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Since its inception 11 years ago, Bitcoin’s usage scenarios and rationalization methods have undergone major changes, from “peer-to-peer cash” to “anonymous darknet currency” to “digital gold”, and so on. Over the years, only one core part has not changed: decentralized finance. As Satoshi Nakamoto mentioned in the Bitcoin white paper:
Internet trade almost entirely relies on financial institutions as trusted third parties to process electronic payments. Although the system can handle most transactions well, its trust-based model still has many inherent weaknesses.
The white paper proposes a decentralized electronic transaction system, introducing the concepts of blockchain and proof of work. Although Bitcoin has made significant progress, as a trust-free financial service tool, it still cannot achieve mass adoption. According to a research paper from the University of Zurich, the Lightning Network has not only a low adoption rate, but also an increasing degree of centralization. 80% of the total amount of Bitcoin locked is concentrated in the hands of 10% of the nodes. Similarly, the transaction volume and supply of USDT based on the Bitcoin Omni layer are declining, highlighting the drawbacks of providing financial services on the Bitcoin blockchain. This is not to discredit Bitcoin. I personally think that Bitcoin has the potential to become a store of value. What I want to emphasize is that with its high degree of decentralization and security, Bitcoin can expand into more uses.
At the same time, Ethereum and other smart contract protocols are also promoting the development of the ecosystem around the concept of programmable currency. Inspired by the concept of Bitcoin, many new types of decentralized services have emerged, taking over the torch of Bitcoin subverting financial services. As a license-free open source agreement, a thriving decentralized application ecosystem has been formed on Ethereum. Although the term DeFi has just emerged, I think that the DeFi field is dominated by Bitcoin, and it would not be possible without Bitcoin. As these agreements reshape the financial industry, Bitcoin may form a symbiotic relationship with other cryptocurrencies, and promote the development of the entire cryptocurrency industry.
Due to the high difficulty of bitcoin cross-chain, all bitcoins on the Ethereum blockchain have been converted into ERC20 tokens. These ERC20 tokens are anchored to Bitcoin 1:1, that is, each ERC 20 token has a Bitcoin endorsement behind it. wBTC is the first recognized ERC-20 Bitcoin, issued in January 2019. wBTC is led by an alliance similar to USDC issuer Circle. Because wBTC requires its holders to trust the custodian that endorses wBTC, trust-free ERC-20 bitcoins such as renBTC and tBTC have emerged.
At the beginning of 2020, even though it has been issued for a year, the market value of wBTC is only less than 5 million US dollars. In the first year, the adoption rate of wBTC was so low, probably because of the lack of integration and functionality, which has no obvious advantage over Bitcoin. As DeFi integrates ERC-20 bitcoin and provides user services on this basis, this situation has begun to change. In May, MakerDAO accepted wBTC as collateral for DAI, marking a breakthrough for Bitcoin in Ethereum. In addition, there are some agreements that provide financial services on ERC-20 Bitcoin. These integrations are a win-win situation for DeFi and Bitcoin: it not only increases liquidity for the DeFi protocol, but also locks up the circulation of Bitcoin.
Although the loan service with Bitcoin as collateral has stimulated the user’s demand for wBTC, in the past few months, the real reason for the parabolic growth of such Bitcoins is the earning of compound interest. The sBTC/renBTC/wBTC capital pool on Curve attracted a large number of Bitcoins to Ethereum, especially after the issuance of CRV governance tokens. In 4 days, the Bitcoin flow into Curve quadrupled from 45 million USD to more than 200 million USD.
What is particularly striking is that the growth rate of ERC-20 bitcoin locks on Curve has exceeded that of stablecoins. Thanks to various incentives, the pledge of ERC-20 bitcoins locked on Ethereum has reached US$800 million, accounting for about 0.38% of the total bitcoin supply.
Although the question of whether the annualized rate of return of more than 50% provided by Curve for ERC-20 Bitcoin is sustainable is still controversial, Curve has successfully generated a positive feedback loop. Users who provide liquidity can get CRV as a liquidity mining reward, which leads to an increase in the value locked in Curve. In this way, the potential value of the governance token CRV increases, and more users are encouraged to provide liquidity. In addition, in theory, this will drive user demand for such profitable assets. Bitcoin will also benefit from this, because more and more investors will lock in ERC-20 Bitcoin in order to obtain liquidity mining income, making Bitcoin’s market selling pressure smaller.
Increase the adoption rate of ERC-20 Bitcoin
By analyzing IntoTheBlock’s key chain indicators, we found that the development of ERC-20 Bitcoin is mainly driven by giant whales and institutional investors. This is reflected in the average balances of wBTC and renBTC holders, which are 95,000 USD and 217,000 USD respectively.
Given that users need to pay high gas fees to tokenize their Bitcoin ERC-20 and deposit them into the DeFi protocol, it is not surprising that users are mostly giant whales and institutional investors. Therefore, the total number of addresses holding these tokens has not increased significantly. For example, the total number of addresses holding wBTC and renBTC are 4600 and 750, respectively. Another reason is that in addition to early adopters, ordinary retail investors need longer time to trust and learn how to use these alternative bitcoins that generate revenue.
As Ethereum 2.0 is about to go online and the DeFi protocol begins to integrate Layer 2 solutions, the cost of Gas may be reduced, allowing users to tokenize a small amount of Bitcoin ERC-20. In addition, USDC has recently begun to adopt new features such as “meta-transactions” that allow users to transfer ERC-20 tokens without having to hold Ether, thereby helping new users reduce friction. Although it is unclear how long these innovations will take to achieve, they must be able to better guide Bitcoin to Ethereum.
As the field of cryptocurrency shifts its focus to high-yield projects, I think a large portion of Bitcoin holders will join this trend. Through the Hodler indicator, we can observe that there are 20.69 million addresses holding a total of 11.7 million Bitcoins, which have not been moved for more than a year. Because the interest-bearing DeFi and CeFi solutions are relatively new, most of these coin hoarders may not be able to earn anything from Bitcoin holdings.
I expect that as more and more long-term currency holders are attracted by the high yields of DeFi, this proportion will decrease. Of course, judging from the risks and learning curves associated with these protocols, I can foresee that most Bitcoin holders will continue to hold coins in the next few years. However, with the development of the cryptocurrency industry and Bitcoin use cases, this trend is likely to continue for several years.
Look to the future
In view of the rapid development of technology in the industry, in the next 10 years, not only the existing DeFi protocol will require ERC-20 bitcoin, but also innovative projects that continue to emerge. Due to the permission-free nature of DeFi, the DeFi protocol will make it easier to provide financial services that support ERC-20 Bitcoin. However, at the same time, the risk of using ERC-20 bitcoin in the short term may increase, especially when the DeFi protocol deploys more and more unaudited smart contracts and attracts millions of funds overnight. Unfortunately, I think ERC-20 Bitcoin will be hacked sooner or later, which may cause its progress to stagnate for at least a few months.
In addition to DeFi, I expect that other areas of Ethereum will propose different reward mechanisms, triggering a new cycle of rapid growth, just like the liquidity mining boom we are experiencing. Among them, ERC-20 Bitcoin may be used to reward users who provide value-added services to bring a positive feedback loop to the DeFi protocol. As mentioned above, these measures will create a win-win situation, which will not only increase users’ demand for Bitcoin, but also encourage more users to adopt the protocol on Ethereum.
In general, since Satoshi Nakamoto released the white paper, Bitcoin has been developing for a long time, and many use cases that were unimaginable in the past have emerged. Driven by DeFi, ERC-20 Bitcoin has further developed. I expect that this trend will accelerate as costs decrease and friction decreases. Given that Ethereum has taken the lead as the main platform for building these DeFi protocols, I suggest that the Bitcoin community accept these protocols instead of continuing to insist on zero-sum games. After all, since the birth of Bitcoin, achieving decentralized finance has always been an important goal.