The Bitcoin blockchain’s lack of programmability has long prevented the world’s most famous cryptocurrency asset from being used easily in decentralized finance, but the arrival of pioneering Layer-2 networks such as Stacks and Rootstock is rapidly changing that.
These L2s, which tap into the foundational security of Bitcoin, are giving birth to an increasingly vibrant new DeFi ecosystem that lets BTC holders put their capital to work, without worrying about custodians.
The rise of Bitcoin DeFi is set to become the most monumental evolution in the history of the OG digital asset, expanding its utility beyond a simple store of value or payment mechanism. Finally, Bitcoin holders can engage with a range of applications that enable decentralized borrowing and lending, staking, and other complex, yield-generating activities.
The roots of Bitcoin DeFi
Despite its lack of smart contracts, Bitcoin’s status as the OG cryptocurrency helped to ensure it remains by far and away the most valuable digital asset in the world, and that has fueled numerous efforts from the community to make it more compatible with DeFi.
Some of the earliest efforts to bridge the gap between Bitcoin and its foundational simplicity with the complexity of DeFi were extremely innovative, yet they encountered substantial challenges that prevented it from fully taking off.
Perhaps the first real effort was Colored Coins, which was an attempt to bring tokenized real-world assets onto the Bitcoin blockchain. The idea was fairly simple, and involved “coloring” individual Bitcoins with metadata so they could represent RWAs that could be transferred between individuals in a decentralized way. Colored Coins first appeared in 2012 and were used to represent assets such as real estate and equities, but the project faced some major challenges with regard to its implementation and scalability, preventing widespread adoption.
What Colored Coins did do, however, is it inspired others to follow in its footsteps and try to bring more utility to Bitcoin. Counterparty was the first to pioneer non-fungible tokens or NFTs that lived on Bitcoin, demonstrating its potential to provide more complex financial instruments. In 2014, it gave rise to the Rare Pepes NFT collection, which capitalized on the growing appeal of digital collectibles, but adoption was stymied by the network’s sluggish transaction speeds and high costs.
Colored Coins and Counterparty weren’t quite able to realize their original grand ambitions, but they provided stepping stones that would inform a number of crucial developments that would later pave the way for Bitcoin DeFi. The challenges they experienced underscored the need for a more efficient and sophisticated infrastructure, and we subsequently saw the 2015 debut of Lightning Network, the first L2 on Bitcoin.
Lightning Network introduced the concept of payment channels, enabling faster, lower cost, and more complex financial interactions on Bitcoin, and it was followed by “sidechains” such as Rootstock (2017) and Liquid Network (2018), which supported the issuance of new digital assets linked to Bitcoin and some simple, DeFi-like applications.
Finally, in 2021 we saw the arrival of the Taproot upgrade, which enhanced Bitcoin’s smart contract capabilities with a technique known as Merklized Alternative Script Trees or MAST, which condenses BTC transactions into a single hash, reducing memory usage. Although not a complete solution to DeFi, Taproot made it easier for developers to implement more complex BTC transactions.
sBTC brings full utility to Bitcoin
More than anything else, Taproot helped to accelerate the development of the sophisticated L2s on Bitcoin that are capable of supporting the complex programmable smart contracts that exist on chains like Ethereum and Solana.
Networks such as Stacks, Merlin Chain, Rootstock, and Build on Bitcoin are closely integrated with Bitcoin and provide highly scalable and programmable environments that support highly sophisticated DeFi applications. What’s appealing about these L2 networks is that they can leverage the core advantages of Bitcoin, such as its decentralization, security, and liquidity, which makes them ideal for BTC-native lending, borrowing, staking, yield-farming, and more.
Stacks, for instance, has created an innovative digital asset called sBTC, which allows users to easily bridge their BTC assets into its growing ecosystem of DeFi applications, so they can use that capital to try and generate a passive income.
sBTC was launched in late 2024 as part of Stacks’ Nakamoto release. It’s a 1:1 backed programmable Bitcoin asset that lives on the Stacks layer, and it’s fully secured by Bitcoin deposits. Essentially, to mint sBTC users are required to deposit BTC tokens into a smart contract first, but there’s no reliance on custodians, as there is with other “wrapped” Bitcoin assets, such as wBTC. Instead of wrapping, sBTC taps into the security of Bitcoin’s blockchain using smart contracts that implement strict rules regarding how locked BTC can be unlocked. The only way to do so is by burning sBTC, eliminating the role of custodians.
“It’s actually secured by a consensus of the [Bitcoin] blockchain,” said Stacks’ co-founder Muneed Ali in an interview with DL News.
sBTC is further secured through its novel Proof-of-Transfer consensus mechanism. It’s a multi-layered approach that significantly enhances its security. Even if all of the Stacks validators decided to collaborate, they wouldn’t be able to cheat anyone out of their funds.
One of the first projects to implement sBTC is Zest Protocol, which has built a decentralized lending application and money market for Bitcoin on Stacks. Its goal is to make it simple for every Bitcoin holder to participate in on-chain lending markets. It makes use of sBTC’s novel pegging mechanism to allow users to deposit standard BTC tokens and immediately receive sBTC in their Zest account. Once they’ve swapped their BTC for sBTC, they can participate in a number of lending and yield-generating activities within the app.
Bitcoin DeFi matures
Stacks isn’t alone in bringing DeFi capabilities to the Bitcoin ecosystem. In fact, there are highly promising and innovative projects on every Bitcoin L2. For instance, Sovryn is a decentralized exchange platform that’s hosted on the Rootstock and Build on Bitcoin networks, and it provides a wide range of DeFi services.
With Sovryn, users can deposit BTC and engage in trading, swapping, liquidity providing, staking, and lending activities. It also supports Bitcoin-based assets such as Runes and Ordinals. Its focus on integrating with multiple blockchains sets it apart from others within Bitcoin’s DeFi ecosystem, and it’s backed by its native SOV token, which is used to reward liquidity providers and other participants and support decentralized governance.
Another compelling project is Babylon Labs, which is a protocol that sets out to boost the security of Proof-of-Stake blockchains by backing them with BTC. With Babylon, Bitcoin holders can stake their native BTC to secure PoS chains and earn yield.
It takes advantage of three key characteristics of Bitcoin to secure other networks, including its native timestamping service, its blockspace, and the value of BTC itself. These three elements form the core of Babylon’s innovative security protocol. They allow users to lock up their BTC in smart contracts hosted on the Bitcoin network, so that capital can be used to provide economic security for partnering PoS networks, including Polygon, Cosmos, and a number of Bitcoin L2s.
The future of Bitcoin
The incredible innovation shown by the above projects underlines how Bitcoin’s L2s are set to thrive with the explosion of DeFi, and some analysts expect them to bring enormous value to Bitcoin’s ecosystem.
For instance, Messari researchers have estimated that if native Bitcoin DeFi is able to achieve the same level of adoption as wBTC today, by tapping into 2.87% of its prospective market, its value could soar to $47 billion. As such, even a relatively low rate of adoption will have a transformative impact. At that scale, it would become one of the top ten DeFi projects in the entire crypto industry based on its market capitalization.
This is why Bitcoin L2s are set to become the most pivotal innovations in Bitcoin’s evolution, transforming its utility and bringing added value to every single BTC holder.