance.

For instance, Sovryn offers a non-custodial, permissionless environment on RSK, a Bitcoin-based layer 2 EVM smart contract blockchain, for trading, lending, and borrowing Bitcoin and other selected assets.

Additionally, platforms like Zest Protocol, backed by Primal Capital, is pioneering peer-to-peer decentralised lending backed by Bitcoin. Meanwhile, Bitcoin DEXs such as Bisq Network operate under Decentralised Autonomous Organizations, facilitating P2P trading.

Ordinals and Runes

It’s becoming widely known that the Runes protocol is gaining momentum, especially as the Bitcoin network evolves. Despite this, many are still unfamiliar with how Runes simplifies trading on Bitcoin by utilising UTXO-based accounting, which is a more affordable entry point compared to traditional methods on platforms like the Unisat marketplace. Before this development, Bitcoin transactions were mostly managed through an Account Model and required specific transaction amounts, which was less user-friendly compared to trading tokens on Ethereum.

Runes, created by the innovator behind Ordinals, aims to be the Bitcoin equivalent of Ethereum’s ERC20, facilitating fungible tokens. This protocol is set to launch post-Bitcoin halving on April 19, potentially increasing transaction fees on Bitcoin’s Layer 1 and possibly boosting activity on Bitcoin’s Layer 2 solutions.

In contrast to Ordinals, which stores data in transaction witnesses and attaches information to individual satoshis, Runes embeds token records into Bitcoin’s Unspent Transaction Outputs (UTXOs). This method aligns seamlessly with Bitcoin’s existing system, enhancing both functionality and blockchain integrity. It’s particularly designed to be easier to implement on various L2 platforms, such as Stacks.

Here are some key projects associated with the Runes protocol:

  • PUPS / Rune Pups: An NFT collection with Post-Runes activation, 23% of the PUPS supply will be distributed through an airdrop to participants.
  • WZRD: This cultural token is an early player in the Ordinal ecosystem and has seen rapid growth in popularity.
  • Runestones: This project will transition into a Runes token after the Bitcoin halving. It has already been airdropped to various Ordinals collections, including Bitcoin Puppets.

When you are buying a BRC20, you are buying access to BRC20s that can be converted to the Runes equivalent when it goes live after the halving.

There will be more of these as the ecosystem launches, just make sure to keep your eyes open.

The bullish thesis for Runes can be outlined as follows:

  • Innovation in Bitcoin’s Fungibility: Runes introduces a new token standard on the Bitcoin blockchain, aiming to improve upon the current BRC-20 fungible token standards. This innovation is considered significant enough to trigger a reevaluation of Bitcoin’s potential for decentralised applications.
  • Efficiency and Design: The Runes token standard is designed to be more efficient by utilising a UTXO-based design. This is a departure from the account-based design of Bitcoin’s BRC-20 and Ethereum’s ERC-20 tokens, which could reduce the bloat and high fees associated with the creation of ‘junk’ UTXOs that occur in the current process.
  • Market Positioning: Bitcoin’s fungible token market cap is relatively small compared to Ethereum and Solana. However, the introduction of a more efficient token standard like Runes could help Bitcoin close the gap.
  • Compatibility and Privacy: Runes is designed to be Lightning Network compatible and promises increased privacy since data is hidden within UTXOs. This compatibility and privacy feature can be seen as a significant improvement over existing standards, potentially making Bitcoin a more attractive platform for DeFi.
Source: Franklin Templeton

RGB++

RGB++ enhances Bitcoin’s capabilities by integrating smart contracts through the Nervos CKB blockchain. The standout feature of RGB++ is its isomorphic binding, which synchronises asset management between Bitcoin and the CKB Nervos blockchain. In practical terms, each Bitcoin UTXO is linked to a corresponding Cell (think of “Cells” as transaction blocks) on the CKB blockchain. Consequently, when a Bitcoin transaction is made using UTXO, it is automatically recorded on the CKB blockchain, and the corresponding Cell on CKB is updated.

This system operates without the need for a third-party multi-sig bridge, allowing trustless transactions across these blockchains while ensuring accurate reflection of activities on both networks. RGB++ is considered a promising BTC Layer 2 solution, particularly as we approach the Bitcoin halving.

In terms of investment, the direct token linked to RGB++ is $CKB, which boasts a $1 billion market cap with over 99% of its tokens already in circulation. This reduces concerns about potential market impacts from new token releases.

Closing Thoughts

There’s quite a bit to digest with all this information, and we understand it can seem complex. However, it’s worth keeping an eye on the Bitcoin ecosystem as BTC still has the highest adoption rate among cryptocurrencies and is recognized by both individual and institutional investors, which can lead to more stability and growth potential.

Thanks to ongoing developments such as the Lightning Network, which speeds up transactions, and initiatives like Runes to enhance token fungibility, Bitcoin is continually improving and broadening its applications.

Disclaimer

This presentation has been prepared by Greythorn Asset Management Pty Ltd (ABN 96 621 995 659) (Greythorn). The information in this presentation should be regarded as general information only rather than investment advice and financial advice. It is not an advertisement nor is it a solicitation or an offer to buy or sell any financial instruments or to participate in any particular trading strategy. In preparing this document Greythorn did not take into account the investment objectives, financial circumstance or particular needs of any recipient who receives or reads it. Before making any investment decisions, recipients of this presentation should consider their own personal circumstances and seek professional advice from their accountant, lawyer or other professional adviser. This presentation contains statements, opinions, projections, forecasts and other material (forward looking statements), based on various assumptions. Greythorn is not obliged to update the information. Those assumptions may or may not prove to be correct. None of Greythorn, its officers, employees, agents, advisers or any other person named in this presentation makes any representation as to the accuracy or likelihood of fulfilment of any forward looking statements or any of the assumptions upon which they are based. Greythorn and its officers, employees, agents and advisers give no warranty, representation or guarantee as to the accuracy, completeness or reliability of the information contained in this presentation. None of Greythorn and its officers, employees, agents and advisers accept, to the extent permitted by law, responsibility for any loss, claim, damages, costs or expenses arising out of, or in connection with, the information contained in this presentation. This presentation is the property of Greythorn. By receiving this presentation, the recipient agrees to keep its content confidential and agrees not to copy, supply, disseminate or disclose any information in relation to its content without written consent.

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Greythorn Asset Management

Melbourne-based asset management firm specialising in Technology, Web3, Cryptocurrency, and Blockchain. Subscribe for our latest industry insights.