A war for on-chain market dominance may develop. The question: What will be the collateral of choice in the decentralized finance (DeFi) economy?
At press time, DeFi protocols exist in all ecosystems locked in worth nearly $126 billion, according to DeFiLlama data, getting closer every day to their 2021 high of $175 billion. Most pledged funds get the form of ether (ETH) and derivatives such as yield-producing staked ether liquid tokens (stETH) and wrapped eETH (weETH), with wrapped bitcoin (wBTC) and stablecoins overall competing for fourth and fifth place.
But the team behind Bitcoin-based DeFi protocol Lombard Finance wants to shake things up with LBTC, a new liquid bitcoin token. The idea, according to Lombard co-founder Jacob Philips, is to dethrone ETH and stETH and install bitcoin as the collateral choice throughout the on-chain economy.
“In centralized areas, bitcoin is the primary collateral. There is no question about it. Why isn’t this the case with DeFi?” Philips told CoinDesk in an interview. “Bitcoin only does one thing, and that’s being a stable store of value. It’s the perfect collateral. There’s no reason we shouldn’t build of DeFi on top of bitcoin.”
Bitcoin has had a torrid year, gaining 124% since January 1 thanks to political tailwinds in the US and the massive success of its nearly year-old spot exchange-traded fund. Ether, for its part, underperformed “only” rising 48% over the same time period, despite being four times smaller in terms of market capitalization. With demand for bitcoin increasing by the day — and chatter continuing to increase about a potential US bitcoin reserve under the incoming Trump administration — it’s not crazy to think that the asset could play a bigger role on – chain.
That, in turn, could change the way DeFi as a whole operates.
“Bitcoin will be the next big source of liquidity for every DeFi protocol, on every chain. It’s a massive influx of net new capital,” Philips said. Noting that bitcoin has a market cap of close to $1.9 trillion, he said: “Even if we only get a fraction of that, it’s still going to put a ton of new activity into the ecosystem and make DeFi better — maybe get to the point where DeFi protocols, through passive liquidity, compete with liquidity on centralized exchanges.”
Bitcoin with yield?
A big difference between bitcoin and ether is that you can lock the latter asset into the Ethereum network — a process called staking — to help secure the blockchain, and earn interest, paid in ETH. At press time, staked ether offers a 3.19% yield annually, according to CoinDesk’s composite ether staking rate (CESR) index..
The Bitcoin network does not offer such capabilities, but Lombard aims to provide a yield-bearing bitcoin token through Babylon, a protocol designed to let users stake bitcoin in order to secure other blockchains.
It goes like this: Users give Lombard some bitcoins, Lombard stakes these coins through Babylon, then it prints one LBTC token for each BTC staked. These LBTC tokens follow the ERC-20 standard, meaning they can be used on Ethereum and all its protocols.
That interest rate on LBTC will be paid by blockchains secured through Babylon, or so the theory goes. Nine different projects — Corn, BOB, Cosmos Hub, Nubit, Fiamma, Manta, LayerEdge, Chakra and Pell — have begun or completed integration into Babylon’s blockchain development environment, or devnet, so far, Coleman Maher said. leading growth in Babylon, CoinDesk. . These integrations should go live next year, after Babylon’s own layer 1 goes live.
Babylon does not provide any staking rewards at the moment, but this has not stopped the protocol accumulating $5.4 billion in value, making it the 10th largest protocol by value locked in all of DeFi, according to DeFiLlama. So why are people so eager to lock up their bitcoin in Babylon? Possibly because it runs a points program, meaning early depositors can receive an airdrop. The Babylon team did not comment on whether a token would be issued.
Intense competition
Of the $6 billion at stake in Babylon, over $1.4 billion is plugged in through Lombard to create LBTC tokens. In the absence of staking rewards provided by Babylon, these tokens have yet to yield any yield.
“Users don’t choose to hold ether or bitcoin based on staking yield alone,” Philips said. “There are much broader reasons why they choose one or the other,” such as bitcoin’s potential reserves in the US and regulators’ views on the two assets. “And the yield is a little cherry on top.”
It is important to note that DeFi users can now use bitcoin as collateral (although without any yield) thanks to wrapped bitcoin. At press time, wBTC’s market capitalization reached $12.9 billion. It is only 22% away from its 2021 all-time-high, despite concerns that wBTC’s issuer, crypto custody and trading firm BitGo, is sharing custody of the underlying bitcoin with BiT Global, an entity partially owned by TRON founder Justin Sun. Sun has been accused of fraud and market manipulation in the US
However, on December 6, wBTC just accounted for for $5.7 billion worth of collateral in some of the biggest DeFi protocols, per Lido data, while $14.5 billion in ETH is in use, and $11.1 billion worth of stETH. Even “wrapped ether,” or eETH — a relatively new liquid token that allows users to benefit from EigenLayer recapturing rewards in tandem with native ETH staking yields — provided $5.8 billion in collateral.
In fact, stETH and weETH are slowly eating into the market share of other coins, to the point that ARK Invest stated a recent report that the entire DeFi economy is reorganizing itself around stETH and the benchmark yield provided by staked ETH. Other tokens — such as Solana’s SOL or Avalanche’s AVAX — offer higher interest rates for staking, the implication being that these assets, which are more volatile, are riskier to hold in long time.
Stablecoin lenders are also feeling pressure from stETH’s surge, says ARK Invest, along with Sky (HEAVEN) (formerly MakerDAO) increases DAI’s locked interest rate, while rewards for lending stablecoins to Aave (ghost) and Compound (comp) has grown, as users prefer to lend stETH and borrow stablecoins rather than lending stablecoins directly.
Not to mention the various tokenized money market funds developed by financial giants such as BlackRock and Franklin Templeton, which could lead to allowing DeFi users to gain exposure to US Treasury bills and use such tokens as collateral.
So LBTC is facing tough competition. But Philips said the token could succeed where wBTC has struggled thanks to the extremely small boost its yield provides. “The staking yield will be generated in time. The LBTC yield is expected to be in the range of the ETH staking rate,” he said.
“Lombard’s first goal was just to get people to get their bitcoin out of the coldest cold storage, and just take the most primitive step into on-chain finance. And then we’ll show you the battle-tested protocols, safer than your bank, that exist out there,” added Philips. “It is possible that the harvest will dry up. LBTC as an asset, producing any amount of yield, will be an attractive asset.”
The pitch was certainly met with interest. Lombard raised $16 million this summer from some heavy hitters, including Polychain Capital, Franklin Templeton and Nomad Capital. Philips says entities familiar with DeFi are the most enthusiastic. “Anyone who has dabbled in crypto, this is an easy pitch to get them on board for bitcoin staking. Or at least they are very open to the conversation.”
