This article is reprinted with permission from Tiger Research Reports, and the copyright belongs to the original author.

Today, Bitcoin has become an asset base of over $1 trillion, but most of these assets are idle. Analysts estimate that 99% of BTC's market value is "idle," meaning almost all Bitcoin is stored in wallets or cold wallets, generating no on-chain yield. On-chain data also confirms this: over 14 million BTC have not been actively used for a long time.

This stands in stark contrast to Ethereum, where a large amount of ETH is actively deployed in DeFi and staking. For example, liquidity staking protocols on Ethereum have locked up over 14.37 million ETH (approximately $56 billion), turning ETH into an income-generating asset and driving a vibrant on-chain economy.

Ethereum's DeFi "summer" showcased how capital efficiency achieved through staking rewards, lending interest, liquidity provision, and other means can unlock tremendous value for smart contract platforms. In contrast, Bitcoin has not been fully utilized in this regard; its massive liquidity yield is 0%, and it cannot be further combined into financial products at the base layer.

The goal of BTCFi (Bitcoin DeFi) is to unlock this dormant capital. As described in CoinGecko's introductory guide, Bitcoin DeFi "transforms Bitcoin from a passive asset into a productive asset," allowing holders to earn yields through BTC or use it for DeFi applications.

Essentially, BTCFi aims to bring the transformation that DeFi has brought to Ethereum to Bitcoin: converting static assets into sources of income and becoming a cornerstone for further innovation.

Institutional demand may be the strongest catalyst driving BTCFi growth, and this trend is already emerging. From the end of 2023 to 2024, several large asset management companies have applied for and been approved to launch spot Bitcoin ETFs, ultimately bringing BTC into mainstream portfolios.

Institutions have viewed Bitcoin as a strategic reserve asset, but they are also yield-sensitive. In traditional finance, capital is never idle; bonds pay interest, stocks pay dividends, and even cash can be deposited in money market funds. Until recently, Bitcoin had not generated any yield.

BTCFi is changing this. Institutions are now asking a logical question: what can we do with the BTC we hold? An increasing number of institutions are exploring ways to lend, stake, or use Bitcoin as collateral to unlock yields, similar to traditional financial models.

With these options emerging, institutional interest in BTCFi is surging. An annualized return of 3%-5% on BTC may not seem high, but when managing billions of dollars, this incremental yield is highly valuable.

As BTCFi matures, BTC holders can now earn annualized yields of 10%-20% through decentralized protocols, making this opportunity even more attractive. If BTC can provide stable and low-risk returns while retaining the potential for price appreciation, it will not only be a reserve asset but also a monetary anchor for DeFi.

As more institutions and individuals adopt BTC as a long-term reserve asset, the demand for earning yields on idle assets becomes increasingly clear. Yield generation is evolving from a niche strategy into a fundamental component of asset management.

Just as U.S. Treasuries underpin traditional capital markets, Bitcoin may become the underlying asset for yield in crypto finance, setting benchmarks across all areas from lending rates to DeFi protocol valuations.

The BTCFi ecosystem is rapidly taking action, launching new products and frameworks designed for institutional adoption:

Companies like Fidelity Digital Assets, Coinbase Custody, and BitGo now support participation in DeFi under strict custody compliance. Emerging solutions like liquidity custody tokens (LCTs), such as BounceBit's BBTC, enable institutions to hold BTC under compliant custody while deploying it on-chain to earn yields. Institutions can enjoy the yield potential of DeFi while maintaining regulatory compliance.

In Europe, yield-bearing Bitcoin ETPs have already launched. Valour's BTCD ETP stakes BTC in Bitcoin Layer-2, with an annualized yield of approximately 5.6% as of the end of 2024. Meanwhile, institutions are beginning to explore BTC-linked structured notes, dual-yield products, and basis trading strategies, combining traditional financial instruments with crypto-native yield engines.

For example, BounceBit Prime combines tokenized U.S. Treasuries with BTC yield strategies in one product, offering traditional investors (such as family offices and hedge funds) familiar dual returns, designed as a Bitcoin yield product for Wall Street.

Another example is SatLayer, which has launched a decentralized insurance tool backed by yield-bearing BTC. SatLayer is often referred to as the "Berkshire Hathaway of Bitcoin," allowing any BTC holder to re-stake their assets into an on-chain insurance pool and earn a portion of the premium income. SatLayer is collaborating with both crypto-native and traditional underwriting institutions (such as Nexus Mutual and Relm) to build a new class of decentralized BTC insurance products.

BTCFi protocols like Babylon and Lombard have seen their total locked value (TVL) exceed billions of dollars, have passed security audits, and are advancing towards SOC2 compliance. Many protocols have also hired seasoned Wall Street professionals as advisors and prioritize risk management in their designs. These initiatives build credibility for large global capital allocators.

All of this points to a future where BTC yields will become a cornerstone of institutional portfolios, just as U.S. Treasuries do in traditional markets. This shift will also create a ripple effect: institutional capital flowing into BTCFi will not only benefit Bitcoin holders but also enhance cross-chain liquidity, drive more DeFi standards, and provide a reliable, productive capital base layer for the entire crypto economy.

In short, BTCFi offers institutions a win-win choice: the reliability of Bitcoin as a premium asset and the opportunity to earn yields.

BTCFi is no longer just a theoretical concept—it is becoming a reality, thanks to breakthroughs in three areas: technological upgrades in the Bitcoin ecosystem, increased market demand from improved infrastructure, and institutional interest driven by regulatory clarity.

Recent upgrades to the Bitcoin protocol and ecosystem lay the groundwork for more complex financial applications. For example, the 2021 Taproot upgrade enhanced Bitcoin's privacy, scalability, and programmability, even "encouraging the use of smart contracts on Bitcoin" by improving efficiency. Taproot also supports new protocols like Taro (now Taproot Assets) for issuing tokens and stablecoins on the Bitcoin ledger.

Similarly, concepts like BitVM (a proposed Bitcoin "virtual machine") are expected to enable Ethereum-like smart contracts on Bitcoin, with a testnet planned for release in 2025. Equally important, a number of Bitcoin-native Layer-2 networks and sidechains have emerged.

Platforms like Stacks, Rootstock (RSK), Merlin Chain, and the new BOB Rollup are introducing smart contracts to the Bitcoin ecosystem.

Stacks supports smart contracts through Bitcoin's computational power, enables cross-chain tokenization via sBTC, and achieves native BTC yield through proof of transfer (PoX) staking, making Bitcoin more programmable and productive for developers and institutions.

BOB (Build on Bitcoin) is an EVM-compatible Layer-2 that uses Bitcoin as its finality anchor. It even plans to leverage BitVM to achieve Turing-complete contracts based on Bitcoin's security.

Meanwhile, the Babylon protocol introduces Bitcoin staking to secure other chains and has attracted tens of thousands of BTC. As of the end of 2024, Babylon has staked over 57,000 BTC (approximately $6 billion), making it one of the top DeFi protocols by TVL. Merlin, once the highest TVL platform in Bitcoin Layer-2, reached a TVL of approximately $3.9 billion within 50 days of launch, significantly expanding the landscape of BTCFi.

These upgrades and new layers together address many early obstacles, allowing Bitcoin to modularly support tokens, smart contracts, and cross-chain interactions.

Over the past two years, the market's demand for more expressive uses of Bitcoin has significantly increased. A typical example is the explosion of Ordinals and BRC-20 tokens in 2023. Users began inscribing assets and NFTs on satoshis (sats), driving a surge in on-chain activity.

As of the end of 2023, over 52.8 million Ordinals inscriptions have been created, growing to approximately 69.7 million by the end of 2024. Meanwhile, miners have collected hundreds of millions of dollars in fees, with fees exceeding 6,900 BTC (approximately $405 million) by the third quarter of 2024.

This frenzy proves that users are willing to do more with Bitcoin's block space than just hold or pay, and the demand for Bitcoin NFTs, tokens, and DeFi applications has become evident.

The emergence of the Ordinals protocol fundamentally enables Bitcoin to carry these new types of assets, while the BRC-20 standard provides a framework for tokenization. Although technically different from Ethereum's ERC-20, its role in expanding Bitcoin's use cases is similar.

All these advancements constitute a technology stack that did not exist a few years ago. The Bitcoin ecosystem is now ready to build a complete DeFi infrastructure around its core asset.

In summary, these catalysts are working together to mature BTCFi, and in the coming years, this trend may accelerate.

The goal of BTCFi is to transform Bitcoin from a passive store of value into a financial asset actively deployed in decentralized finance.

The lifecycle of BTCFi typically begins with BTC holders transferring their assets to a bridge or custodian. The original BTC is locked, and a 1:1 tokenized version is issued. This wrapped BTC enters the asset layer of the ecosystem, allowing it to integrate with smart contracts and DeFi protocols.

Once tokenized, BTC flows through structured hierarchies in the BTCFi tech stack. At the asset level, Solv Protocol enables BTC to serve as cross-chain yield-bearing collateral through SolvBTC and a staking abstraction layer (SAL), supporting structured products and capital-efficient use cases.

Institutional adoption has been supported by products like lstBTC. lstBTC was launched in collaboration between Maple Finance and CoreDAO, utilizing Core's dual staking mechanism. BitLayer provides a trust-minimized Bitcoin-native Layer-2 environment, where Peg-BTC can support smart contract activities.

In terms of compliance, IXS offers real-world yields based on BTC through compliant financial structures. Meanwhile, infrastructure projects like Botanix expand Bitcoin's programmability by introducing EVM compatibility, enabling BTC to serve as Gas for supporting smart contracts.

With the improvement of infrastructure, BTC can be used as collateral. For example, on bitSmiley, BTC can be used to mint stablecoins, thereby generating yields or implementing stablecoin strategies. Emerging staking models are also expanding the use of BTC: protocols like Babylon allow native BTC to participate in securing proof-of-stake (PoS) networks and earn rewards for doing so.

Throughout this process, BTC holders retain economic exposure to Bitcoin price fluctuations while earning yields from DeFi protocols. These positions are reversible: users can exit at any time by closing positions, redeeming wrapped BTC, and retrieving the original Bitcoin (minus fees or yields).

Supporting this liquidity are diversified profit models. Lending platforms earn income by initiating and utilizing fees, capturing the spread between borrowers and lenders. DEXs charge liquidity fees on each transaction, which are typically shared with liquidity providers and the protocol treasury. Staking and bridging services take a commission from earned rewards, incentivizing them to maintain uptime and network security.

Some protocols use native tokens to subsidize usage, guide activities, or manage treasuries. Custodial products often adopt traditional asset management models, charging an annual fee (e.g., 0.4%-0.5%) on the assets under custody or management.

Additionally, spread capture provides a less obvious but important source of income: protocols can profit from interest rate differentials and basis trading through cross-chain arbitrage or structured yield strategies.

These models collectively demonstrate how BTCFi protocols can activate idle Bitcoin while establishing a sustainable revenue base. As more BTC enters this layered system, it not only circulates but also compounds, generating yields and supporting a Bitcoin-centric parallel economy.

Related: Opinion: DeFi is becoming the new standard interface for the financial system

Original article: “BTCFi #1: Why DeFi on Bitcoin is Inevitable”

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