Will BTCFi Become the New Fuel for Bitcoin's Growth?

Bitcoin-based decentralized finance (BTCFi) no longer looks like an enthusiast's dream - it's a rapidly growing and promising trend.

Over the past year, the TVL segment's (Total Value Locked) has increased ~2400% from $0.3 billion to a peak of $7.47 billion (December 2024), propelling the ecosystem into the top 5 of the DeFi Llama rankings.

BTCFi reflects a paradigm shift in the use of digital gold. Whereas bitcoin used to be primarily a means of saving, now it is a full-fledged participant in the DeFi sphere and the most diverse usecases - staking, cryptocurrency lending, yield farming, etc.

BTCFi is perhaps one of the most undervalued niches of the crypto market right now, given the more than trillion-dollar capitalization of digital gold, colossal amounts of dormant liquidity, and the untapped potential of L2.

The real "Ethereum killer?"

In the current market cycle, the bitcoin dominance index is showing strong growth - capital is flowing into the first cryptocurrency faster than into other crypto-assets combined.

This is a sign of active accumulation by hodlers and retail investors, the deepening integration of the first cryptocurrency with TradFi, and the manifestation of the Lindy effect.

The successful debut of spot bitcoin ETFs in the U.S. has given major asset managers like BlackRock direct access to digital gold; companies and even states are increasingly seeing cryptocurrency as a reliable financial reserve.

They believe that regulatory changes can accelerate the development of this trend. As a positive example, experts mentioned the abolition of the SAB 121 rule in the United States, which previously effectively prohibited banks from storing digital assets.

The simplification of bureaucratic procedures and the further development of financial infrastructure pave the way for bitcoin's fuller potential - its active use in everyday payments, as collateral and as part of structured financial products.

Is HODL so good?

The "whale" demand, active accumulation and propaganda of "eternal HODL" by bitcoin maximalists have a downside: a significant portion of coins are out of circulation, ceasing to fulfill the function of a medium of exchange and bringing no profitability to their owners.

The graph below shows that more than 60% of bitcoins have not left their wallets for more than a year - and this share continues to increase. This trend reflects the growing number of long-term holders focused on a passive accumulation strategy.

According to experts, the main barrier to more fully unlocking bitcoin's potential has long remained the "lack of available financial instruments."

In their opinion, "unlocking even a small part of underutilized coins" can significantly increase bitcoin's capital efficiency - turning it from a passive means of saving into a more active financial instrument and opening up new opportunities for "value generation".

The unplowed field of BTCFi

Bitcoin's adoption rate in DeFi remains low. Binance Research calculates that only 0.79% of the total digital gold supply is locked in smart contracts in decentralized applications.

One of the main reasons for this situation is that bitcoin was not originally designed to support complex financial applications. Unlike platforms like Ethereum, the first cryptocurrency did not have built-in programmability.

This left hodlers with a limited choice of "advanced" usecases, such as lending against digital gold via custodial services or wrapped tokens on other blockchains. However, each of these options carries its own risks, including low returns, centralization, and security threats.

This contrasts with Ethereum, where holders of ETH and ERC-20 tokens can seamlessly and non-custodially participate in staking, lending, liquidity provision, and enjoy a wide range of intricate "financial LEGO" tools.

Comparison of popular ecosystems by TVL to market capitalization ratio. Data: DeFi Llama, CoinMarketCap, Binance Research as of March 11.

Despite a market value of over $1 trillion, bitcoin remains one of the least active blockchains. This is clearly demonstrated by the chart below, which compares the ratio of TVL to market capitalization of the leading platforms.

Digital Gold's performance is ~0.32% (with a TVL of $5.65 billion and a capitalization of $1.7 trillion as of March 20). Ethereum's corresponding value is 48.6%, Solana is 23.8%, BNB Chain is 9.5%, and TON is ~5.9%.

The landscape of the new segment

The BTCFi sector is gaining momentum, but most of the digital gold involved in DeFi is still in the form of wrapped tokens on other blockchains.

Much of the first cryptocurrency is used as collateral in lending protocols or for yield pharming.

The screenshot below shows the top 5 bitcoin-based TVL protocols, according to DeFi Llama. The first four lines of the ranking are restaking projects led by Babylon.

According to the observations of Binance Research analysts, user activity in BTCFi closely correlates with general bitcoin market cycles and current market conditions. 

During periods of strong price growth, demand for digital gold-based financial services - especially in the lending and staking segments - increases noticeably. Market participants strive to generate income without parting with coins;

The development of native bitcoin applications gives additional impetus to the activity: both the number of active BTCFi-wallets and the volume of transactions in the network are increasing.

The researchers emphasized that the race for the title of the dominant execution layer is still ongoing - none of the L2 platforms has yet gained widespread support.

Among other notable participants in the sector, experts highlighted:

• BOB (8.4%);
• BSquared (6.9%);
• Stacks (6.1%);
• BEVM (5.3%); 
• BounceBit (3.1%); 
• MAP Protocol (3.1%).

The latter three are gradually gaining momentum "at the expense of more highly specialized offerings."The infographic below outlines the key elements of the evolving BTCFi ecosystem, including scaling solutions, wrapped tokens, stablecoins, wallets, steaking/restocking services, etc.

Although WBTC holds 60% of the tokenized bitcoin market, the custodial and other inherent risks of TradFi are increasing demand for alternatives. Native BTCFi-based solutions have the distinct advantages of relying on bitcoin security directly and virtually eliminating storage risks. 

A significant portion of WBTC is still used in lending services like Aave and Maker. This means that DeFi-friendly hodlers are primarily interested in lending protocols.

"BTCFi's ability to compete with the wrapped BTC markets depends on whether native lending protocols can (1) offer higher yields by increasing demand for leveraged BTC and (2) provide sufficient liquidity of stable coins for lending," Binance Research noted.

Investor interest and future prospects

Interest in BTCFi continues to grow - this can be seen in the increase in investment volumes and fund activity.

According to Binance Research, demand is fueled by the expansion of native bitcoin use cases, including Ordinals, BRC-20, Runes, etc.

The ecosystem - from infrastructure and second-tier solutions to DeFi projects - is increasingly attracting investment. Over the past two years, the number of deals has grown from 19 to 115, with total investments exceeding $491 million. More than 86% of the funds have been raised beyond 2024.

As the ecosystem and L2 solutions in particular mature, investor attention is gradually shifting from infrastructure developments to native bitcoin-based applications "capable of unlocking onchain liquidity and financial activity."

According to them, if BTCFi follows the path of tokenized versions of bitcoin like WBTC, the segment could grow to $31.9 billion.

According to them, digital gold "in a wrapper" involves "limited access" and additional security risks, making it less attractive to users, especially those who prefer cold storage.

Pitfalls

The development of bitcoin-based L2 solutions is crucial not only for BTCFi through the introduction of smart contract functionality, but also for improving the overall programmability and scalability of the network. 

The UTXO bitcoin model is inherently optimized for simple transactions, the researchers stressed; however, it "lacks the necessary flexibility to perform complex transactions within DeFi". 

Unlike the accounts-based Ethereum system, bitcoin's scripting language is not Turing-complete, which limits its ability to handle the complex states that smart contracts handle. The limited block size and slow block formation reduce scalability, increase L2 storage costs, and limit throughput compared to DeFi-centric blockchains.

Existing solutions like statechains or sidechains involve trade-offs because they "do not always inherit the strong security model of the first cryptocurrency," they said. In turn, this creates additional risks that can affect user trust. 

Until Tier 2 solutions for bitcoin reach proper maturity, such restrictions will continue to stifle the growth and usability of BTCFi.

There is hope

Fortunately, innovation in the L2 segment continues to evolve, overcoming structural limitations and providing scalability as well as improved capabilities for smart contracts. The emergence of BitVM and other trustless solutions has brought attention to the native programmability of bitcoin.

Different second-tier approaches involve different trade-offs between decentralization, security, and scalability, but all play a key role in shaping the "next phase of financialization" of the first cryptocurrency.BTCFi could increase revenue from transaction fees, partially offsetting the effects of regular reductions in block rewards. The development of this segment will allow miners to remain economically motivated to secure the network.

Conclusions

A stagnant market needs new narratives - like ICO, institutionalization, DeFi and NFT once did. The industry is waiting for the next impetus.

BTCFi is gradually transforming the first cryptocurrency from a dormant store of value to a key component of the decentralized finance sphere, where enormous potential is hidden. Infrastructure development will create the foundation for unlocking multi-billion dollar liquidity.

Bitcoin is limited in programmability and scalability, making it more difficult to integrate into a "financial LEGO" compared to Ethereum and other popular platforms. However, the development of innovative solutions is gradually removing these obstacles, and secure and profitable alternatives to wrapped tokens are emerging without compromising decentralization.

The success of the new segment depends on the maturity of L2 solutions that not only improve bitcoin functionality, but also support miners through increased commissions. 

Overcoming technical and regulatory hurdles could make BTCFi an important driver of truly mass adoption of digital gold and sustained growth of the broader market.