Jade ARdinals analyst says the future of Bitcoin defi includes smart contracts

on May 24, 2024
  • BRC-20 tokens and Ordinals enable decentralised applications and NFTs on the Bitcoin blockchain.
  • Layer-2 solutions and technical advancements are crucial for addressing Bitcoin’s transaction throughput.
  • Continuous advancements in smart contracts will define Bitcoin's defi future.

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Bitcoin is now stepping into the DeFi space with the introduction of BRC-20 tokens and Ordinals. The Taproot upgrade has made this possible by allowing the creation of decentralised applications (DApps) on the Bitcoin blockchain.

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This change enhances Bitcoin’s potential, enabling it to offer diverse financial services. These include decentralized exchanges, automated loan platforms, and non-fungible tokens (NFTs).

However, challenges remain. Scalability and transaction fees are major concerns. The increased transaction load from BRC-20 tokens and Ordinals could worsen these issues. Solutions like Layer-2 protocols and sidechains, such as the Lightning Network, Stacks, and Rootstock, are crucial.

They help improve transaction throughput and reduce fees, ensuring the network remains efficient. Despite these hurdles, Bitcoin’s move into DeFi shows promise, driven by continuous innovation.

To delve deeper into these developments, Invezz spoke with Nathan, a Jade ARdinals analyst, to discuss the opportunities and challenges in Bitcoin’s DeFi space.

Impact of BRC-20 tokens and ordinals

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Invezz: BRC-20 tokens and Ordinals now enable NFTs and fungible tokens directly on the Bitcoin blockchain. How do you see this impacting Bitcoin’s DeFi space in terms of the opportunities and challenges that might arise, especially around scalability and transaction fees?

The integration of BRC-20 tokens and Ordinals into the Bitcoin network is a game-changer for Bitcoin’s DeFi space, but it’s also creating many challenges.

On the opportunity side, developers will be able to build DApps that leverage Bitcoin’s security and decentralization. This unlocks new tokenomics models and user engagement strategies, such as staking, farming, and liquidity management, similar to what we see on Ethereum and Solana.

Still, with these opportunities come challenges. Scalability is a major concern: transaction throughput has been the Achilles heel of Bitcoin’s blockchain, and the addition of BRC-20 tokens and Ordinals could make this issue worse.

As more people use the network for these new functions, we might see slower transaction processing times. Increased demand on the network could also lead to higher transaction fees, making it more expensive for users to get their transactions processed quickly.

Then, there is technological complexity: maintaining a fast and efficient system while supporting a large volume of transactions is no small feat.

Solutions like Partially Signed Bitcoin Transactions (PSBT) and transaction batching manage these challenges, but they do not fully solve them. I believe that Layer-2 solutions will be more effective here.

Strategies to tackle scalability issues

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Invezz: As more people use Ordinals and BRC-20 tokens on Bitcoin, network congestion and rising fees have become significant issues. What strategies or innovations do you think are crucial to tackle these scalability challenges?

First, it’s crucial that we use Layer 2 solutions. The Lightning Network is a good example: it processes instant and low-cost transactions through a network of payment channels that only settle the net results on the Bitcoin blockchain.

Similarly, projects like Stacks and RootStock (RSK) add programmability to Bitcoin, allowing for more complex operations and smart contracts to be executed off-chain, and using the main network for settlement.

Another solution is to enhance block efficiency on the main chain. The Segregated Witness (SegWit) protocol upgrade, which separates transaction signatures from transaction data, has already helped increase block size limit and improved transaction throughput.

Future developments could also rethink how data is stored and processed within blocks.

Increasing block size or implementing dynamic block size adjustments can help, too.

By allowing the block size to scale with network demand, we can accommodate more transactions per block during peak times. Still, it’s crucial to keep this balanced — too much scaling could compromise the network’s decentralization and security.

In addition to the above, transaction batching — where multiple transactions are bundled together into a single transaction — can help reduce the number of individual transactions, easing congestion and lowering fees.

Difference between the tokens

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Invezz: There are clear differences between BRC-20 tokens on Bitcoin and ERC-20 tokens on Ethereum, especially when it comes to smart contracts and integration. How do you think these differences will impact Bitcoin’s ability to develop strong DeFi protocols and applications?

BRC-20 tokens and ERC-20 tokens are like different types of building blocks. For instance, Ethereum’s ERC-20 tokens are similar to Lego.

They are designed for easy interoperability, flexibility, and seamless integration, allowing developers to easily build complex DeFi applications.

Bitcoin’s BRC-20 tokens are more like traditional building blocks: sturdy and reliable, they reflect Bitcoin’s inherent security and robustness. However, they are not as flexible or easy to use as ERC-20 tokens, which makes integrated DeFi app development more challenging.

This difference makes Ethereum the preferred platform for DeFi protocols; Bitcoin, on the other hand, calls for a more innovative approach to achieve a similar functionality.

For example, mechanisms like Partially Signed Bitcoin Transactions (PSBT) and Taproot provide Bitcoin with some level of smart contract capability, although they are not as seamless or intuitive as Ethereum’s solutions.

Despite this, Bitcoin’s solid foundation and the increasing use of BRC-20 tokens are opening up new opportunities for innovative financial solutions. While it might face a steeper climb in the DeFi space compared to Ethereum, its secure backbone and ongoing innovations suggest a promising future.

Invezz: Layer 2 solutions have played a vital role in improving Bitcoin’s scalability and enabling DeFi applications. How do you think these networks will evolve to support a broader range of DeFi features on Bitcoin?

Imagine Layer 2 solutions as tunnels that help Bitcoin handle more traffic without getting too crowded. These tunnels, like the Lightning Network, have already made it faster and cheaper to use Bitcoin, which is highly beneficial to DeFi.

As Layer 2 solutions continue to develop, they’ll become even more advanced, evolving to support features like lending, borrowing, and trading. This means Bitcoin will be able to offer its users more handy tools and opportunities — as Ethereum and its DeFi projects do.

We might also see new networks appear, each specializing in different DeFi features or catering to specific needs. This diversity could make Bitcoin’s DeFi ecosystem richer, more powerful, and more versatile.

Smart contract on Bitcoin

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Invezz: Projects like BitVM are looking into adding smart contracts to Bitcoin. How do you think this will influence the development of Bitcoin’s DeFi ecosystem?

Picture Bitcoin stepping up from a mere currency to automating things like Ethereum does. That’s what adding smart contracts, such as those BitVM is working on, could bring to Bitcoin.

If Bitcoin starts supporting smart contracts, it could draw in developers and users looking to craft and use these new tools. Users would be able to access a variety of financial tools and applications right on the Bitcoin blockchain, without the need for middlemen.

Bitcoin is already the biggest cryptocurrency, so adding smart contracts could make its DeFi ecosystem one of the most robust and influential worldwide.

Innovations in Bitcoin’s DeFi landscape

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Invezz: As Bitcoin’s DeFi ecosystem continues to evolve, what emerging innovations do you think will shape Bitcoin’s DeFi landscape and enhance its position in decentralized finance?

First, I believe that soon, we’ll see smart contracts integrated into the Bitcoin blockchain. Then, Bitcoin will be able to support a wide array of financial applications without relying on third-party platforms.

Second, Layer-2 products are the backbone of Bitcoin’s future. As solutions like the Lightning Network are developed and adopted, they will improve scalability and transaction throughput, making DeFi applications on Bitcoin more user-friendly and efficient.

Third, protocols that allow seamless communication and asset transfers between different blockchains will allow Bitcoin to interact more effectively with other ecosystems.

Interoperability is key to creating a more diverse and interconnected DeFi environment, where assets can move freely across various platforms, boosting liquidity and usability.

Fourth, RWA tokenization is another significant trend. It expands the range of assets available for DeFi applications, increases liquidity, and introduces new financial products to the Bitcoin ecosystem.

Security enhancements such as such as confidential transactions and zero-knowledge proofs are essential, too. They will bring in more confidential DeFi transactions, protecting users’ financial privacy, and the integrity of the network.

And lastly, we can’t overlook the power of community-driven efforts. Just like the enthusiasts tinkering in their garages laid the foundations of Silicon Valley, Bitcoin community members experiment and collaborate, driving the creation of novel protocols, applications, and governance models.

This grassroots spirit is vital for the ecosystem to evolve — and get stronger.

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