What Is BTCFi? Meaning, Use Cases, Benefits, and How It Works Explained

The ‘security’ of the Bitcoin network and the ‘liquidity’ of Bitcoin remain as two of the prominent reasons behind Bitcoin becoming the most used digital currency. However, in most cases the Bitcoins just remain ideal in the digital wallets or in its best use case - Bitcoins are used to transfer funds between two entities. People found out that it would be groundbreaking if they could combine features of Bitcoin, such as security and liquidity with a decentralized finance system. And the result we got is BTCFi. Curious to know ‘what is BTCFi’ - keep reading this post till the end to get all your queries answered.

An Introduction to BTCFi

BTCFi brings two concepts together - Bitcoin and decentralized financial systems. Using the advantages of the respective technology, we can make payments, lend or borrow funds and all these would not require a third-party entity.

To properly understand BTCFi, one needs to dive down a bit into a decentralized finance system.

Decentralized finance & its core concept:

The financial system we currently use in our daily life has a central authority who with their complete control over the system supervises the entire system. This financial system, which we now refer to as the traditional financial system, has banks and other financial institutions.

In the recent time, developers have created a completely new financial system based on blockchain in which there is no central authority regulating the transactions - this new digital financial system is known as decentralized finance or DeFi.

How does BTCFi work?

In the following lines we are going to see exactly how Bitcoin operates on the decentralized finance system.

Tokenization: The blockchain network in which Bitcoin operates isn't quite suitable for DeFi transactions, primarily due to the reason that it doesn’t extensively support smart contracts. That’s why for Bitcoin to work on DeFi, first the Bitcoins are tokenized. Bitcoin tokenization is a process in which Bitcoins are represented by digital token on another blockchain network (preferably the ones which support smart contracts), for example: on an Ethereum network. In other words, tokens represent the ownership of a certain amount of Bitcoin. In our case with BTCFi, Bitcoins are often tokenized into wrapped tokens which enables it to be used in DeFi systems.

Borrowing: Now a user can take a loan against the Bitcoin they have without needing to sell them in the first place. Smart contracts determine how much loan the borrower will get, it also determines the interest rate that the borrower has to pay. If the borrower fails to repay the debt within a given time limit, the deposited bitcoin is then debited.

Yield generation: One of the best implementations of BTCFi is that Bitcoin owners can now earn bank-like interest from Bitcoin through yield-farming instead of the coin sitting idle in their digital wallet. We have discussed more about that later in this post.

BTCFi vs Traditional Finance

BTCFi and traditional finance stand on two opposite poles based on their underlying mechanisms and rules. Here we have presented the most notable differences between BTCFi and traditional finance.

Security: As discussed, BTCFi packs with it the security of the blockchain network. The transaction ledger on Bitcoin’s blockchain network is technically free from any-kind of temperament. If a transaction is once registered on the blockchain, it is almost next-to-impossible to temper the transaction details.

On the other hand, in a traditional banking or finance system, as everything is operated by a central authority there’s a greater chance of data breach.

Transparency: BTCFi beats traditional finance systems in terms of transparency too. Every transaction record on a blockchain remains available on every active node of the blockchain, thus ensuring a complete transparency. But, in the traditional finance system, there’s very little to no transparency for transactions made.

Transaction cost: (In most cases) Traditional finance systems change the user for every transaction made. The cost increases on the basis of amount or if the user wants to make a cross-border payment. However, compared to these charges, the charges of transacting over BTCFi is very nominal.

Transaction speed: Traditional banking system may take days to complete a fund transfer, if it’s an international fund transfer, the complete process takes even more time. In contrast, BTCFi transfers funds almost instantly.

Blockchain BTCFi Applications

Loans : Using BTCFi users can opt for a loan by depositing their Bitcoins into smart contracts. The smart contracts act as a transparent entity and determine the loan opportunity based on the value of Bitcoin an user deposited. It determines the loan amount, loan interest rate.

Yield generation: Using BTCFi, users can lend, stack and farm yield to generate yield and make money out of Bitcoin.

Lending: To lend their Bitcoins, BTCFi users deposit their Bitcoin in a decentralized lending platform. All the amount of Bitcoin that an user deposits goes into a deposit pool from which it is distributed among the borrowers. The lenders earn interest based on the amount of Bitcoin they had deposited into the deposit pool.

Staking: Users can create digital tokens for their Bitcoin or use their existing version of Bitcoin and can stake Bitcoins for the Bitcoin decentralized network to perform better. When users participate in stacking contracts, the Bitcoins are locked so that the users can not transact using the Bitcoins, instead the coins are usually pooled with other digital currencies for various DeFi operations. For participating in the stacking contracts and for locking up their assets, users are rewarded with Bitcoins are other tokens - the reward system as explained mainly depends on the user’s contribution of funds in the stacks.

BTCFi Technology Adoption

To get BTCFi integrated in the day-to-day life of common people, it needs to be adopted by everyone - including large financial institutions.

Cross-chain bridging: Cross-chain bridging demolishes the constraint of Bitcoin that it could not be used outside its native blockchain. Now Bitcoins are tokenized and can be used as a blockchain that has native support for smart contracts and the blockchain that can be programmed - like the Ethereum blockchain.

For example, the Ren Protocol can be used to create tokens like renBTC representing Bitcoin by 1:1 proportion. With tokens like renBTC, users can perform activities mentioned above, extending BTCFi use cases which was otherwise not possible on traditional Bitcoin blockchain.

Institutional support : As a promising technology, large financial institutions are looking for ways to integrate BTCFi and Decentralized finance in their companies. Finance giants like Blackrock are already into it - Blackrock has introduced their Bitcoin ETFs for users to experience Bitcoin and DeFi and the users don’t even need to purchase Bitcoins for that. Countries like EL Salador have already adopted Bitcoin as a legal tender along with their national currency. However, the US government has not yet clarified the rules and regulations that would be imposed on BTCFi and decentralized finance.

BTCFi benefits

Apart from yield generation, BTCFi has plenty of other benefits too, including:

International availability: BTCFi has emerged as an international payment medium. Unlike traditional digital wallets, BTCFi can be used irrespective of the user’s region - all you need is an internet connection.

Cost-effective: BTCFi is much more cost-effective than traditional finance and remittances systems. The loan interest rates are also much lesser if you are taking a loan through BTCFi.

No central authority: The non-presence of a central authority in the BTCFi system is the reason why users have to pay less interest on the loan taken against their deposited Bitcoins. The non-existence of the central authority also gives users the freedom to make their own decisions with their funds.

Phần kết luận

We hope that our readers have been able to understand BTCFi's meaning through this blog post. Every new technology progresses at its own pace for it to be adopted by the mass. As a growing technology, BTCFi has the power to revolutionize our financial system and eventually establish itself as a prominent alternative to our traditional finance system.

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Frequently Asked Questions:

What is the main difference between BTCFi and investing in Bitcoin?

The only way to earn from Bitcoin investing is through capital gain, that is: you'll earn if the value of Bitcoin goes above your buying price. But, in BTCFi, you have several options to earn, including lending your Bitcoin, interest, etc.