Could Bitcoin Become DeFi’s Collateral of Choice? Lombard Finance Says So

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What to know:

  • Ether and its derivatives make up most of the collateral in the DeFi ecosystem.
  • Lombard Finance wants to change that with a new bitcoin yield-bearing token, LBTC.
  • LBTC aims to succeed where wrapped bitcoin (wBTC) struggled.

As someone who has been navigating the complex and ever-evolving world of cryptocurrencies for quite some time now, I find the emergence of LBTC particularly intriguing. The idea of staking bitcoin to generate yield, something that was previously unheard of, is a game-changer in my opinion.

In the realm of blockchain, a potential power struggle over market supremacy could be looming. The query at hand: Which asset class will hold the most value in the Decentralized Finance (DeFi) world?

Currently, as we speak, decentralized finance (DeFi) platforms across all networks collectively hold approximately $126 billion in assets, according to DeFiLlama statistics. This figure is steadily approaching the 2021 peak of $175 billion. The bulk of these locked funds are primarily ether (ETH) and related derivatives such as staked ether liquid tokens (stETH) and wrapped ETH (weETH). Wrapped bitcoin (wBTC) and stablecoins combined hold the third and fourth positions, respectively.

However, the team developing Bitcoin-linked DeFi protocol Lombard Finance plans to disrupt the current landscape with LBTC, a fresh liquid Bitcoin token. As explained by Jacob Philips, one of Lombard’s co-founders, their objective is to unseat ETH and stETH and make Bitcoin the preferred collateral in the entire on-chain economy.

As an analyst, I expressed during my conversation with CoinDesk that Bitcoin serves as the primary collateral in centralized venues, and I don’t see this changing. The question then arises: why isn’t this the case within DeFi (Decentralized Finance)? My reasoning is that Bitcoin excels at one thing – it provides a stable store of value, making it an ideal collateral. Therefore, there’s no justification for not constructing DeFi platforms around Bitcoin.

2021 has been quite remarkable for Bitcoin, with its price jumping approximately 124% since January 1, largely due to supportive political conditions in the U.S. and the exceptional performance of its nearly year-old spot exchange-traded funds. Conversely, Ether has struggled to keep pace, managing a rise of just 48% during the same timeframe, despite having a market capitalization four times smaller than Bitcoin. As interest in Bitcoin continues to grow, fueled by rumors about the possible creation of a U.S. strategic bitcoin reserve under the incoming Trump administration, it’s not unreasonable to speculate that its influence within the blockchain ecosystem could expand further.

That, in turn, could transform the way DeFi as a whole operates.

In simpler terms, Philips predicts that Bitcoin will be a significant source of funds for all Decentralized Finance (DeFi) platforms across various blockchains. He refers to this as a substantial influx of fresh capital. Noting Bitcoin’s market cap of nearly $1.9 trillion, he suggests that even if only a fraction of this amount is directed towards DeFi, it would greatly boost the ecosystem’s activity and potentially make DeFi protocols’ liquidity comparable to that found on centralized exchanges through passive investment.

Bitcoin with a yield?

One significant distinction between Bitcoin and Ethereum lies in the ability to “stake” Ethereum on its own network, a process that aids in securing the blockchain. In simple terms, this means keeping your Ethereum assets idle for this purpose. As a reward for contributing to security, you’ll receive Ether as interest. At the moment, staked Ethereum is offering an annual yield of approximately 3.19%, according to CoinDesk’s composite Ethereum staking rate (CESR) index.

As a crypto investor, I’m always on the lookout for opportunities beyond Bitcoin itself. That’s why I’m excited about Lombard, a project that aspires to introduce a yield-generating Bitcoin token. This is made possible through Babylon, a protocol they’ve developed, which enables users like me to stake Bitcoin not just for its own security, but also to contribute to the security of other blockchains.

It goes like this: Users give Lombard some bitcoin, Lombard stakes these coins through Babylon, then it mints one LBTC token for each BTC staked. These LBTC tokens follow the ERC-20 standard, meaning they can be used across Ethereum and all of its protocols.

As an analyst, I’ve been following the developments surrounding Babylon’s blockchain ecosystem. According to Coleman Maher, the growth lead at Babylon, nine projects – Corn, BOB, Cosmos Hub, Nubit, Fiamma, Manta, LayerEdge, Chakra, and Pell – have either started or completed integration with Babylon’s development network (devnet). These integrations are expected to go live next year, following Babylon’s layer 1 mainnet launch. This means that these projects will potentially be part of the Babylon ecosystem, which could imply that they might participate in the interest rate payments facilitated by the secured blockchains within Babylon.

Currently, Babylon isn’t distributing staking rewards, but its value has still grown to a staggering $5.4 billion, placing it as the 10th largest DeFi protocol in terms of value locked, as reported by DeFiLlama. This eagerness among people to secure their bitcoin within Babylon might be due to its points program. By depositing early, users could potentially receive an airdrop. However, the Babylon team has remained silent on whether a token will ever be introduced.

Fierce competition

From the total $6 billion invested in Babylon, approximately $1.4 billion was channeled via Lombard to generate LBTC tokens. At this point, since there are no staking rewards issued by Babylon, these tokens currently don’t offer any return.

According to Philips, users aren’t deciding to invest in ether or bitcoin solely based on staking returns. Instead, they are making these choices for a variety of reasons, such as the possibility of a U.S. bitcoin reserve and regulatory attitudes towards the two assets. The yield serves as an additional incentive, similar to a cherry on top.

It’s worth mentioning that users of DeFi platforms can currently utilize Bitcoin as collateral, even though it doesn’t earn any interest, due to wrapped Bitcoin. As we speak, the total value of wBTC is approximately $12.9 billion, which represents a mere 22% gap from its record high in 2021. This close proximity to its all-time-high market cap comes despite speculations that BitGo, the issuer of wBTC, is jointly managing the stored Bitcoin with BiT Global, a company partially owned by Justin Sun – a person who has faced allegations of fraud and manipulation in U.S markets.

As for December 6, Lido data indicates that wBTC accounted for approximately $5.7 billion in collateral across major DeFi protocols, whereas a staggering $14.5 billion was tied up in ETH and $11.1 billion in stETH. Notably, “wrapped ether” or eETH, a relatively novel liquid token that enables users to enjoy EigenLayer restaking rewards concurrently with native ETH staking returns, boasted a collateral value of $5.8 billion.

To put it simply, stETH and weETH have gradually been taking over a larger portion of the market from other coins. A recent report by ARK Invest suggests that the entire Decentralized Finance (DeFi) sector is shifting towards stETH and the returns offered by staked ETH. Tokens such as Solana’s SOL or Avalanche’s AVAX provide higher interest rates for staking, which might indicate that they are riskier to hold over a prolonged period due to their volatility.

In simpler terms, the rise of stETH has put stress on stablecoin lenders, according to ARK Invest. This is due to MakerDAO (now Sky) increasing the interest rate for locked DAI, while the rewards for lending stablecoins on Aave and Compound have increased. The reason being, users prefer to lend stETH and borrow stablecoins instead of directly lending stablecoins.

Apart from the diverse money market funds based on tokenization that financial titans like BlackRock and Franklin Templeton are working on, these might eventually enable DeFi users to access U.S. Treasury bills and utilize the tokens as collateral.

In essence, LBTC is encountering intense rivalry. However, Philips posits that the token could thrive where wBTC has faltered, owing to an additional boost provided by its yield. Essentially, he suggests that staking rewards will eventually be generated with LBTC’s yield anticipated to be on par with the ETH staking rate.

Philips stated, “Lombard aims to encourage individuals to move their Bitcoin from the coldest storage into on-chain finance for a start. Once they do, we’ll introduce them to robust protocols, even safer than banks, that are already in existence. Despite the potential risk of yield reduction, LBTC as an asset, capable of generating any level of return, would still be enticing.

The proposal has sparked quite a bit of curiosity. Lombard successfully gathered $16 million this summer from several prominent investors, such as Polychain Capital, Franklin Templeton, and Nomad Capital. Philips noted that those already involved in Decentralized Finance (DeFi) were particularly interested. “Individuals who have experimented with cryptocurrencies find it relatively simple to become engaged with bitcoin staking, or at the very least, they are quite receptive to the discussion.

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2024-12-20 19:50