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 a seasoned crypto enthusiast who has navigated the volatile waters of digital assets for years, I must say that the emergence of LBTC and other innovative DeFi solutions is truly intriguing. Having witnessed the rise and fall of numerous projects, I am always on the lookout for the next big thing that could disrupt the status quo.

In the world of decentralized finance (DeFi), a fierce competition for market supremacy might be emerging. The query at hand: Which asset will serve as the preferred security in this decentralized economy?

Currently, at the moment of this report, decentralized finance (DeFi) protocols throughout all networks have locked approximately $126 billion in worth, based on DeFiLlama statistics. This amount is steadily approaching its 2021 peak of $175 billion. The main portion of these pledged funds are held as ether (ETH) and related assets like staked ether liquid tokens that generate yield (stETH) and wrapped eETH (weETH). Wrapped bitcoin (wBTC) and stablecoins collectively occupy the fourth and fifth positions in terms of value.

however, the team developing Bitcoin-linked DeFi protocol Lombard Finance plans to disrupt the current landscape with LBTC, a novel liquid form of Bitcoin. The aim, as stated by Jacob Philips, one of Lombard’s co-founders, is to challenge Ethereum and stETH’s dominance and establish Bitcoin as the preferred collateral across the entire on-chain economy.

In centralized platforms, Bitcoin serves as the primary collateral without any debate. However, this isn’t the case in Decentralized Finance (DeFi). Philips explained to CoinDesk in an interview, “Bitcoin excels at one thing – being a reliable store of value. It is an ideal collateral. So, there’s no justification for not constructing DeFi on Bitcoin’s foundation.

2021 has been an impressive year for Bitcoin, with its value soaring by 124% since January 1st, largely due to supportive political climate in the U.S. and the thriving performance of its near one-year-old spot exchange-traded funds. In contrast, Ether has seen more modest growth, increasing “only” by 48%, despite having a market capitalization four times smaller. The growing interest in Bitcoin, along with speculation about a potential U.S. government-held Bitcoin reserve under the new Trump administration, suggests that this asset might take on a larger role within blockchain networks.

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

Philips stated that Bitcoin is expected to become a significant source of funds for every Decentralized Finance (DeFi) system, across all blockchains. He referred to this as an enormous influx of fresh capital. Noting Bitcoin’s market cap of nearly $1.9 trillion, he suggested that even if just a fraction of this amount is absorbed, it would generate substantial activity within the ecosystem and potentially make DeFi protocols, through passive liquidity, competitive with the liquidity found on centralized exchanges.

Bitcoin with a yield?

One key distinction between Bitcoin and Ethereum lies in the ability to secure or “stake” Ethereum on the Ethereum network itself. This process aids in maintaining the blockchain’s security, and as a reward, you receive Ether, paid out in the form of interest. As of now, staked Ethereum provides an annual return of approximately 3.19%, according to CoinDesk’s composite Ethereum staking rate (CESR) index.

As an analyst, I’m excited about the potential of Lombard, a groundbreaking protocol that aspires to introduce a yield-generating Bitcoin token. Unlike the Bitcoin network itself, which doesn’t offer such capabilities, Lombard allows users to stake their Bitcoins with Babylon, thereby contributing to the security of other blockchains.

Users send bitcoin to Lombard, which in turn uses these bitcoins as collateral via Babylon. Subsequently, Lombard creates one LBTC token for every BTC that was staked. These LBTC tokens conform to the ERC-20 standard, allowing them to be utilized across Ethereum and all of its associated protocols.

As a crypto investor, I’m excited about the prospect of earning interest on LBTC, which is said to be paid by the blockchains secured through the Babylon platform. So far, nine projects – Corn, BOB, Cosmos Hub, Nubit, Fiamma, Manta, LayerEdge, Chakra, and Pell – have integrated with Babylon’s development environment, also known as devnet. According to Coleman Maher, growth lead at Babylon, these integrations are expected to go live next year, following the launch of Babylon’s layer 1 blockchain. This integration could potentially bring a new wave of opportunities for crypto investors like myself.

Currently, Babylon isn’t distributing staking rewards, but its value has reached $5.4 billion, placing it as the 10th largest DeFi protocol by value locked, as reported by DeFiLlama. One might wonder why individuals are keen on depositing their Bitcoin in Babylon. It could be due to its points program, which may potentially lead to an airdrop for early depositors. However, the Babylon team has remained silent on whether they will ever release a token.

Fierce competition

From the total $6 billion invested in Babylon, approximately $1.4 billion was channeled through Lombard to generate LBTC tokens. At this point, since there are no staking rewards issued by Babylon, these tokens currently do not offer any returns.

According to Philips, users aren’t opting for ether or bitcoin solely because of the staking return. Instead, there are numerous factors influencing their decision, including potential U.S. bitcoin reserves and regulatory attitudes towards the assets. The yield serves as an additional incentive, much like a cherry on top.

It’s worth mentioning that DeFi users currently have the option to utilize Bitcoin as collateral, albeit without earning any returns, due to the use of wrapped Bitcoin (wBTC). As we speak, wBTC’s total market value is approximately $12.9 billion, which represents a mere 22% gap from its record high for the year. However, there are concerns about wBTC’s issuer, BitGo, who is jointly responsible for holding the Bitcoin with BiT Global, an entity that has ties to TRON founder Justin Sun. Sun has been implicated in allegations of fraud and market manipulation within the U.S. jurisdiction.

Even so, as of December 6, wBTC only accounted for $5.7 billion worth of collateral in some of the largest DeFi protocols, per Lido data, whereas $14.5 billion in ETH was being used, and $11.1 billion worth of stETH. Even “wrapped ether,” or eETH — a relatively new liquid token that allows users to benefit from EigenLayer restaking rewards at the same time as native ETH staking yield — provided $5.8 billion in collateral.

As a researcher, I’ve noticed a fascinating trend: stETH and weETH have been gradually eroding the market share of other coins. This shift is so significant that ARK Invest recently reported a reorganization within the DeFi economy, with staked ETH and its associated tokens like stETH at its core. Other tokens such as Solana’s SOL or Avalanche’s AVAX offer higher returns for staking, but they come with a higher degree of volatility. This suggests that these assets might be riskier to hold in the long term due to their potential for significant fluctuations.

Lenders of stablecoins have faced increased strain due to the rise of stETH, according to ARK Invest. This is partly because Sky (previously known as MakerDAO) has boosted the interest rate on locked DAI, and because rewards for lending stablecoins on platforms like Aave (AAVE) and Compound (COMP) have become more enticing. The reason behind this trend is that users tend to prefer lending stETH and borrowing stablecoins instead of lending stablecoins directly.

Besides these, there are also numerous tokenized money market funds in the works from financial leaders like BlackRock and Franklin Templeton. These could potentially provide DeFi users with access to U.S. Treasury bills and even allow them to use these tokens as collateral.

In a challenging market, it’s believed that LBTC could thrive even where wBTC has faltered, due to an added advantage from its yield. Phillips suggests that this yield will accumulate over time and is anticipated to be on par with the yield generated by staking ETH.

Philips explained that Lombard’s primary objective is to encourage individuals to move their bitcoin from the most secure offline storage and make their first step into on-chain finance. Once they do this, he promises to present reliable, bank-beating protocols that are available. He also mentioned the possibility of a decrease in yield, but LBTC as an asset with any level of yield would still be enticing.

The pitch has certainly been met with interest. Lombard raised $16 million this summer from a number of heavy-hitters, including Polychain Capital, Franklin Templeton and Nomad Capital. Philips said that entities already familiar with DeFi had been the most enthusiastic. “Anybody who has dabbled in crypto already, it’s an easy pitch to get them onboard for bitcoin staking. Or at least they’re very open to the conversation.”

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2024-12-20 20:09