Bitcoin staking, defi and L2s

Bitcoin staking, defi and L2s

Oct 21, 2024 | Crypto, Defi

In 2024, numerous liquid restaking protocols emerged within the Ethereum ecosystem, allowing users to leverage their staked Ethereum as capital to support new proof of stake networks. There is now a growing interest in exploring methods to stake bitcoin as well. A lot of techniques are being developed to make the idle bitcoin “liquid” without having to alienate them in complex financial assets.

We will go over the latest projects in the bitcoin ecosystem. We’ll explore the latest advancements in this field and assess their benefits, drawbacks and risks.

Wrapped BTC

Bitcoin’s lack of smart contract support led to the initial idea of encapsulating Bitcoin in another token on Ethereum. This token maintains a 1:1 peg to Bitcoin’s value. It is tradable across various decentralized exchanges and can be utilized in Ethereum’s decentralized finance ecosystem. Users have the option to redeem the token for BTC at any time.

Custodial projects like cbBTC function similarly to USDT or USDC. Wrapped Bitcoin is held in custody by entities such as Coinbase. These companies are responsible for issuing and burning the wrapped tokens. They ensure that the amount of wrapped Bitcoin on chains like Ethereum corresponds 1:1 to the Bitcoin held in reserve. This model relies on on-chain proof of reserves for transparency, confirming the existence of the underlying Bitcoin.

WBTC is one of the first and largest examples. It has a market cap of around $10 billion, compared to cbBTC’s $0.5 billion market cap. However, custodial wrapped Bitcoin introduces certain risks. It includes smart contract vulnerabilities, potential insolvency of the custodial entity, and the risk of de-pegging if reserves become insufficient.

As blockchain is often synonymous to decentralization, new technologies have emerged to decentralize the storage of the wrapped Bitcoin. In the context of wrapped Bitcoin (WBTC), there have been attempts to decentralize the storage and issuance process. Newer technologies and protocols are emerging to address this centralization, aiming for more decentralized control over the Bitcoin collateral used in wrapped tokens.

Decentralized wrapped BTC

  • tBTC: A decentralized protocol where Bitcoin is locked in a trustless manner, using multiple signers to manage Bitcoin collateral without a centralized custodian.
  • renBTC: It allows users to mint wrapped Bitcoin on Ethereum through a decentralized network of nodes.

These systems aim to remove the reliance on a single centralized custodian by distributing the responsibility of managing Bitcoin reserves. However, decentralization in this space is still evolving and is not as widespread as centralized models like WBTC. Therefore, while decentralization efforts exist, custodial wrapped Bitcoin still dominates the space.

Babylon

Babylon allows users to stake their bitcoin to secure other chains while keeping them on bitcoin’s chain under their full custody. However, they have to provide a slashing guarantee. Whenever a malicious activity occurs, a slashing can be triggered. Babylon uses Bitcoin in self-custodial vaults for staking, and slashing penalties apply when misbehavior like double-signing occurs. If you double-sign, the network can extract your private key via Extractable One-Time Signatures (OTS), proving the violation and triggering a slashing event. Babylon likely does not penalize validators for simply going offline, as its focus is on preventing provable malicious behavior.

It is important to note that the private key exposed is the key of the validator (finality provider). It is only possible to expose the key when the validator tries to double spend by signing the same block twice at the same height. A regular user will usually delegate the validation process to a finality provider and not himself. This exposes him to slashing only, without exposing his private key and compromising his other assets. The finality provider has to be vigilant about the assets present in its account and refrain from using the same keys for validating many POS. So users can reduce their risk by not signing blocks for securing any PoS.

Risks

Since Bitcoin does support smart contracts, the design of Babylon is limited to cryptography and Bitcoin’s timestamping and scripting language. This limitation increases the risks of malfunctions and reduces the flexibility of the protocol, which uses drastic techniques such as private key exposure to ensure slashing guarantees.

Babylon is in its beginnings and the risks are real. Even if you are planning on delegating your votes, make sure to use a newly created wallet with the amount of Bitcoin you’re ready to stake and that no other BRC20 tokens are present.

Here’s a good article that explains how Babylon works. We can view Babylon as a native staked protocol for Bitcoin.

Lombard LST

You may have heard of protocols like Lombard and solvBTC, which offer Liquid Staked Bitcoin (LSBTC) solutions. These protocols issue their own liquid staking tokens, such as LBTC (from Lombard), representing Bitcoin staked via the Babylon protocol. The key benefit of holding an liquid staked Bitcoin like LBTC is that it allows users to continue earning staking rewards without locking up their Bitcoin. This token can be used in decentralized finance (DeFi) platforms to generate additional yield or swapped for other assets.

When you deposit Bitcoin into a protocol like Lombard, it stakes that Bitcoin through Babylon. In return, you receive a proof of deposit. This proof is then used to mint the LBTC token on the Ethereum network via a smart contract. However, while LBTC offers flexibility and yield opportunities, it carries certain risks. Users are still subject to the same slashing risks associated with Babylon’s staking mechanism. Additionally, there are smart contract risks involved in issuing and burning LBTC on Ethereum. as well as potential de-pegging risks.

These additional risks highlight the need for careful consideration when engaging with liquid staking protocols.

SolvBTC LST

SolvBTC is similar to Lombard with the main difference that it has a Staking Abstraction Layer that is designed to support different staking protocols such as Babylon, CoreDAO, Ethena etc… This makes it more robust since it does not depend on a single protocol like Babylon, but it adds a complexity. SolvBTC is also available on many L2s and different chains such as BNB and Avax.

Bitcoin LRT & DEFI

New protocols and DeFi platforms are evolving to offer users the ability to re-stake liquid staked Bitcoin (LSBTC). This enables them to secure additional blockchain networks while earning even more rewards. This process, called liquid restaking, allows the LSBTC—tokens like LBTC or solvBTC—to be staked again on other chains or DeFi platforms. By doing this, users can simultaneously participate in securing multiple protocols and earn additional yield from each network.

For example, a user might stake their LSBTC in a DeFi protocol that offers additional rewards for providing liquidity or securing another layer of blockchain infrastructure. This could include cross-chain staking, where a single LSBTC can help validate transactions on Ethereum, Cosmos, etc. The restaked LSBTC creates a compounding effect where users are not only benefiting from the underlying Bitcoin’s yield but also from the staking rewards and incentives provided by the additional protocols. Some platforms even provide a liquid version of the restaked token that can be further used in DEFI compounding the yield.

However, with re-staking comes the potential for additional risks, including cross-chain security vulnerabilities, increased exposure to slashing, and liquidity risks, as multiple chains rely on the same staked asset for security.For example, we can restake them in symbiotic, karak or ether.fi to earn a further yield.

Ether.fi

An example of liquid staking and restaking is eBTC offered by EtherFi, which integrates with Lombard and Babylon for Bitcoin staking. Through partnerships like Symbiotic, EtherFi allows users to restake eBTC for additional rewards while still earning staking yields. The eBTC token remains liquid and can be utilized in DeFi protocols, offering flexibility while combining both staking and restaking opportunities.

Other restaking platforms include Swell’s swbtc, eigenlayer and karak.

pStake

pSTAKE is focused on liquid staking for Bitcoin, where users can stake BTC and receive a liquid staked token (such as yBTC) in return. This allows them to earn rewards via Babylon’s security-sharing protocol while keeping liquidity. It enables users to utilize their staked Bitcoin in decentralized finance (DeFi) without locking it up fully, providing yield opportunities while securing PoS chains

Fractal

Fractal Bitcoin is a Bitcoin sidechain aimed at improving Bitcoin’s scalability while retaining its core proof-of-work (PoW) consensus. It introduces Cadence Mining, a mechanism that alternates between independent block mining and merged mining with Bitcoin to enhance security and efficiency. Fractal also supports BRC-20 tokens, enabling token creation and trading, similar to Ethereum’s ERC-20 standard. Additionally, it re-enables the OP_CAT opcode, providing limited smart contract capabilities. The network focuses on faster transactions and reduced fees.

Bitcoin Layer2

Bitcoin Layer 2 solutions, such as the Lightning Network, Stacks, and Liquid Network, aim to enhance Bitcoin’s scalability, speed, and functionality. They enable faster and cheaper transactions by moving processes off-chain while still benefiting from Bitcoin’s security. These solutions also allow for new use cases, like smart contracts and decentralized finance (DeFi), making Bitcoin more versatile.

Some of the newer Bitcoin L2s are B2, CoreDAO, CoreDAO, BOB, merlin, fuel.

Bitcoin native bridges

A key development in Bitcoin’s cross-chain space is the introduction of decentralized native Bitcoin bridges. Symbiosis recently launched a decentralized bridge that allows users to transfer and swap Bitcoin between different blockchains. Unlike traditional wrapped Bitcoin solutions, Symbiosis’ bridge uses native Bitcoin rather than tokenized representations. This provides a more seamless and decentralized process for users to move Bitcoin across ecosystems.

The bridge leverages smart contracts and a non-custodial architecture, enhancing security while maintaining decentralization. It also supports low-cost swaps and bridging for small amounts of Bitcoin. This addresses challenges like high fees and slow transaction times. This native bridge can also integrate with protocols that restake Bitcoin for additional yield, making it a versatile tool for decentralized finance.

Other bridges in the ecosystem provide similar services, with varying degrees of decentralization. For instance, projects like ThorChain have long offered decentralized swapping for Bitcoin, but Symbiosis distinguishes itself by supporting a broader range of chains and focusing on the native asset rather than wrapped tokens. These innovations mark a significant shift towards making Bitcoin more compatible with DeFi and other blockchain applications.

Which Layer2 will survive?

Which Layer2 will survive?

Oct 6, 2024 | Uncategorized

The beginning of 2024 saw the emergence of multiple layer2; each promising to scale Ethereum, offer a high transaction throughput and reduce network fees. We will go over the major solutions and compare their performance.

The beginning

Polygon (Matic) was the first layer2 to get mass adoption. It is designed to improve the scalability and efficiency of Ethereum by offering faster and cheaper transactions while retaining the security and decentralization of the Ethereum blockchain. Polygon acts as a Proof of stake sidechain that does commit all transactions to Ethereum. It uses a technique called checkpointing to periodically batch and commit information about the state of the sidechain (transaction summary) to the Ethereum.

Zero-Knowledge Proofs

Zero-knowledge proofs are a well-established cryptographic concept that has been researched and developed by cryptographers for several decades. ZK-proofs are based on the idea that a party (the “prover”) can demonstrate to a different party (the “verifier”) that a statement is true without disclosing any specifics about the information itself. ZK-Rollup solutions will be developed by many players for scaling Ethereum

Polygon zkEVM

In order for Polygon to offer all the benefits of Ethereum’s security and compatibility with existing smart contracts, a new zkEVM solution is offered. zkEVM is a specific implementation of ZK-proofs on Ethereum Virtual Machine. The focus shifts to using ZK-proofs to commit transactions directly to Ethereum in a more efficient and secure way, rather than relying on periodic checkpoints. Polygon is not moving entirely to zkEVM but rather positioning it as one of several options within its broader ecosystem.

zkSync

zkSync uses ZK-Rollups but incorporates a unique virtual machine and transaction logic to optimize for scalability and developer flexibility. zkSync aims to provide compatibility with many Ethereum-based tools and smart contracts, but it does so by using a custom virtual machine called the zkSync VM. Since it’s a custom VM, developers might need to make slight modifications to their smart contracts. zkSync focuses on providing a developer-friendly environment while striving to support more advanced features. It is not as deeply tied to Ethereum’s architecture as zkEVM. zkSync is focused on more complex use cases such as account abstraction and native layer3 support.

Polygon POS vs zkEVM vs zkSync

Transactions fees on zkEVM and zkSync are paid in ETH. This lowers the demand on the native tokens MATIC and ZK. Polygon POS still uses MATIC as its transaction fee token.

MATIC will be migrated to POL. The goal is to use it as a core utility token that can help secure and scale multiple chains inclusing zkEVM. POL’s primary goal is to be used for staking to secure all of Polygon’s chains and may be used as a transaction token.

zkSync just launched its native token ZK. For now, it is mostly a governance token that allows users to vote on protocol upgrades. It is used for staking and securing the network, but it’s still not used for transaction fees. It might be used to pay for transaction fees on the different chains that launch of zkSync, so its future depends on new interconnected ZK chains.

The price of ZK token has not performed well following the airdrop, probably because of lack of utility. The migration from MATIC to POL did not help the token gain in value. POL and ZK have a potential, but they greatly depend on the chain’s adoption. Polygon will be more suited for general purpose applications while Zksync will be more suited for specific applications.

Let’s do a comparison of Polygon vs Zksync:

token pricetotal supplyFully diluted Market CapTVL
zksync0.13$21b2.6b136M
Polygon0.38$10.2b3.9b900M Polygon + 14M Zkevm

In terms of zk technology, we can see that zksync has more adoption, while polygon relies more on its legacy. However, both chains are facing stiff competition.

Optimistic rollups

Optimistic Rollups is a Layer 2 scaling solution that garnered considerable interest due to its ability to process more transactions efficiently while utilizing Ethereum’s security. Unlike ZK-Rollups, which employ cryptographic proofs for transaction validation, Optimistic Rollups operate on the premise that transactions are inherently valid but incorporate a dispute resolution mechanism (fraud proofs) to address any disputes. If a transaction is fraudulent, the fraud proof triggers a challenge period, and the invalid transaction can be reverted. ZK-Rollups deliver quicker finality by eliminating the challenge period. On the other hand, Optimistic Rollups are typically more convenient for developers to develop and maintain in terms of EVM-compatibility, making them more developer-friendly in the immediate future.

Optimism and Arbitrum One

Both optimism and arbitrum are implementations of Optimistic rollups. Both are very fast, low fee and more fluid to use compared to zkSync. Let’s compare them:

token pricetotal supplyFully diluted Market CapTVL
Optimism1.6$4.3b6.8b640M
Arbitrum0.55$10b5.5b2.4b

Considering the total supply, OP token is performing better than ARB token, however Arbitrum has much more adoption. This might be because OP is considered by many as an exposure to the Base network. Both chains use ETH as transaction fee, which makes their token more of a governance/staking rather than a utility token.

Superchains

Optimism developed the OP stack, which is an open source modular framework developed that enables the creation and deployment of custom Layer 2 solutions (or Optimistic Rollups) on Ethereum. It is part of Optimism’s vision of a superchain to foster a vibrant ecosystem of Layer 2 networks, allowing developers to easily build their own scaling solutions tailored to specific use cases. The OP token does not benefit directly from the OPStack.

We can find a similarity with the Cosmos ecosystem, where blockchains can use Cosmos to spin off new interconnected chains. The ATOM token was not directly benefiting from the ecosystem growth. Some proposals were made to inscease the utility of the ATOM token, but it did not have a great traction so far. OP and ATOM token both get their value from speculation and their future role in their ecosystem. For example, while Base network reached a profit sharing agreement with Optimism, it does not translate directly to profits for the OP token.

Arbitrum orbit offers an alternative to the OPstack that enables developers to create and deploy custom Layer 2 solutions (also known as rollups) on the Arbitrum ecosystem.

Base and Mode

Base and Mode are two chains that are developed using the OPstack. While Base is developed by Coinbase with a goal of mass retail adoption, Mode is a chain dedicated initially for gaming.

token pricetotal supplyFully diluted Market CapTVL
Mode0.01$10b112M303M
BaseNo token––2.24b

We can see that the Mode network is not getting much traction. Most of the remaining TVL is temporary and aiming at the season 2 of the airdrop. Season 2 will dilute the token even more. Mode has received many fundings from optimism and it’s switching its narrative to AI-powered financial applications. This new niche might help it recover for the future.

Base continues to attract widespread retail adoption despite not offering an airdrop. Its achievements can be attributed to effective marketing strategies, a reliable network, and the adoption of meme coins. Although Scroll and Linea incentivize liquidity provision with airdrops, Base’s higher Total Value Locked (TVL) sets it apart as a network.

Linea and scroll

Linea and Scroll are the two leading zkRollup solutions. Scroll is more focused on zkEVM for full compatibility with Ethereum. Linea is developed by Consensys, a leading blockchain software company, which works on products like MetaMask and Infura. As of today, Linea is more fluid than Scroll.

Both have a competing airdrop campaign which is supposed to attract a lot of liquidity. Linea expecting as much as 3b. However, Linea has a 500 M TVL while Scroll has around 700M. This TVL does not compare this the 2.24b that is locked at Base, which does not offer a clear airdrop. Most of the TVL in Linea and Scroll will probably go towards newer projects once the airdrop campaigns end.

Mantle

Mantle is an optimistic rollup layer2. Mantle’s primary use cases include supporting DeFi applications, NFT platforms, and gaming dApps that require fast, low-cost transactions while maintaining security.

token pricetotal supplyFully diluted Market CapTVL
Mantle0.6$6.2b3.7b415M + 1.2b ETH LRT

Mantle looks like a strong contender in the layer2 market. It was able to capture a good chunk of Ethereum’s LRT market with its meTH token and the COOK airdrop. Mantle’s marketing around the PUFF meme coin was brilliant. Another distinction is the usage of MNT token for transaction fees, which shows confidence at this early stage.

Dapps are launching their own chain

An increasing number of decentralized applications (dapps) are opting to create their own blockchain. This gives them more options and adaptability for their offerings. For instance, prominent decentralized exchanges (DEXs) and perpetual exchanges are establishing their blockchains. Logx has launched using the Arbitrum orbit stack, while Aevo is utilizing the OP stack. This move will strengthen the positions of both Arbitrum and Optimism as superchains rather than just Layer 2 solutions. The success of their respective tokens within the Superchain ecosystem will be crucial in determining their success, as the primary focus now lies in innovation rather than revenue generation.

Upcoming Layer2 – Does the market need more solutions?

New Layer2 projects such as Mintchain, redstone, fraxtal, ZetaChain, and Taiko are emerging. Each chain is targeting a specific market niche and many of them are built on a superchain. Platforms like Dymension are simplifying the process of launching new rollups. The market is rapidly becoming saturated, while Solana continues to thrive without requiring layer2 solutions. Several layer2 projects on Ethereum are expected to shift their focus to serve as a layer2 solution for Bitcoin. The layer2s that will stand out after the bull run and airdrop hype are over will probably be Base, Mantle and Linea.