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Bitcoin DeFi and Layer 2s: The Next Trillion-Dollar Opportunity?

Lincoln Murr

Summary: The development of decentralized applications and DeFi has revolutionized how we interact with money and cryptocurrencies by providing many wealth-creation opportunities previously only available to banks and corporations. At the same time, these products have been primarily limited to the Ethereum and Solana ecosystems and have been unable to natively introduce Bitcoin, the most legitimate ...

The development of decentralized applications and DeFi has revolutionized how we interact with money and cryptocurrencies by providing many wealth-creation opportunities previously only available to banks and corporations. At the same time, these products have been primarily limited to the Ethereum and Solana ecosystems and have been unable to natively introduce Bitcoin, the most legitimate and established cryptocurrency, into the world of DeFi. However, this is rapidly changing, and we are in a renaissance of Bitcoin development that could bring BTC's value to new heights.

When Bitcoin was created in 2008, its vision was to be a peer-to-peer electronic cash system, nothing more. It was quickly realized that blockchain's potential went far beyond transfers of value and could be used to create a trustless computing engine capable of executing arbitrary logic-based events, and thus, Ethereum and blockchain-based smart contracts were born. Bitcoin never upgraded to include these features because its main goal was always to be an electronic cash or digital gold, and its supporters did not feel it made sense to add additional features that could make the blockchain unstable or stray from Satoshi’s original vision. 

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Recently, there has been a shift in this sentiment, and Bitcoin is becoming more and more modernized. It started with the Ordinal theory released in March of 2023, which individually numbered each satoshi, one hundred millionth of a Bitcoin, effectively making every sat a non-fungible token. From there, users began trading satoshis based on their value and inscribing specific code or images into the satoshis to create NFTs on Bitcoin. This innovation continued with the introduction of BRC20 fungible tokens on Bitcoin, and the Runes token standard introduced this past halving. Though some Bitcoiners are frustrated that these memecoins and useless items are congesting the blockchain and preventing it from being used for simple Bitcoin transfers, they can do nothing to stop it. 

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Some Bitcoin leaders suggest even greater changes to unlock new capabilities for Bitcoin. For example, the Taproot Wizards, a community dedicated to making Bitcoin magical again, are promoting re-introducing the OP_CAT opcode into Bitcoin’s programming language. OP_CAT was originally removed by Satoshi after it was causing some issues related to something that has been patched, but today, it can be implemented into Bitcoin with little technical complexity yet allows for incredible new use cases. For example, OP_CAT enables developers to create smart contracts, zero-knowledge proof verification, and even trustless bridges to zero-knowledge Bitcoin Layer 2s. This innovation is where a lot of excitement lies, as it appears that cryptographically secure environments would be the only ones that hardcore Bitcoiners would trust. Still, it would allow for DeFi to be fully implemented in a Bitcoin-native system, unlocking trillions of dollars in BTC for all sorts of activities like borrowing and lending, liquidity provision, and even restaking. Though it is possible to get this functionality on Ethereum via wrapped BTC (WBTC), this is simply Bitcoin custodied by BitGo and is not a trustless solution.

There are various Bitcoin L2s being developed; some are optimistic rollups, while others are zk. Some of the most prominent include Merlin Chain, Build on Bitcoin (BOB), Botanix, and Stacks. Each have technical differences and are at various stages of development, but generally all aim to provide smart contract functionality to Bitcoin and use BTC as a native asset. The sector has been rapidly growing, with new L2s coming out on what feels like a weekly basis, many of which are doing a points system to reward depositors with future tokens.

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Bitcoin is entering one of its most exciting developmental eras since its creation, and shows no signs of slowing down. As OP_CAT gains support, Layer 2s get closer to creating flourishing ecosystems, and Bitcoiners become more comfortable with the idea of moving to L2 solutions, the BTC ecosystem will only continue to grow and may even become competitive with Ethereum.

By Lincoln Murr

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