Betting on Bitcoin Defi

Bitcoin Defi will emerge as a prevailing narrative in the coming months.

As Stacks’ founder Muneeb Ali recently tweeted, “As Bitcoin grows from a $2T to a $5-10T asset in the coming years, the market opportunity for institutional BTC defi and fast payment rails for BTC remain large. Whichever network captures institutional BTC defi and BTC payment rails should be worth hundreds of billions in the long term.”

Hivemind has long been bullish on this opportunity for Bitcoin programmability and defi, having invested in leaders advancing Bitcoin’s potential, such as Stacks, Trust Machines, Hiro, ALEX, Luxor, and more soon-to-be-announced projects. Years of Bitcoin ecosystem development towards this vision have finally led to an inflection point.

As more institutional capital flows into BTC, demand is growing among institutional, corporate, and retail investors to earn secure BTC yield. At the same time, emerging tech advancements to Bitcoin programmability are finally enabling BTC holders to earn yield on their BTC without sacrificing its security.

As Bitcoin’s utility expands beyond a store of value into yield generation, the significant capital inflows into BTC as an asset will soon start to trickle down to investment and activity within the Bitcoin ecosystem. This will unlock Bitcoin’s massive ~$2T market for additional use cases, including yield generation.

Below, I break down the demand and supply drivers fueling Bitcoin Defi and where we believe the biggest investable opportunities are forming in this sector.

Demand: Institutions, Corporations, Retail

Bitcoin was the best-performing asset over the last decade with unparalleled returns of 26,931% vs S&P 500’s 193%. Its record performance has captured the interest of institutions, retail, and governments. Recent crypto-friendly regulatory shifts around the world, the launch of Bitcoin ETFs in the US, and the recent formation of a US Strategic Bitcoin Reserve have further accelerated Bitcoin adoption by removing regulatory barriers and providing legitimacy, staying power, and access.

Now, institutional, corporate, and retail investors are actively seeking secure ways to earn yield on their BTC holdings. While these BTC yield opportunities are just starting to emerge, early evidence of demand in this category includes the $5.7B TVL currently in Bitcoin defi (Babylon comprises $4.6B of this) and a recent TwinStake survey reflecting that 43% of institutions are exploring potential BTC yield opportunities. Anecdotally, our team has had many conversations with institutions and corporations that have expressed demand for BTC yield. Institutions seeking investment opportunities that can generate more consistent returns can finally utilize Bitcoin as more than a store of value, adding BTC yield opportunities to their existing managed portfolios for greater diversification and growth potential.

In addition to businesses seeking BTC yield through various off-chain approaches, such as lending and leveraged Bitcoin treasury strategies, there are a growing number of on-chain BTC yield opportunities emerging for both institutional and retail investors. These include on-chain lending and borrowing, liquidity provisioning, market making, staking, and spot and perp trading.  

Supply: Bitcoin Native Programmability

It’s no surprise that Bitcoin remains the dominant cryptocurrency by market cap but trails behind other ecosystems in terms of on-chain metrics and ecosystem activity.  

Bitcoin (in orange) vs other chains by Fees and TVL:

The chain is simplistic and inflexible by design, prioritizing its security and decentralization over scalability and programmability. This presents a very challenging environment for developers to build ecosystem projects, which explains why Bitcoin’s value as a secure store of value has appreciated, while its ecosystem has seen little growth.

However, recent technical improvements & advancements have created new opportunities for Bitcoin programmability:  

• SegWit Upgrade in 2017: Soft fork that addressed transaction malleability and indirectly increased block size, allowing for greater throughput and decreased Bitcoin transaction times.
• ‍Taproot Upgrade in 2021: Soft fork that enhanced Bitcoin’s privacy, efficiency, and scalability through Schnorr signatures, which allows for smart contract-type abilities. ‍
• Taproot Assets in 2022: Protocol developed by Lightning Labs for multi-asset issuance on Bitcoin.  ‍
• Ordinals in 2023: Metaprotocol enabling content or data to be inscribed to individual Bitcoin satoshis. ‍
• Runes in early 2024: Metaprotocol for an efficient, scalable UTXO-based fungible token standard. ‍
• Stacks’ Nakamoto Upgrade & sBTC launch in late 2024: Upgrade that improved the L2’s transaction speed while securing transactions by 100% of Bitcoin’s hash power.   ‍
• OP_CAT and BitVM(2) likely in the future: OP_CAT is a proposed soft fork that would enhance native L1 smart contract functionality. BitVM(2) aims to use ZK to enable secure Bitcoin L1<>L2 bridging without requiring a soft fork to Bitcoin.

Given these innovations, it is finally becoming possible for Bitcoin L1 to support native defi opportunities, thus enabling Bitcoin holders to earn yield on their BTC without sacrificing its security.

Below, we dive into: 1) the current Bitcoin defi landscape, 2) which segments within Bitcoin defi we categorize as ‘Bitcoin native’ defi opportunities, and 3) why we see this as an important distinction with regard to our investment thesis in the Bitcoin ecosystem.

The Bitcoin Defi Landscape

Bitcoin defi can be broken into 2 overarching categories based on the infrastructure/ecosystem that a defi project chooses to build on: 1) generate BTC yield by bridging BTC to other ecosystems for yield-gen opportunities, and 2) generate BTC yield natively on assets and protocols secured by Bitcoin L1.  

Let’s dive deeper into each of these categories:

1. BTC yield via bridging to other ecosystems  

This general concept has been around for years, starting with the first wrapped Bitcoin WBTC, but new approaches continue to emerge as this space evolves. The biggest trends in this category over the last two years have been defi projects building on various iterations of Bitcoin EVM L2s and defi projects building on Babylon.  

These defi projects bridge a derivative of BTC to another ecosystem, but in doing so, introduce smart contract, centralization, and other potential risks while relinquishing Bitcoin’s security. Even if the actual BTC holdings stay locked on Bitcoin L1 (as is the case with Babylon ecosystem projects), if a user loses their BTC derivatives while interacting in another ecosystem, they are unable to redeem their original BTC. Additionally, many of these defi projects bridge assets using a multi-sig that they control, introducing significant additional risk.  

Due to the magnitude of risks associated with bridging assets for BTC yield, Hivemind prioritizes native BTC yield opportunities that fall under category 2, below.

2. Native BTC yield via Bitcoin L1

This concept has been envisioned for years but has only recently become feasible with technical advancements. Given that the Bitcoin ecosystem is still in its early development phase, we at Hivemind have adopted a flexible framework for identifying 'Bitcoin-native' opportunities. We believe that Bitcoin native infrastructure/ecosystems enhance Bitcoin programmability, while minimizing trust assumptions more than their counterparts in category 1. They more closely inherit Bitcoin L1 security through various approaches, none of which depend on upgrades to Bitcoin’s core architecture (i.e. OP_CAT).

Our definition of Bitcoin native ecosystems encompasses:  

• Metaprotocols (Ordinals, Runes, BRC-20s, etc): L1 native programmability via inscriptions, UTXO transactions, or other means. ‍
• First Mover Bitcoin L2s (Stacks & Lightning Network): Stacks can read Bitcoin L1 state and is 100% secured by Bitcoin finality. Lightning Network utilizes BTC as its network token and enables unilateral exit; additionally, the Taproot Assets protocol equips it with greater programmability and multi-asset issuance capabilities. Both chains have also been battle-tested over several years. ‍
• Trust-Minimized ZK Bridges (Bitcoin OS, QED, Fiamma, Strata, Citrea, Starknet, etc): BitVM and other ZK-based Bridging solutions enable more secure asset transfers between Bitcoin L1 and other L1 / L2 ecosystems using a combination of smart contracts, ZK, and fraud proofs.  

Of course, none of these Bitcoin-native ecosystems are fully trustless or without risk. They employ new, experimental tech and may introduce additional trust assumptions, such as using off-chain indexing or small operator/validator networks. We expect that some of these risks will be minimized over time as these ecosystems evolve.

The ‘Bitcoin Native’ Opportunity

At Hivemind, we see strong long-term potential for ‘Bitcoin-native’ ecosystems and the defi protocols building on them. These will continue to be among the dominant Bitcoin ecosystems long-term because: 1) Bitcoin L1 is not going anywhere, 2) first-mover Bitcoin L2s have already stood the test of time and continue to innovate to enhance their programmability and security, and 3) emerging trust-minimized bridges have the potential to open up Bitcoin’s ecosystem to the entire on-chain crypto community of users, liquidity, apps, and protocols, further strengthening Bitcoin’s security and dominance long-term.  

We believe these ecosystems have a higher likelihood of long-term viability than newer Bitcoin L2s, where ecosystem risk is less understood and competitive moats may only be defensible short-term. Should a number of newer Bitcoin L2s take off in the future, Bitcoin native defi projects can expand to these additional chains while still retaining Bitcoin security for their activity on Bitcoin L1.  

Bitcoin Defi Opportunities: Today & in the Future

As you can see from the market map above, Bitcoin native defi is still in its infancy today, with limited competition in some sub-categories. We expect this map to become increasingly crowded in the coming months and years as Bitcoin ecosystem investment and trading activity accelerate. Below are several emerging sub-sectors and catalysts that we expect will contribute significantly to Bitcoin defi activity in the future:

• Stablecoins: The Bitcoin ecosystem has historically lacked support for native stablecoins, which has significantly limited on-chain trading activity and use cases. Stablecoins offer a reliable medium for transactions and allow traders to quickly convert between assets without experiencing the volatility often associated with Bitcoin. This liquidity is essential for fostering a vibrant trading environment, as it supports price stability and encourages more participants to engage in the market, thereby enhancing overall adoption and utility.  

We are just starting to see Bitcoin native stablecoins emerge, such as Ducat Protocol’s UNIT stablecoin, which is natively issued on the L1 and secured by a user’s BTC holdings. Additionally, Tether just made a major announcement that they will be launching USDT natively on both Bitcoin L1 and Lightning Network, powered by Taproot Assets. USDT will inherit Bitcoin's security while benefitting from Lightning's speed and scalability. This move will position USDT at the center of the emerging Bitcoin defi space, providing much needed liquidity across the Bitcoin ecosystem, and putting Lightning Network and Taproot Assets back in the spotlight. It will also connect Bitcoin to other ecosystems and usher in additional liquidity from other chains.  

• Payments: Bitcoin is increasingly being sought as a viable option for settling on-chain payments. Leveraging the security of Bitcoin L1 with the efficiency of ‘near-native’ L2 scaling solutions such as Lightning Network and newcomers Spark (by Lightspark) and Ark presents a compelling payments solution. USDT’s native integration also brings renewed potential for payments to become a promising use case on Bitcoin. ‍
• Tokenization of RWAs: Tokenized real-world assets, a market predicted to reach $30T by 2030, presents a massive opportunity for the Bitcoin ecosystem to capture. As institutions invest more heavily into tokenized RWAs, security remains their top priority, and Bitcoin is well-suited to deliver on this. The emergence of RWAs in Bitcoin will bring far greater functionality, utility, and yield-gen opportunities to the Bitcoin ecosystem, contributing towards a thriving, active, and liquid network. Tokenized RWAs will also increase and diversify fee revenues for the Bitcoin ecosystem, further strengthening Bitcoin’s long-term security. ‍
• Institutional Tools: One of the biggest impediments to Bitcoin native defi adoption today is that many major exchanges and custody providers have not implemented Taproot support for Bitcoin deposits and withdrawals, meaning that they do not support the new token standards such as Runes, Ordinals, SIP10, STX20, etc. that have been developed with the Taproot Upgrade. Institutions that are legally required to use custodians are therefore unable to participate in these Bitcoin native opportunities. Coinbase recently enabled Taproot support, alongside OKX, Kraken, Bitfinex, BitMEX, Blockchain.com, and Magic Eden. However, Binance, Crypto.com, Gemini, and other exchanges have yet to follow suit. A further impediment is that exchanges with ‘Taproot support’ enable users to send Bitcoin to their Taproot Wallets, but only the Taproot Wallets have native support for new Taproot-enabled token standards. Ideally, in the future, all major exchanges and custody providers will enable Taproot support, as well as support for new Taproot-enabled tokens. This will make the Bitcoin ecosystem significantly more accessible to users. With these implementations and growing demand for secure BTC yield, we expect that more institutional products, tools, and features will come to market to enhance the ways in which the growing institutional market can participate in native Bitcoin defi.  

Wrapping It Up

We are on the cusp of a huge opportunity as Bitcoin enters its Phase 2: Programmability & Yield. Technical progress has finally made native BTC yield opportunities possible, and these opportunities are being met with ample demand from retail and institutional investors alike. It’s a perfect time to be investing in this space.

At Hivemind, we are actively investing in the promising first-movers and future category leaders of Bitcoin Native Defi. Stay tuned for more of our Bitcoin research and funding announcements soon. In the meantime, if you’re building or investing in projects in this space, I’d love to connect on X @kay_phillips_, DMs are open!