Bitcoin, unlike Proof-of-Stake (PoS) networks, does not natively offer interest or staking rewards due to its Proof-of-Work (PoW) consensus mechanism. Despite this limitation, Bitcoin holders are eager to find solutions that allow them to access yield and put their assets to work. This desire has fuelled the emergence of the BTC.fi narrative, which explores ways to integrate Bitcoin into the broader DeFi ecosystem.
Centralized exchanges (CEXs) have long been the primary destination for Bitcoin yield, leveraging trading and lending strategies rather than generating native yield on the Bitcoin network. While the rise of BTC.fi has fuelled interest in decentralized alternatives, CEXs continue to dominate in trading volume and offer a diverse range of Bitcoin-related products—from structured financial instruments to simple earn plans—packaged with 24/7 customer support. Despite declining Bitcoin reserves, CEXs remain the go-to platform for BTC yield.
The growing interest in on-chain solutions is driven by a desire for greater control and decentralization. Within BTC.fi, there are differing opinions on where the best solutions should reside. While these protocols may not offer true “native” Bitcoin yield, they are innovating to attract Bitcoin holders, and the space is seeing a battle for dominance between Bitcoin-centric and multi-chain approaches.
Two Competing Camps for Bitcoin DeFi
Bitcoin Ecosystem Exclusive: This camp believes that true BTC.fi solutions should be built on Bitcoin’s sidechains or layer-2 networks. By enhancing Bitcoin’s scalability and smart contract capabilities, these solutions aim to create a DeFi ecosystem native to Bitcoin.
Alternative L1s/L2s: The other camp favours using other Layer-1 (L1) and Layer-2 (L2) networks to bring DeFi to Bitcoin holders. This involves tokenizing Bitcoin on chains like Ethereum or Solana, allowing users to participate in those ecosystems. The argument is that these chains offer greater efficiency, lower fees, faster transactions, and a broader range of applications to explore.
The argument is that these chains offer greater efficiency, lower fees, faster transactions, and a broader range of applications to explore.
Bitcoin’s Extended Ecosystems Simplified
- Layer 2 (L2) Solutions – BTC Never Leaves the Network. These operate on top of Bitcoin. Example: Lightning Network.
- Sidechains – BTC Leaves the Network (Pegged BTC). BTC is locked on Bitcoin, and an equivalent amount is issued on the sidechain. Example: Rootstock (RSK).
- Bridges to Alternative L1s/L2s – BTC Leaves the Network (Wrapped BTC). BTC is fully moved to another blockchain by locking it on Bitcoin and minting a wrapped version on the destination chain. Example: Wrapped Bitcoin (WBTC on Ethereum).
Note: Though sidechains and alternative L1s may sound similar by design, Bitcoin sidechains are designed specifically for Bitcoin, whereas alternative L1s are general-purpose blockchains that happen to also support tokenized Bitcoin.
These camps compete for Bitcoin holders by offering:
- Enhanced Rewards/Point Systems: DeFi protocols incentivize participation through rewards, often in the form of the protocol’s native token.
- Better Bridges/Solutions: Innovation in bridge technology focuses on improving security, speed, and cost-effectiveness.
- Permissionless Minting and Burning: Protocols allowing users to create and destroy wrapped Bitcoin tokens without intermediaries.
- Instant Release: Quick, efficient release mechanisms for wrapped Bitcoin, facilitating seamless movement between networks.
The Battle for Bitcoin Yield: Some Leading Solutions
Several platforms illustrate this competition between Bitcoin-native and multi-chain solutions:
- Sidechains (Rootstock): As a pioneer in Bitcoin-based smart contracts, Rootstock is the longest-standing Bitcoin sidechain and offers dual-mining and EVM compatibility.
- Layer 2 (Bitlayer): Bitlayer is a Bitcoin Layer 2 solution based on the BitVM paradigm that aims to achieve scalability on Bitcoin without compromising its security. Bitlayer aims to offer security equivalent to that of Bitcoin’s Layer 1, with BTC bridging with minimized trust, EVM compatibility, and unlimited throughput.
- Layer 2 (Stacks): Stacks brings smart contracts and decentralized applications to Bitcoin.
- Layer 2 (Portal to Bitcoin): This platform facilitates Bitcoin liquidity through the Lightning Network and atomic swaps, ensuring security and decentralization.
- Bitcoin Economic Security Staking (Babylon): Babylon allows Bitcoin holders to stake their BTC to secure decentralized networks and receive rewards, but this does not involve PoS-like consensus on Bitcoin itself. Instead, it leverages BTC as an economic security layer for other networks while keeping it unwrapped and within Bitcoin’s custody model.
- Alternative L1 (Zeus Network): Zeus Network introduces zBTC, a tokenized form of Bitcoin, on Solana’s blockchain. This allows Bitcoin holders to participate in Solana’s DeFi ecosystem and earn yield, though the yield is generated within the Solana ecosystem using zBTC, not natively on the Bitcoin network.
- Alternative L1/L2 (Bridged Bitcoin Solutions: WBTC, tBTC, cbBTC, etc.): These tokens (like WBTC) are used in liquidity pools (LPs) on decentralized exchanges (DEXs) across various blockchains. There are also WBTC alternatives, such as tBTC and cbBTC, which aim to address the limitations of WBTC by offering varying degrees of decentralization.
How Much Bitcoin Is Being Put to Work?
Currently, almost 1% of the circulating Bitcoin supply is allocated across wrapped BTC in DeFi, native BTC in L2s, and staked BTC. This equates to nearly $20 billion worth of BTC being actively utilized within decentralized ecosystems, excluding capital locked in centralized exchanges.
In contrast, over 2 million BTC remains on centralized exchanges, where it is deployed in lending programs, structured products, and dual-yield strategies. The difference is stark—while CEX net balances have been on a decline in recent years, they still dominate Bitcoin’s trading volume.
In Short:
- CEX BTC yield → Usually BTC payouts.
- DeFi BTC yield → Typically mixed asset payouts, but NOT BTC.
Conclusion: A Developing, But Not Disruptive Narrative—Yet
While Bitcoin yield opportunities in DeFi are growing, BTC.fi remains a young and relatively small narrative compared to the massive capital still locked in centralized exchanges. Although CEX net balances have been declining, they still hold over 2 million BTC, and centralized platforms continue to dominate Bitcoin trading volume. However, trading volumes have not shown an exponential uptrend, suggesting a shift towards long-term holdings, off-the-books trading, or increased activity in derivatives rather than spot markets. Since Bitcoin itself doesn’t support smart contracts, a fully native on-chain Bitcoin DeFi ecosystem is not yet possible without sidechains, L2s, or bridging solutions.
The broader on-chain economy across EVM and non-EVM chains—such as Ethereum, Solana, and Tron—is rapidly expanding, with increasing daily transactions and a growing user base. Meanwhile, improvements in Web3 wallets, UI/UX, and the efficiency of L1s and L2s are challenging the historical advantages that CEXs had over DeFi.
Yet, Bitcoin—despite being the most dominant crypto asset, controlling over 50% of the total crypto market cap—still sees the bulk of its activity happening on centralized platforms. It seems BTC holders may prefer self-custody post-FTX and other bad actors, but for liquidity, on-ramping, and off-ramping, CEXs continue to lead the way.
The emergence of BTC.fi solutions is gradually shifting some liquidity on-chain. However, given the current landscape, a massive disruption to CEX dominance in Bitcoin trading is unlikely to occur perhaps this year. BTC.fi could gain significant traction in the coming years, its impact remains incremental rather than revolutionary—at least for now. Additionally, the broader financial sector continues to integrate Bitcoin through ETFs, with Coinbase playing a pivotal role as the custodian for a significant portion of these funds. The custodial nature of these services underscores the ongoing reliance on centralized entities for secure and compliant asset management.
We observe Bitcoin continue to predominantly exist within the realm of centralized exchanges and their solutions, reflecting the enduring dominance of CEXs and the ongoing reliance on them due to their superior liquidity and user experience. This is largely because Bitcoin is not Turing-complete and lacks native smart contract functionality, preventing the development of complex trading platforms and DeFi applications directly on its network. Additionally, Bitcoin’s scalability limitations—such as its low transaction throughput and high fees during periods of congestion—further restrict its ability to support a thriving on-chain economy. These challenges have led to the emergence of sidechains, Layer 2 solutions, and tokenized Bitcoin on alternative L1s, which offer ways to integrate Bitcoin into DeFi and scalable financial applications. However, this also results in fragmentation of Bitcoin’s supply across multiple ecosystems, as BTC gets locked, wrapped, or pegged onto different networks.
As we move forward, it will be crucial to remain vigilant for upcoming developments that could provide new avenues for on-chain Bitcoin yield, improved trading infrastructure, and decentralized custody solutions. The race to build a more robust Bitcoin financial layer—BTC.fi—is still in its early stages, and whether Bitcoin’s dominance on centralized platforms can be meaningfully challenged remains an open question.
Disclaimer:
The information provided in this newsletter is for informational purposes only and should not be considered financial, investment, or legal advice. Please consult with a qualified professional before making any investment or financial decisions. Past performance is not indicative of future results, and all investments carry risks, including the potential loss of principal.
