Is Bitcoin Set to Become the Preferred Collateral in DeFi? Insights from Lombard Finance

The decentralized finance (DeFi) landscape is on the brink of transformation, with an ongoing battle for market dominance taking place amongst various blockchain assets. As DeFi protocols accumulate value close to their 2021 highs, the pressing question arises: will Bitcoin become the collateral of choice in the DeFi economy? According to data from DeFiLlama, DeFi protocols have locked in nearly $126 billion in value, approaching the all-time high of $175 billion recorded in 2021, with the majority of these assets being ether (ETH) and its derivatives.

The Current Landscape of DeFi Collateral

Currently, collateral in the DeFi ecosystem is predominantly composed of ether and its liquid staked derivatives like staked ether (stETH) and wrapped ether (weETH). Wrapped Bitcoin (wBTC) and various stablecoins are vying for the fourth and fifth positions. However, Lombard Finance, a Bitcoin-centric DeFi protocol, is aiming to disrupt this status quo with its introduction of LBTC, a new liquid Bitcoin token.

Bitcoin vs. Ether: The Case for LBTC

Jacob Philips, co-founder of Lombard Finance, argues that Bitcoin should be the primary collateral used in DeFi, just as it is in centralized financial venues. “Bitcoin is a rock-solid store of value. It is the perfect collateral. There’s no reason we shouldn’t be building DeFi on top of Bitcoin,” Philips stated in a recent interview with CoinDesk.

Bitcoin has demonstrated significant price growth, surging 124% since the beginning of the year, driven by favorable political developments in the U.S. and the success of spot exchange-traded funds (ETFs). In contrast, ether has only risen 48% in the same timeframe, despite its smaller market capitalization.

The Potential of Bitcoin in DeFi

With increasing demand for Bitcoin and discussions of a U.S. strategic Bitcoin reserve under the new administration, the asset’s role in the on-chain economy could evolve dramatically. Philips envisions Bitcoin becoming a major liquidity source for all DeFi protocols across various chains, injecting fresh capital into the ecosystem.

“Even if we only capture a fraction of Bitcoin’s $1.9 trillion market cap, it will significantly boost activity in the DeFi space,” he emphasized. This influx could lead to a more efficient DeFi landscape, potentially rivaling the liquidity available on centralized exchanges.

Yield Opportunities for Bitcoin Holders

A key distinction between Bitcoin and ether is that ether holders can stake their assets on the Ethereum network to earn interest. Currently, staked ether offers an annual yield of 3.19%, according to CoinDesk’s composite ether staking rate index. Bitcoin, on the other hand, lacks such staking capabilities—until now.

Lombard Finance aims to bridge this gap by offering LBTC as a yield-bearing Bitcoin token through its Babylon protocol. Users can stake their Bitcoin via Lombard, which then mints one LBTC token for each Bitcoin staked. These LBTC tokens adhere to the ERC-20 standard, allowing them to be utilized across Ethereum and its various protocols.

Integrations and Future Prospects of Babylon

As of now, nine projects, including Corn, BOB, Cosmos Hub, Nubit, Fiamma, Manta, LayerEdge, Chakra, and Pell, have initiated or completed integrations with Babylon’s development environment. These integrations are expected to go live next year upon the launch of Babylon’s layer 1. Although Babylon currently does not distribute staking rewards, it has still managed to accumulate $5.4 billion in total value locked, making it the tenth largest protocol in the DeFi space.

Users may be incentivized to lock their Bitcoin in Babylon due to its points program, which could lead to a potential airdrop for early depositors. However, the Babylon team has not confirmed whether a token will be issued.

Challenges Ahead for LBTC

Despite the enthusiasm surrounding LBTC, the token faces fierce competition in the DeFi landscape. Currently, over $6 billion is staked in Babylon, with $1.4 billion originating from Lombard to create LBTC tokens. While these tokens do not yet generate yield, Philips notes that users’ choices between ether and Bitcoin are influenced by broader factors, including the potential for a U.S. Bitcoin reserve and regulatory attitudes towards the two assets.

It’s noteworthy that DeFi users can already utilize Bitcoin as collateral through wrapped Bitcoin (wBTC), which has a market capitalization of $12.9 billion. Despite concerns regarding the management of wBTC by BitGo and its association with TRON founder Justin Sun, wBTC still represents a significant portion of collateral in DeFi, although it lags behind ether (which holds $14.5 billion) and stETH (which has $11.1 billion).

The Rise of Staked ETH and Its Implications

Staked ether (stETH) and wrapped ether (weETH) have been gradually increasing their market share, leading to reports by ARK Invest that the DeFi economy is reorganizing itself around stETH and the yield provided by staked ether. Other assets, such as Solana’s SOL and Avalanche’s AVAX, are also attracting attention due to higher staking yields, albeit with increased volatility and risk.

Stablecoin lenders are feeling the pressure from stETH’s rise, resulting in increased interest rates for locked DAI on platforms like Sky (formerly MakerDAO) and other lending protocols like Aave and Compound. Additionally, new financial products from major institutions like BlackRock and Franklin Templeton could further complicate the landscape by allowing DeFi users to access U.S. Treasury bills as collateral.

Lombard’s Vision for the Future

Philips remains optimistic about LBTC’s potential to succeed where wBTC has struggled, primarily due to its yield-generating capabilities. “The LBTC yield is expected to align with the ETH staking rate,” he shared. Lombard’s initial aim is to encourage users to move their Bitcoin from cold storage to engage in on-chain finance, demonstrating the safety and reliability of established protocols.

The recent fundraising efforts by Lombard, which raised $16 million with backing from notable investors like Polychain Capital, Franklin Templeton, and Nomad Capital, further illustrate the interest in Bitcoin staking. Philips notes that individuals familiar with DeFi have been particularly receptive to the concept of Bitcoin staking, making it easier to onboard new users.

Conclusion: The Future of Bitcoin in DeFi

As the DeFi landscape continues to evolve, the potential for Bitcoin to emerge as the preferred collateral is becoming increasingly plausible. With the introduction of LBTC and the innovative Babylon protocol, Lombard Finance is positioning itself to lead this shift. Whether Bitcoin can dethrone Ethereum and its derivatives as the go-to collateral remains to be seen, but the groundwork is being laid for a future where Bitcoin plays a central role in the decentralized finance ecosystem.

For further insights on cryptocurrency investments, check out our guides on How to Buy Bitcoin and How to Buy Ethereum. Stay informed on the latest trends and developments in the ever-changing world of cryptocurrency.