Bitcoin DeFi May Be Unstoppable, What Does It Look Like?

One of the quietest yet best-funded bitcoin companies in the world is gearing up to enter the 2020 decentralized finance (DeFi) bull run. 

In July the DG Lab conglomerate, which like Ethereum powerhouse ConsenSys includes both an investment arm and an adjacent software company, open sourced its proposal for self-sovereign derivatives trading on the Bitcoin blockchain, using the Lightning Network. 

These contracts turn bitcoin, the asset itself, into programmable money capable of a wider variety of functions. 

This offers a stark contrast to the typical DeFi approach so far, which relies on “wrapped” representations of bitcoin or exchange platforms. The Silicon Valley startup cLabs recently acquired DeFi firm Summa, which spearheaded the bitcoin-on-Ethereum approach. Now it looks as though DG Lab, founded in 2015, is the leading incumbent exploring DeFi opportunities for Bitcoin. 

“I’ve been working on a proposal to integrate DLC [Discreet Log Contracts] and channels into the Lightning Network,” DG Lab researcher Ichiro Kuwahara said of his recent work. “We can establish many contracts without broadcasting transactions on the blockchain.”

This software uses the Lightning Network to execute business logic without clogging up the base-layer blockchain. The hottest trend among Bitcoin veterans these days is imagining DeFi functionality applied to the bitcoin currency through such layers. There are many opinions on how to approach this opportunity, from DLC to soft forks.

Competition

Not everyone agrees on how to use Lightning for smart contracts. 

Bitcoin veteran Jeremy Rubin, who launched his Judica startup this summer, believes Blockstream’s Liquid Network, which companies like Crypto Garage use to experiment with such smart contracts, overcomplicates the construction. 

“I think we can do it much simpler. … It’s solvable on-chain but can be done in [Lightning] channels as well,” Rubin said in an interview, explaining how his proposed Bitcoin soft fork could optimize the base layer for smart contracts. “I can construct this contract, which is a derivative, without you being online. I can make a valid contract then email it to you.”

These days, both ends of a Lightning transaction need to participate at roughly the same time for the payment to go through. (Or, at least, both need to set everything up in advance.) Rubin is arguing there’s a way to make it so one party can execute a consensual transaction. Public keys allow the other party to see, whenever they come online, proof of everything about the deal.

“It’s this notion of flow and conditionality that doesn’t currently exist in Bitcoin,” Rubin said. “[These 2020 DeFi projects] are about helping define commutes … a sequence of steps that can happen based on choices along the way.”

There are enough engineers working on DeFi options for Bitcoin that one of them might technically work, even if socially it doesn’t catch on. Only time will tell which ones find product market fit, and how that may or may not spur crypto adoption.

Japanese bulls

Stepping back, the DeFi bulls at DG Lab Fund raised over $93 million in 2019 and, according to the firm’s blog post, are raising a second fund in 2020. 

The fund invested in DG Lab, the separate namesake startup, which simultaneously attracted investors from Japanese enterprises including the e-commerce giant Kakaku.com and the telecommunications provider KDDI. Meanwhile, the DG Lab Fund itself invested in River Financial, Arwen, Blockstream and Curv, to name a few, in addition to startups in adjacent sectors such as AI and security. 

“We have several startups that are working with DLC. For example, Suredbits is one of the key players in this field and we are working closely with them,” said Shunichi Kimuro, senior manager at DG Lab Fund. “We wanted to show what is possible using the Bitcoin protocol by using our peer-to-peer [P2P] derivatives.”

Yet another startup called Crypto Garage, in which DG Fund did not invest directly, is using Blockstream’s Liquid technology to explore this type of smart-contract software.  

“You define the outcomes of your contracts and create a transaction for each of the outcomes. And it can only be unlocked with one of the outcome transactions or with mutual agreement between the contract participants,” Crypto Garage engineer Thibaut Le Guilly said in an interview. 

Rubin pointed out that even if he disagrees with Le Guilly on certain aspects these Bitcoin projects have much more in common with each other than with Ethereum DeFi projects.

Different goals

“There’s a really big gap between DeFi, as Ethereum is trying to do it, and P2P finance,” Rubin said. “Uniswap is really great. But they tokenize their liquidity pools. … We [Bitcoiners] are talking about finding a way for people to work directly with each other.”

Bitcoin DeFi projects aren’t using representatives of bitcoin, they want to enable traders to do tasks directly with bitcoin.

“There are about 20 people in the Bitcoin community working on tools, applications and specifications for [Discreet Log Contracts], including at SuredBits,” Le Guilly said in an interview. “[Traders] don’t have to involve an exchange.”

It appears as though Ethereum DeFi advocates offer a different interpretation of decentralization than their node-obsessed Bitcoiner brethren. Bison Trails CEO Joe Lallouz said his infrastructure startup can easily move accounts across borders, thanks in part to a distributed team. This, from his perspective, is a slightly decentralized step away from Silicon Valley norms. 

“If Amazon said you can’t run nodes, for example, we can very quickly and seamlessly move our infrastructure to other cloud providers,” Lallouz said. “Everyone at the same time would have to say the blockchain network is something we don’t support [to censor our customers] across the internet.” 

While Ethereum DeFi experiments attract quick flashes of capital, losing considerable sums as advocates iterate, Bitcoin DeFi experiments seem comparatively modest. Yet, veterans know not to underestimate the Bitcoin development scene in Tokyo, home to the creators of self-sovereignty experiments including BTCPay and DG Lab. This period may just be the calm before a perfect storm. 

“Once there are enough people to create a real market, we might offer services or tools we can monetize,” Crypto Garage’s Le Guilly said. “At this stage, our goal is to raise awareness about what can be done with Bitcoin.”