BTCFi will become an inevitable trend through improvements in capital efficiency, driving factors of institutional adoption, and the development of technological infrastructure.
Written by: Tiger Research
Compiled by: AididiaoJP, Foresight News
Summary
The funding base of Bitcoin is vast but has not been fully utilized, BTCFi will change this situation:
Currently, there are over 14 million BTC in idle status, and Bitcoin lacks capital efficiency in the Ethereum DeFi ecosystem. BTCFi releases liquidity by transforming BTC into interest-bearing assets, enabling its use in lending, staking, insurance, and other decentralized financial applications built on the security of Bitcoin.
The demand for BTC native yields among institutions is growing, and the infrastructure is ready: from compliant custody solutions to real-world yield protocols, the BTCFi ecosystem now encompasses ETFs, licensed lending, insurance models, and staking agreements that meet institutional standards.
Technological breakthroughs and Layer-2 innovations have endowed BTCFi with scalability and programmability. Upgrades like Taproot and emerging Layer-2 platforms now support smart contracts, token issuance, and composable DeFi applications on Bitcoin.
Liquidity Bottleneck: The Significance of BTCFi
Data Source: Glassnode
Bitcoin is now an asset base worth over 1 trillion dollars, but most of these assets are idle. Analysts estimate that 99% of BTC’s market value is “idle”; in other words, almost all bitcoins are stored in wallets or cold wallets and have not generated any on-chain yield. On-chain data also confirms this: over 14 million BTC have not been utilized for a long time.
Data Source: DefiLlama
This stands in stark contrast to Ethereum, where a large amount of ETH is actively deployed in DeFi and staking. For example, liquid staking protocols on Ethereum have locked over 14.37 million ETH (approximately $5.6 billion), converting ETH into yield-bearing assets and driving a vibrant on-chain economy.
Ethereum’s DeFi “summer” showcased how capital efficiency achieved through staking rewards, lending interest, and liquidity provision 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 stated in CoinGecko’s beginner’s guide, Bitcoin DeFi “transforms Bitcoin from a passive asset into a productive asset,” allowing holders to earn returns through BTC or use it for DeFi applications.
The essence of BTCFi’s goal is to bring the transformation that DeFi has brought to Ethereum to Bitcoin: to turn static assets into sources of yield and become the cornerstone for further innovation.
Institutional demand for returns is growing.
The historical development of Bitcoin ETF. Data source: Fioderers
Institutional demand may be the strongest catalyst driving the growth of BTCFi, and this trend is already evident. 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 regarded Bitcoin as a strategic reserve asset, but they are also sensitive to yields. In traditional finance, capital is never idle; bonds pay interest, stocks pay dividends, and even cash can be deposited into money market funds. However, Bitcoin had not generated any yield until recently.
BTCFi is changing this. Institutions are now asking a logical question: what can we do with the BTC we hold? More and more institutions are beginning to explore ways to lend, stake, or use Bitcoin as collateral to unlock yields, similar to traditional financial models.
With the emergence of these options, institutional interest in BTCFi is surging. The annualized return rate of BTC at 3%-5% may not seem high, but when managing billions of dollars in funds, this incremental gain is extremely valuable.
As BTCFi matures, BTC holders can now earn an annual yield of 10%-20% through decentralized protocols, making this opportunity even more attractive. If BTC can provide stable and low-risk returns while retaining its price appreciation potential, 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 returns on idle assets has become 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 returns in crypto finance, setting benchmarks across all areas from lending rates to DeFi protocol valuations.
The infrastructure is in place.
The BTCFi ecosystem is rapidly taking action, launching new products and frameworks designed specifically for institutional adoption:
Compliance Custody and Liquidity Packaging
Fidelity Digital Assets, Coinbase Custody, and companies like BitGo now support participation in DeFi under strict custody compliance. Emerging solutions such as Liquidity Custody Tokens (LCTs) like 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.
ETF and Yield Integration Products
The first interest-bearing Bitcoin ETP in Europe. Data source: CoreDAO
The Bitcoin ETP has been launched in Europe. Valour’s BTCD ETP stakes BTC into the Bitcoin Layer-2, with an annualized yield of approximately 5.6% by the end of 2024. Meanwhile, institutions are beginning to explore BTC-linked structured notes, dual-return products, and basis trading strategies, combining traditional financial instruments with crypto-native yield engines.
BounceBit aims to enable institutions to earn yields through BTC. Data source: BounceBit
For example, BounceBit Prime combines tokenized US Treasury bonds with BTC yield strategies in one product, offering a dual return familiar to traditional investors (such as family offices and hedge funds), making it a Bitcoin yield product designed for Wall Street.
Another example is SatLayer, which has launched a decentralized insurance tool backed by yield-generating 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 share of the premium income. SatLayer is working with both crypto-native and traditional underwriting institutions, such as Nexus Mutual and Relm, to build a new class of decentralized BTC insurance products.
Protocol Maturity and Institutional Trust
The total locked value (TVL) of BTCFi protocols such as Babylon and Lombard has surpassed several billion dollars, passed security audits, and is advancing towards SOC2 compliance. Many protocols have also hired seasoned Wall Street professionals as advisors and prioritize risk management through design. These measures have established credibility for large global capital allocators.
All of this points to a future where BTC returns will become a cornerstone of institutional portfolios, just like U.S. Treasuries do in traditional markets. This shift will also create a ripple effect: the influx of institutional funds into BTCFi not only benefits Bitcoin holders but also enhances cross-chain liquidity, promotes more DeFi standards, and provides a reliable and productive capital base layer for the entire crypto economy.
In short, BTCFi offers institutions the best of both worlds: the reliability of Bitcoin as a premium asset and the opportunity to earn yields.
Why Now? The Technology Stack Driving the BTCFi Boom
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 driven by improved infrastructure, and institutional interest spurred by clearer regulations.
From Taproot to BitVM
Taproot upgrade enhances Bitcoin privacy and efficiency. Data source: chaindebrief
The latest upgrades to the Bitcoin protocol and ecosystem lay the foundation for more complex financial applications. For example, the Taproot upgrade in 2021 enhanced Bitcoin’s privacy, scalability, and programmability, even “encouraging the use of smart contracts on Bitcoin” by improving efficiency. Taproot also supports new protocols such as Taro (now Taproot Assets) for issuing tokens and stablecoins on the Bitcoin ledger.
BitVM. Data source: Bitcoin Illustrated
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 batch of Bitcoin-native Layer-2 networks and sidechains have already emerged.
For example, 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 computing power, enables cross-chain tokenization via sBTC, and achieves native BTC earnings 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 utilize BitVM to achieve Turing-complete contracts based on Bitcoin security.
Merlin’s TVL is currently higher than many ETH Layer-2s, such as ZkSync, Linea, and Scroll. Data source: Merlin
Meanwhile, the Babylon protocol has introduced Bitcoin staking to protect 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 USD), making it one of the top DeFi protocols by TVL. Merlin, as the platform that once had the highest TVL in Bitcoin Layer-2, reached a TVL of about 3.9 billion USD within 50 days of its launch, greatly expanding the territory of BTCFi.
The combination of these upgrades and new layers addresses many early obstacles, allowing Bitcoin to now support tokens, smart contracts, and cross-chain interactions in a modular way.
From Ordinals to BRC-20
2023 is the breakout year for Ordinals and BRC-20 tokens. Data source: Dune @dataalways
In the past two years, the market has seen a significant increase in the demand for more expressive uses of Bitcoin. A typical example is the explosion of Ordinals and BRC-20 tokens in 2023. Users began to inscribe assets and NFTs on sats, driving a surge in on-chain activity.
As of the end of 2023, over 52.8 million Ordinals inscriptions have been created, expected to grow to about 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 USD) by the end of the third quarter of 2024.
This trend proves that users are willing to utilize Bitcoin’s block space for more than just simple holding or payment; the demand for Bitcoin NFTs, tokens, and DeFi applications has already emerged.
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 the use of Bitcoin is similar.
All these advancements constitute a tech 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 work together to mature BTCFi, and in the coming years, this trend may accelerate.
5. BTCFi Ecosystem Scenarios
The goal of BTCFi is to transform Bitcoin from a passive store of value into a financial asset actively deployed in decentralized finance.
Introducing Bitcoin to DeFi
The lifecycle of BTCFi typically begins when BTC holders transfer 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.
Explore BTCFi Technology Stack
After tokenization, BTC flows within the BTCFi technology stack through a structured hierarchy. At the asset level, the Solv Protocol enables BTC to serve as cross-chain yield-bearing collateral through SolvBTC and the Staking Abstraction Layer (SAL), supporting structured products and capital-efficient use cases.
The institution has adopted products such as lstBTC. lstBTC is launched in cooperation 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 provides real-world returns based on BTC through a compliant financial structure. At the same time, infrastructure projects like Botanix expand the programmability of Bitcoin by introducing EVM compatibility, enabling BTC to serve as Gas for supporting smart contracts.
Using BTC as collateral and staking assets
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 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.
Risk Management and Exiting Positions
Throughout the process, BTC holders retain economic exposure to Bitcoin price fluctuations while earning yields from DeFi protocols. These positions are reversible: users can close their positions at any time, redeem wrapped BTC, and retrieve the original Bitcoin (minus fees or yields) to exit.
Incentive and Revenue Model
The liquidity is supported by diversified profit models. Lending platforms generate income by initiating and utilizing fees, capturing the interest spread between borrowers and lenders. DEX charges liquidity fees on each transaction, which are usually shared with liquidity providers and the protocol treasury. Staking and bridging services take a commission from the earned rewards, incentivizing them to maintain uptime and network security.
Some protocols use native tokens to subsidize usage, incentivize activities, or manage the treasury. Custodial products typically adopt traditional asset management models, charging an annual fee on the assets held or managed (e.g., 0.4%-0.5%).
In addition, spread capture provides a less conspicuous but important source of income: protocols can profit from interest rate differences and basis trading through cross-chain arbitrage or structured yield strategies.
These models collectively demonstrate how the BTCFi protocol activates idle Bitcoin while establishing a sustainable income base. As more BTC enters this layered system, it not only circulates but also compounds, generating returns and supporting a Bitcoin-centric parallel economy.
