• Decentralized finance has the potential to revolutionize the financial sector – and Bitcoin

  • Without a doubt, the DeFi movement is transforming the financial sector. By transforming traditional financial components into open, transparent protocols across a decentralized network, decentralized finance is well on its way to changing the world of finance as we know it.

    In fact, the total value of DeFi assets is a whopping $54.56 billion, and it appears that this figure is only going to rise. DeFi use cases range from making basic financial services such as loans and insurance available to all to promoting financial inclusion for the general population.

    While borrowing and lending within a peer-to-peer network are the most common use cases for DeFi applications, there are other use cases, such as becoming a liquidity provider for a decentralized exchange. DeFi interest rates are much lower and more appealing when compared to traditional bank loans. You also can’t ignore the fact that DeFi has extremely low entry barriers. Obtaining DeFi loans is a relatively simple process; all you have to do is provide collateral in the form of crypto assets. Users can also provide their non-fungible tokens (NFTs) as collateral, depending on the DeFi protocol they are using.

    While DeFi is still in its infancy and regulation is almost non-existent, several DeFi applications are already making waves in a variety of industries. Bitcoin in DeFi is a concept that has recently gained a lot of traction.

    Because of its advanced smart contract functionality, Ethereum (ETH) is typically used to build most DeFi applications. However, the number of DeFi applications built on top of Bitcoin has increased noticeably. According to DeFi Prime, an analytics firm, at least 26 of the 223 DeFi projects they have listed are Bitcoin-based.

    Taproot, in particular, will be a significant update to Bitcoin’s technology architecture, bringing with it a slew of new features. Taproot’s activation path is unknown, but it is expected to be activated in the near future. Taproot will impact opportunities in smart contracting and thus lay the foundation for future upgrades, in addition to the impact this new upgrade will have on privacy, security, and scalability. Surprisingly, these technological advancements in Bitcoin occur at a time when Bitcoin adoption is also rapidly increasing with each passing day.

    Another issue with Bitcoin is that because it is based on a public blockchain, anyone can monitor transactions. With the Taproot upgrade, Bitcoin will transition from its current ‘elliptic curve digital signature’ algorithm, which consumes more space, to Schnorr signatures, which have the potential to render basic transactions indistinguishable from complex transactions. As a result, transactions will be more anonymous and transparent.

    Distinct log contracts (DLCs), with a specific focus on DeFi on Bitcoin, are another area that has seen a lot of progress recently. A DLC is essentially a type of Bitcoin transaction that uses an oracle to execute a smart contract. As a result, DLCs enable the creation of smart contracts as well as a wide range of other financial contracts such as options and futures.

    A DLC typically enables multiple parties to place wagers on the Bitcoin blockchain. It is necessary for two parties to lock funds in a multi-sig address in order to build a DLC. And these funds can only be used if the oracle provides the requested information on time. Simply put, DLCs work by using the signature of an Oracle message as a private key. This enables the bet winner to sign a transaction using the funds initially committed to the contract by the two counterparties.

    Looking ahead

    Recently, Twitter CEO and co-founder Jack Dorsey announced that his mobile payments company Square will launch a platform that will allow developers to build ‘decentralized finance’ projects based on Bitcoin. This is expected to be one of the first large projects of its kind in the nascent market, with the goal of making the creation of non-custodial, permissionless, and decentralized financial services much easier.

    Another reason that DeFi on Bitcoin is gaining popularity is that Bitcoin is the best type of collateral in the entire world. Bitcoin is extremely secure, transactions are extremely fast, markets never close, and Bitcoin is extremely liquid. This has been the primary motivator for adopting DeFi on Bitcoin. Not to mention that Bitcoin’s security has been developed to a wartime security level.

    Indeed, this is only one of several major DeFi on Bitcoin projects that are expected to be released. There is certainly a lot of growth potential to look out for as more Bitcoin-based DeFi projects launch, and with the Taproot upgrade.

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