Bitcoin has long been regarded as the store-of-value layer in crypto assets, but its native chain does not support complex smart contracts like Ethereum. Therefore, "bringing Bitcoin into DeFi" does not mean transforming the Bitcoin mainnet directly into a DeFi execution environment. Instead, it involves integrating BTC's value and liquidity into lending, staking, trading, and asset management scenarios through wrapping, cross-chain bridges, sidechains, Layer 2 solutions, and several quasi-native protocols. This direction is often referred to as BTCFi.
Why Bitcoin Needs DeFi
Bitcoin's core characteristics are security, scarcity, and settlement finality, but these come at the cost of programmability. A large amount of BTC remains in wallets or custodial accounts for extended periods, serving only as held assets rather than participating in on-chain financial activities. In July 2025, some statistical estimates suggested that over 14 million BTC had remained untouched for a long time; at that time, Ethereum's liquid staking protocols also accumulated tens of millions of ETH. This comparison illustrates that the Bitcoin ecosystem suffers from insufficient capital efficiency and on-chain activity.
DeFi offers several typical demands for BTCFi: collateralized lending, liquidity provision, leveraged trading, asset issuance, cross-chain settlement, and staking rewards. For holders, the key is not price volatility, but enabling BTC to become a deployable, composable asset capable of generating on-chain activity, without exiting the crypto ecosystem.
Wrapped Bitcoin: Bringing BTC to Smart Contract Chains
The most straightforward path is wrapped Bitcoin. Users lock BTC in a custodial or contract system to receive tokenized BTC usable on smart contract chains. Take WBTC as an example: it was jointly launched by Kyber, Ren, and BitGo in 2019. BTC is held in custody by institutions like BitGo, and issued on-chain as an ERC-20 token, which can be used as collateral, a liquidity asset, or a trading pair in Ethereum DeFi protocols.
- Pros: Compatible with mature DeFi ecosystems like Ethereum, with lower costs for accessing lending, DEXs, and liquidity pools.
- Limitations: Relies on custody, minting, and redemption mechanisms, posing risks related to centralized custody, audit transparency, compliance, and smart contracts.
- Other Attempts: Wrapped or pegged assets like tBTC, renBTC, sBTC, and cbBTC have explored different trust models, but their issuance scale, liquidity, and use cases vary with market changes.
Sidechains and Layer 2: Building Execution Layers Outside Bitcoin
Another path involves establishing smart contract-executable environments outside the Bitcoin mainnet, then connecting them to the BTC settlement layer via two-way bridges or cross-chain bridges. Sidechains typically have independent consensus and asset bridges; Layer 2 solutions emphasize inheriting Bitcoin's security or forming a settlement relationship with it.
- Rootstock (RSK): An Ethereum Virtual Machine-compatible Bitcoin sidechain, facilitating the migration of Ethereum DeFi applications to the Bitcoin ecosystem.
- Stacks: Attempts to introduce smart contracts on the Bitcoin settlement layer, supporting asset issuance and on-chain applications.
- Liquid Network: Enhances settlement efficiency with a sidechain and multi-signature mechanism, focusing more on asset issuance and fast transfers rather than full DeFi.
- Lightning Network: Primarily addresses payments and micro-settlements, not a DeFi execution layer, but can provide a foundation for channel liquidity, micro-payments, and instant settlements.
- Rollups and New Layer 2s: Projects like BOB, Bitlayer, and Merlin Chain attempt to use Bitcoin as a settlement or security reference, offloading transaction execution to off-chain or new execution layers.
The appeal of these paths lies in preserving the Bitcoin mainnet's settlement attributes while introducing programmability. However, cross-chain bridges, sidechain consensus, and asset mapping expand the attack surface, and the multi-chain ecosystem has experienced bridge contract vulnerabilities and liquidity fragmentation issues.
Native and Quasi-Native Mechanisms: Making Bitcoin Itself More Programmable
While wrapping and sidechains "move BTC out," another category of solutions attempts to enable the Bitcoin network itself to handle more functions. The Taproot upgrade, activated in 2021, expanded scripting capabilities, providing a foundation for more complex contract logic and privacy-preserving compositions. Ordinals and BRC-20 introduced data and asset identification onto the Bitcoin chain, promoting asset issuance and trading, though they are not equivalent to DeFi themselves.
- Taproot Assets: Attempts to issue and transfer assets within the Bitcoin and Lightning Network ecosystems, extending on-chain asset capabilities.
- BitVM: A research-oriented approach that verifies external computations via Bitcoin scripts, offering possibilities for cross-chain contracts and trust-minimized interactions.
- Babylon: Proposes allowing native BTC to participate in Proof-of-Stake network security, enabling BTC holders to earn participation rewards through staking mechanisms, while facing protocol, staking, and potential slashing risks.
The common goal of these mechanisms is to reduce reliance on fully entrusting BTC to external chains or custodians. However, most are in early stages, with standards, security, liquidity, and regulatory boundaries still evolving.
Institutional and Compliance Paths: Custodial Tokens and On-chain Deployment
When institutions hold BTC, they typically cannot directly accept unaudited on-chain protocols or high-risk custodial arrangements. Therefore, concepts like Liquid Custodial Tokens (LCTs) were proposed by some projects in 2025, such as BBTC and similar assets, attempting to strike a balance between compliant custody, asset segregation, and on-chain yield. The basic idea is: BTC is held under regulated or auditable custodial arrangements, and institutions participate in lending, staking, or liquidity strategies through tokenized certificates.
These paths are closer to traditional financial infrastructure but shift risks from purely on-chain to custody, legal documentation, auditing, and operational processes. Institutions need to evaluate yield sources, redemption terms, counterparty credit, and regulatory applicability.
Key Challenges: Security, Trust, and Regulation
For BTCFi to scale, at least four types of constraints need to be addressed.
- Custody and Centralization: Wrapped assets like WBTC rely on custody and minting mechanisms. If issues arise with the custodian, auditor, or redemption process, tokenized BTC may de-peg or become irredeemable.
- Smart Contract and Bridging Risks: Cross-chain bridges, staking contracts, and liquidity pools can all have vulnerabilities. Public reports show that some Bitcoin ecosystem protocols have disclosed vulnerability attacks, and security audits and insurance mechanisms remain shortcomings.
- Liquidity Fragmentation: BTC is dispersed across wrapped assets, sidechains, L2s, and native protocols, leading to different versions of the same asset on various chains, affecting depth and price consistency.
- Regulatory Uncertainty: Different jurisdictions have varying definitions for staking, lending, token issuance, custodial services, and securities attributes, requiring compliance assessments for institutional participation.
Path Combinations: BTCFi Is Not a Single Answer
Bitcoin's entry into DeFi is more likely to present a layered structure: the Bitcoin mainnet handles settlement and security, wrapped assets connect BTC to mature DeFi ecosystems like Ethereum, sidechains and Layer 2s provide execution environments, mechanisms like Taproot, Ordinals, BitVM, and Babylon explore native or quasi-native capabilities, and institutional paths lower participation barriers with custodial tokens and compliance processes.
The trade-offs for different paths are also clear: wrapped assets offer good liquidity but strong trust dependencies; sidechains and L2s have strong programmability but high bridging risks; native mechanisms are closer to Bitcoin but are still developing in maturity and user experience. Whether BTCFi can transition from narrative to large-scale adoption depends on whether security, liquidity, compliance, and real-world use cases can all be simultaneously addressed.
