Need help understanding Bitcoin DeFi?
Need help understanding Bitcoin DeFi?
Need help understanding Bitcoin DeFi?
Need help understanding Bitcoin DeFi?
Need help understanding Bitcoin DeFi?

Using Blockchain - Is the Future of Finance in the Bitcoin Ecosystem?

The internet is broken. 46.4% of global IT security executives estimated that their organizations have been victims of one to five cyber attacks within the last year. The treasure trove of data collected and mined by corporations coupled with the infrastructural vulnerabilities have led to the average cost of a data breach to climb to $4.24 million worldwide in 2021. Unsurprisingly, 53% of malicious data breaches worldwide were perpetrated by actors motivated by financial gain. Yet despite these issues, the world is becoming more digital by the day.

Deep dive
January 20, 2022
Lead Content Manager
Using Blockchain - Is the Future of Finance in the Bitcoin Ecosystem?

The global economy is shifting away from physical goods to services, digital goods, and the knowledge economy. As more economic activities shift to digital mediums, decentralized financial solutions powered by blockchain will become central to enabling security and trust in an untrusting world.

Digital Economies Require Reliable Digital Currencies

As the global economy becomes increasingly digitized, services have started to overtake goods in terms of contributions to the global economy. In 2019, McKinsey reported that the flow of services and data now plays a much bigger role in the global economy, and trade in services grew more than 60% faster than the trade in goods over the past decade.

Yet despite the increasing digitization of the economy, currencies have not experienced a similar evolution. Today, central banks play zero-sum games through currency wars in their bid to improve their economic standing at the expense of other countries, and fiat currencies still need to eventually settle in cash. They aren’t natively digital, which makes them inefficient as a means of exchange in a fully digital economy.

Cryptocurrencies are more suited to facilitate the transfer of value in a digitized global economy because they are designed for the digital world. Cryptocurrencies exist as code with near-instant settlement. Bitcoin, by far the most popular cryptocurrency, has all the key pieces aligned for it to become a lynchpin in the global economy. Here’s why.

Bitcoin has the best brand appeal. It’s becoming a household name, and more than 40 million people own at least one Satoshi (0.00000001 Bitcoin).  Bitcoin’s security is unassailable, and in the first decade of its existence, Bitcoin has never been hacked. That’s a powerful fact for an open-source software worth nearly $1 trillion.

Bitcoin is also fully decentralized without being subject to a foundation, corporation, or government, and it is deflationary in nature. Bitcoin has a fixed supply of 21 million BTC, and the demand and supply dynamics of Bitcoin make it a powerful hedge against inflation. 

Another factor that positions Bitcoin for increased relevance in the global economy is its rising adoption across sectors and economies. For instance, 42 institutions now hold more than 6% of the total Bitcoin supply. Likewise, Bitcoin has recorded an 880% surge in adoption across emerging economies, and its legal tender status in El Salvador has started the conversation about Bitcoin’s potential as the next global reserve currency.

Why is Bitcoin able to achieve this growth? Let’s take a step back and talk about the technology behind it.

A Refresher on Blockchain and the Bitcoin Ecosystem

A blockchain is a digital, decentralized, public ledger that exists across a distributed network. The blockchain stores information in “blocks” of data, and each new block of data also contains the history of every block that came before it, in the “chain.” 

One of the key selling points of blockchains is that they store information transparently, securely, and immutably on a public ledger. On a blockchain, anyone can find relevant details about wallets and transactions using a block explorer, and all the data is stored with end-to-end encryption secured by cryptography.  There is no middleman to verify transactions. Everything is public.

The participants on the blockchain also have private keys that serve as personal digital signatures, and it is impossible to falsify records because each transaction is linked to a unique cryptographic signature. Attempting to alter the data stored on the blockchain will invalidate the hash (a cryptographic proof), and other participants in the blockchain could see the attempt as an act of bad faith and route around it.

The entire history of the blockchain is maintained by a distributed network of computers called nodes. What qualifies as a node varies across different blockchains, ranging from Raspberry Pi and regular computers to high-end dedicated servers. The nodes in a blockchain network stay connected and communicate with each other about the latest state of the blockchain. One of the key features of decentralization in public blockchains is that there are no permissions to add a node to the network; anybody can set up a node and join the blockchain. 

In 2008, Satoshi Nakamoto’s whitepaper established the model for a blockchain that can power the peer-to-peer transfer of value without traditional financial intermediaries. After all, the actions of those intermediaries led to the 2008 global financial crisis. A year after the publication of the Bitcoin whitepaper, Bitcoin launched as the first implementation of blockchain for the trustless transfer of value.

Since that launch, Bitcoin has proven to be an inspirational success, showing that monetary supply can be free from centralized control. Other cryptocurrencies have emerged, building on Satoshi’s original idea of decentralized money, but Bitcoin is still the leading cryptocurrency by market dominance with a market cap of nearly $1 trillion

Using Blockchain: Trustless Transactions Through Smart Contracts 

The emergence of smart contracts extended the application of blockchain beyond facilitating the transfer of value and recording the truth of those transactions. Through smart contracts, blockchains now had programmability, so that you could set conditions on when a transaction would be executed. 

For example, Bob can send 1 BTC to Alice as a peer to peer transfer. The Bitcoin ledger will record the "truth" of that transaction to show that Bob sent Alice 1 BTC, and there's an immutable record of that transfer on the blockchain. 

Smart contracts come into play for “complex” transactions. Let’s take the same example above, but now Bob is obligated to send 1 BTC to Alice only if she scores 700 on her GMAT test. 

How can Alice be sure that Bob will send her 1 BTC? She assumes risk to trust the following:

  1. Bob has 1 BTC 
  2. Bob won't use that 1 BTC for other purposes before her GMAT score is ready 
  3. Bob will keep his word and send 1 BTC if she scores 700 

A blockchain alone can only provide Alice security on the first of those 3 conditions: that Bob has 1 BTC. It can’t enforce the terms of the agreement, the second and third condition.

However, a smart contract can provide that security because the conditions of the agreement are written in code that is autonomously evaluated and executed. Alice doesn’t need to trust Bob; she only needs to trust the smart contract.

This ability to program complex conditions into smart contracts has opened up a new world of possibilities for trustless, decentralized solutions, with the most notable innovations being decentralized finance (DeFi), decentralized autonomous organizations (DAOs), and non-fungible tokens (NFTs).

However, Bitcoin didn’t support the functionality for smart contracts—and this was by design. Bitcoin was first and foremost designed to enable a decentralized, trustless, and immutable record and facilitate the transfer of value. 

To maximize its security, Bitcoin has a limited scripting language, which makes it difficult to introduce new features, change Bitcoin’s code, or add complexities that could, in turn, create new security vulnerabilities. In other words, Bitcoin’s simplicity is a feature, not a bug.

The fact that Bitcoin wasn’t optimized for smart contracts excluded it from the early days of decentralized applications powered by smart contracts. Therefore, the ecosystems for dApps have gone on to thrive on other blockchain platforms, and developers have gone to those blockchains to build. For context, 22% of monthly active developers work on Ethereum (the most popular blockchain for developers in 2021), and only 3.7% work on Bitcoin.

However, that is changing. Bitcoin is now evolving with the introduction of different innovations and upgrades designed to enable a decentralized economy within the Bitcoin ecosystem. For instance, the Stacks blockchain, the Lightning Network, and the Taproot upgrade, among others, are working to enhance Bitcoin’s programmability, versatility, and scalability. Stacks, in particular, is making Bitcoin programmable by enabling fully expressive smart contracts for the Bitcoin ecosystem.

Learn how builders are creating Bitcoin DeFi applications in a recent episode of Web3 on Bitcoin Explained with Bitcoin educator Dan Held:

The Future of Finance Is in the Bitcoin Ecosystem

As the Bitcoin ecosystem evolves and matures, Bitcoin could become an important lynchpin in a digitized global economy because its decentralized nature enables a level playing field free from manipulation by governments, central banks, and other agents. 

However, beyond serving as a means of exchange in the global economy, Bitcoin could potentially power DeFi applications as Stacks continues to extend Bitcoin’s programmability with fully expressive smart contracts. Stacks is complementing Bitcoin with a smart contract layer to enable developers to build trustless, decentralized solutions in an untrusting world. 

The development of smart contracts for Bitcoin is a game changer, and now developers can build complex financial applications within the Bitcoin ecosystem. Bitcoin’s security, deep capital, and network effects could unlock higher confidence in the use of smart contracts to enforce the terms of a predefined agreement trustlessly, impartially, and automatically. 

We are still in the early days of decentralized finance in the Bitcoin ecosystem, but if there’s any single blockchain with the best shot at powering the evolution of finance, it’s Bitcoin. 

Interested in building decentralized solutions for the Bitcoin ecosystem? Download our free guide to Bitcoin's evolution to learn more about how Bitcoin became an ecosystem for Web3 apps.

Download a Developer's Guide to Bitcoin's Evolution
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