Author: Castle Labs

Translation: Deep Tide TechFlow

Deep Tide Reading: Bitcoin's market capitalization is $1.3 trillion, making it the 13th largest asset globally, but only 310,000 BTC (1.5%) can generate yield, while the remaining 98.5% are just sleeping. Ethereum's 32.5% of ETH is earning yield through staking; why can't Bitcoin? This article breaks down the current state and risks of the BTC yield ecosystem and how Layer 2 solutions like Stacks can activate this dormant capital without sacrificing security.

Bitcoin (BTC) is the 13th largest asset globally, with a market cap of approximately $1.3 trillion, increasingly being adopted by company treasuries, ETFs, and investment portfolios, positioning itself as a "reserve asset."

Even with a strong foothold in financial markets, Bitcoin's financial uses still lag far behind similarly sized traditional assets. Holders of BTC mainly watch for price fluctuations, unable to gain any native yield as traditional assets naturally appreciate. In traditional finance, assets can safely be used for lending or receive dividends from company cash flows. Although Bitcoin can also be used as collateral for loans, most existing solutions introduce smart contract or counterparty risks, which may not align with the risk preferences of current holders.

The result is that of the 20.05 million active supply of BTC, only 311,000 (approximately 1.5%) can earn any yield, including DeFi lending, staking BTC, deploying BTC on decentralized exchanges, and vaults.

The second-largest asset, Ethereum (ETH), has created a layered financial primitive that turns idle ETH into operating capital. 32.5% of circulating ETH is staked, earning a native yield of about 2%. On top of basic staking, there is a second layer of liquid staking: Lido alone accounts for 21% of all staked ETH, issuing stETH, a rebalanced asset usable in DeFi.

This gap is a downstream effect caused by the design of Bitcoin and the behavior of its holders.

Bitcoin is a proof-of-work network with no staking mechanisms.

Conservative holder behavior means that large holders will never take risks for yield, as seen in the 2022 collapse of centralized BTC lending platforms like Celsius, BlockFi, and Voyager.

This article aims to highlight the current issues leading to underutilization of BTC as an asset while reflecting on how ongoing steady development through case studies like Stacks can address this problem.

Bitcoin Yield Stacks

Only a limited amount of BTC can earn active yield, and nearly all yield comes from the mature DeFi ecosystems of EVM chains and Solana, as these ecosystems have financial primitives such as lending markets, DEX, and vaults to support ongoing yield generation. This section focuses on the BTC yield stack and its evolving sources over time.

Centralized BTC Lending

Before the on-chain ecosystem matured, centralized platforms like Celsius, BlockFi, and Voyager provided BTC yield but sacrificed custodianship. These platforms ultimately collapsed in 2022 through nearly identical mechanisms: acquiring legal ownership of deposited cryptocurrencies (Celsius's terms explicitly transferred “all rights and ownership” of depositors' assets to the platform, giving the platform the right to re-collateralize) and lending to opaque counterparties. Celsius's failure was triggered by the liquidity crunch following the Terra/Luna collapse: 75% of the platform's withdrawals occurred after this event, forcing it to suspend redemptions. Voyager went bankrupt after a $350 million USDC and 15,250 BTC loan default from 3AC. BlockFi suffered the same blow from 3AC and then faced a second blow from a default on a loan of about $680 million to Alameda Research.

What they all have in common is funding under-collateralized institutional loans with retail deposits, with contract terms stripping depositors of ownership rights to the underlying assets.

DeFi Ecosystem

DeFi has been proven in the EVM and Solana ecosystems, giving users greater confidence in usage. However, to use these products, BTC holders must first convert native BTC into a form understandable by the target chain. This includes categories of assets like custodied minted coins (WBTC and Coinbase's cbBTC), decentralized bridging assets (tBTC), and liquid staking tokens (LBTC). All these categories add layers of risk:

Bridge risk: To mint a representation, users send native BTC to the holding address or custodian and receive a 1:1 receipt token on the target chain. For custodied minting (WBTC and cbBTC), this mechanism is operated by centralized operators, making it vulnerable to private key leaks or social engineering attacks. Threshold's tBTC has a network of signers with no single custodian but still carries signer set and smart contract risks.

Custodian risk: For assets like WBTC, the custodian BitGo transitioned from holding all three keys of a WBTC 2-of-3 multi-signature unilaterally in August 2024 to a multi-jurisdictional split across BitGo Inc (USA), BitGo Singapore Ltd., and BiT Global (Hong Kong). Even after this change, the third key is still held by BiT Global, a joint venture related to Justin Sun's Tron ecosystem, where BitGo is only a minority shareholder, making it still a key risk for the asset. On the other hand, cbBTC has a 1:1 backing but is entirely held by Coinbase, a single custodian that can freeze or seize funds according to user agreements.

Smart contract risk: Engaging with any DeFi protocol exposes depositors to smart contract risks. There are multiple instances of various protocols being hacked, and there is fundamentally no solution. In the Balancer hack of November 2025, despite the protocol passing several audits, liquidity providers suffered significant losses after approximately $128 million was drained from the Balancer V2 pool.

Even after years of real-world testing, DeFi protocols are not the perfect places to park capital.

In the recent kelpDAO rsETH vulnerability, over 86,000 BTC left the protocol within the first six hours as users worried about contagion. In the kelpDAO hacking event, attackers deposited rsETH as collateral and borrowed large amounts of wETH. As all wETH liquidity was drained, lenders began to use their deposits as collateral to borrow in other stablecoin markets. To avoid becoming part of this contagion, users decided to withdraw their assets. These withdrawn assets accounted for about 12% of the BTC-based assets in the protocol.

This was a significant blow to confidence, as Aave, the largest lending protocol, suffered a collapse due to external asset attacks causing various factors, including gaps in governance oversight during E-mode integration, pushing its LTV to 93%. Since then, Aave's market cap has decreased by more than 50%.

Bitcoin L2 and Staking Protocols

The second pathway for BTC yield is through Bitcoin L2 and staking protocols like Babylon, Lombard, Stacks, Rootstock, and BOB, with a total locked value of approximately $4 billion.

Among these, Babylon represents the most locked value. It primarily operates as a staking protocol where BTC holders lock assets on L1 itself, thus using Bitcoin's L1 security guarantees to safeguard PoS networks. In return, these users earn yields denominated in the network’s native token by helping to maintain its security.

To obtain a liquid representation, holders need only deposit native BTC or WBTC into Lombard, receiving a liquidity and yield-bearing representation LBTC, making Lombard a liquid staking protocol.

Nevertheless, these assets still expose BTC holders to slashing risks.

The remaining locked value originates from Bitcoin L2s designed to launch their own chains, which has historically been more challenging as it requires on-chain activities, attraction of builders, stablecoin channels, excellent UX, and incentives to retain capital.

Current Gaps and Trust Assumptions

Overall, all these yield-generating pathways reflect a market demand and infrastructure, but they are fundamentally not on the same page. EVM has deep liquidity and applications but imposes custodial/bridging risks. Bitcoin L2 is ideologically more consistent with BTC holders but lacks yield diversity and retail capital UX. Centralized lending has structurally collapsed post-2022.

Each of these deployments carries different trust assumptions:

Packed BTC relies on custodians and/or bridge signer sets, combined with wrapper and downstream smart contract risks.

Babylon's native staking trusts a contract committee and an M-of-N multi-signature (currently 6-of-9, including 3 signers from Babylon Labs, 1 each from CoinSummer Labs, RockX, AltLayer, Zellic, Informal Systems, and Cubist) to collectively sign unwrapping and slashing transactions.

Stacks’ sBTC bridge relies on a set of 15 institutional signers, including Figment, Chorus One, Stacking DAO, etc. For the bridge to function properly, 70% (11-of-15) of the signers must participate honestly, and even if 33% of the signatories vote honestly, meaning 5-of-15, the system’s security can still be maintained and allows for withdrawal without issues.

The unmet demand represents a way to preserve the Bitcoin trust model as intact as possible while still providing applications and liquidity that make capital productive.

Bitcoin Native Finance

Bitcoin native finance refers to financial products that use BTC as the primary asset while settling, securing, and transferring assets as close to Bitcoin's base layer as possible, minimizing additional trust assumptions.

Bitcoin native finance cannot be achieved on L1 itself due to Bitcoin's design:

Bitcoin Script can enforce simple spending conditions but is not Turing complete; thus, it cannot execute arbitrarily complex logic or loops, rendering it incapable of expressing the state machines needed by DeFi protocols (AMM curves, health factor checks, liquidation logic, etc.)

The UTXO model lacks a shared persistent state. Bitcoin scripts do not maintain state outside of the current transaction, while lending markets or AMM precisely require shared mutable state that the UTXO model cannot provide.

Block space is scarce and slow. Bitcoin's approximately 10-minute block time and truly scarce block space means that high-frequency DeFi operations cannot be executed on L1.

Bitcoin lacks a native yield mechanism to build derivatives, as this chain uses proof-of-work.

Bitcoin cannot verify external chain states, making the transfer of BTC to any programmable environment rely on custodians or signers.

Within these constraints, purely Bitcoin native finance is unattainable. Every product on the market today relies on some trust assumption outside of Bitcoin consensus. To mitigate this issue, some protocols are being built as close to Bitcoin as possible.

Babylon requires no bridging: staked BTC remains in time-locked Bitcoin UTXOs but incurs risks from its contract committee as well as from the finality providers it delegates to protect external proof-of-stake chains, introducing slashing risks.

BOB pairs Bitcoin finality with a complete EVM environment through BitVM-style bridging: effectively, it currently settles on Ethereum, treating full Bitcoin security as a phased roadmap.

Stacks directly anchors the finality of its execution layer to Bitcoin consensus while accepting a signer set for its BTC-backed bridged asset sBTC, requiring 70% (11 of 15) to move funds.

Among the current solutions, some have achieved great scale. Babylon (staking protocol), Lombard (liquid staking protocol), and Solv (yield generation) have TVLs of $2.6 billion, $800 million, and $480 million, respectively.

These protocols gain attention due to their strong composability with other DeFi, allowing users to earn more on the base yields generated by their assets.

Yields come from various sources. Lombard’s LBTC achieves yield through staking, obtaining it from the Babylon network that protects the PoS blockchain. Solv’s solvBTC generates yields through delta-neutral strategies, lending, liquidity provision, staking, and real-world assets (RWA).

While there isn't a complete Bitcoin-native solution today, this means:

Directly earning yield on Bitcoin L1 itself without relinquishing self-custody or introducing any new risks.

If users need, they can obtain liquid representations of committed BTC.

Full transparency regarding the risks involved in these steps.

Users should ask a series of questions to understand if the solution is Bitcoin-native:

Does the solution allow for self-custody?

What is the level of decentralization of the bridge signers?

Where do the yields actually come from?

Can holders withdraw or redeem, or is there a locking period?

In the next section, we discuss how to use Stacks' case study to answer these questions and how it constructs Bitcoin-native finance.

How Does Stacks Build Bitcoin Native Finance?

Stacks is a BTC L2 that anchors its execution to the Bitcoin base layer. Its current on-chain TVL is approximately $90 million, with an additional $190 million in sBTC. It is one of the most comprehensive attempts to combine all parts of the Bitcoin-native stack in one place:

Bitcoin-anchored execution layer

Trust-minimized BTC bridging

Native BTC-denominated staking

Liquid staking representation (sBTC will launch alongside self-custodied staking)

Real-time DeFi applications (Zest, Bitflow, StackingDAO, Hermetica, etc.)

Bitcoin-Anchored Settlement

The finality model anchored to Bitcoin underpins sBTC and the broader chain. Since the Nakamoto upgrade in October 2024, each Stacks miner's block submission transaction anchors the complete chain state of the prior term to Bitcoin transactions, requiring a reversion of the corresponding Bitcoin block to reverse the finality of a Stacks term. Thus, Stacks blocks achieve full Bitcoin finality about one block after their term ends.

sBTC: Trust-Minimized BTC Movement

sBTC is the mechanism that enables BTC to move between L1 and Stacks without traditional custodians, serving as the bridged representation of Bitcoin on Stacks, currently with a TVL of approximately $190 million.

All bridged BTC resides in a single anchoring wallet, a Bitcoin Taproot address, controlled by a collection of 15 community-elected signers, requiring a threshold of 70% (11 out of 15) to move funds, as highlighted in the previous section.

Native, Self-Custodied Bitcoin Staking

Stacks recently proposed the PoX-5 upgrade, allowing BTC holders to earn BTC-denominated yields while BTC is locked on Bitcoin L1 (expected to launch in late August). To do this, Stacks uses a standard OP_CHECKLOCKTIMEVERIFY time lock, which lets BTC remain committed and generate yields in the holder's own custody; the locking is enforced by Bitcoin consensus itself, requiring no trust in custodians, bridges, or signer sets.

The yields in PoX-5 come from the Stacks consensus mechanism, where miners bid BTC to mine Stacks blocks. This mechanism has already distributed over 4,200 BTC to STX stakers since January 2021. Now BTC stakers can also earn yields through the same mechanism.

Participating in BTC staking requires a protocol margin that locks BTC on L1, along with a STX position of at least 5% of BTC value for a six-month period. The paired BTC-STX margin provides priority, granting the miner's BTC pool first claim for each cycle, aiming for an APY of 3%. The remaining yield is distributed to those who stake only STX (forming secondary claims) and to a reserve fund, which accumulates excess mining income. The reserve fund is used to pay yields during future cycles when miner income may be insufficient to meet yield obligations.

Additionally, there is no enforced exit; holders can withdraw with BTC within a few Bitcoin blocks' time but will forgo yields for the remainder of the term, while the paired STX is locked for the entire duration. In this model, there is no slashing risk, meaning stakers do not risk losing funds.

Generating yields natively in BTC is the first step of the Stacks roadmap; the team is also actively researching self-custodied Bitcoin lending. Through this, users will be able to use BTC as collateral in lending protocols like Zest on Stacks, while their BTC never leaves L1. Stacks continuously verifies the Bitcoin collateral on L1 by reading the Bitcoin state, allowing borrowers to obtain stablecoins like Circle's USDCx and Hermetica's Bitcoin-backed USDh, further generating yields on their assets while still earning staking yields from PoX-5.

stBTC and the Application Layer

The BTC paired with STX staking on L1 is productive as it earns base yields and can be redeemed at any time. However, the same BTC cannot be used elsewhere while staked, lacking composability. For those seeking DeFi use cases, a possible solution is liquid staking assets (LST).

StackingDAO is about to launch such a product, stBTC. This is a liquid staking Bitcoin token, a Bitcoin analog to stETH.

The primary advantage of staking with stBTC is that BTC holders do not need to acquire the 5% STX pairing themselves. StackingDAO provides it from the already supported STX of its stSTX and stSTXbtc products, allowing holders to earn BTC yield without the STX risk while remaining in priority and retaining the highest yield rights.

In their model, users deposit native L1 BTC or sBTC and receive stBTC, whose value automatically compounds as the sBTC rewards generated by the PoX-5 mechanism accumulate and are paid out at the end of each cycle. A portion of these rewards flows to STX supporters who lend stSTX and stSTXbtc for the STX pairing. The remaining sBTC is reinvested into pools supporting stBTC (automatically compounding), increasing the stBTC/sBTC ratio.

Furthermore, for withdrawals, stBTC exiting is facilitated through a reserve buffer with a small fee, or if the buffer is exhausted, through a cooling-off period using withdrawal NFTs.

All these value streams lead to applications in DeFi.

Zest is the largest on-chain DeFi application and lending market. Zest allows its users to deposit BTC-denominated collateral (sBTC, STX, stSTX) and borrow stablecoins from risk-isolated markets. Zest also announced its “Stacks Vaults,” which will go live alongside Stacks' BTC staking. The first vault will be a fully automated stBTC loop strategy targeting a 6-8% APY, which is the first example of making liquid-staked BTC productive through the Stacks financial stack. Following this, another lending protocol, Granite, will allow users to borrow stablecoins with BTC/sBTC collateral, incorporating risk isolation.

Hermetica issues USDh, a synthetic dollar backed by Bitcoin.

Bitflow is a DEX on Stacks, operating on a Curve-style Stableswap AMM built for BTC-anchored assets (sBTC, xBTC, aBTC, and WBTC) as well as Stacks native stablecoins.

Funnel Top Model

Bitcoin staking is the funnel top of Stacks; it attracts BTC capital seeking yield without relinquishing custody. Once bound, this capital becomes identifiable around the surrounding application layer: Zest for lending, Bitflow for swapping, Hermetica for structuring basis trade yields, and StackingDAO will provide liquidity after stBTC goes live. The usage of these applications drives chain activity, producing transaction fees that ultimately become a meaningful, self-sustaining source for consensus yields, alongside miners bidding in the PoX pool.

Conclusion Thoughts

The issue of idle capital in Bitcoin is real and structural.

Bitcoin lacks a native yield mechanism, and every pathway constructed to compensate for this—be it wrapped BTC, BTC L2, or CeFi lending—carries certain trust assumptions.

These pathways have been adopted, and BTC currently accounts for about 7% ($5.2 billion) of DeFi TVL. However, considering its scale, its representation is insufficient. Most BTC today lacks productivity and remains an asset held for price appreciation.

Stacks has been steadily building to reduce these trust assumptions, and with the upcoming PoX-5 upgrade, Bitcoin holders can earn yield natively from miners of the Stacks blockchain who bid BTC to mine Stacks blocks.

Whether their model becomes the most adopted or utilized depends on how closely their ecosystem grows with native BTC staking, as maintaining yield (3% APY) requires ongoing bidding from miners. This has already been proven by over five years of activity since the Stacks mainnet launch.

Nevertheless, BTC remains a reserve asset widely adopted by institutions. Enhancing its productivity will only amplify the asset's ability to continue becoming part of more balance sheets and be profitable for new holders.