Two years have passed since the inscription craze. Will BTCFi lead the Bitcoin ecosystem bull market again?

Author: Tiger Research

Compiled by AididiaoJP, Foresight News

Summary

Bitcoin's capital base is vast but underutilized. BTCFi will change this:

With over 14 million BTC currently idle, Bitcoin lacks the capital efficiency of the Ethereum DeFi ecosystem. BTCFi transforms BTC into an interest-bearing asset, unlocking liquidity for lending, staking, insurance, and other decentralized financial applications built on Bitcoin's security.

Institutional demand for native BTC yields is growing, and the infrastructure is in place: From compliant custody solutions to real-world yield protocols, BTCFi's ecosystem now includes ETFs, permissioned lending, insurance models, and institutional-standard staking protocols.

Technical breakthroughs and Layer-2 innovations make BTCFi scalable and programmable. Upgrades like Taproot and emerging Layer-2 platforms now support smart contracts, token issuance, and composable DeFi applications on Bitcoin.

Capital Liquidity Bottleneck: The Purpose of BTCFi

Data Source: Glassnode

Bitcoin now represents an asset base exceeding $1 trillion, but much of this assets remains idle. Analysts estimate that 99% of BTC's market capitalization is "idle," meaning that almost all Bitcoin is stored in wallets or cold storage, generating no on-chain returns. On-chain data confirms this: over 14 million BTC remain unused for extended periods.

Data source: DefiLlama

This stands in stark contrast to Ethereum, where a significant amount of ETH is actively deployed in DeFi and staking. For example, Ethereum's liquidity staking protocols have locked over 14.37 million ETH (approximately $56 billion), transforming ETH into interest-earning assets and fueling 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 been underutilized in this regard; its massive liquidity yields 0% and is unable to be further combined into financial products on the base layer.

BTCFi (Bitcoin DeFi) aims to unlock this dormant capital. As Coingecko's introductory guide explains, Bitcoin DeFi "transforms Bitcoin from a passive asset into a productive asset," enabling holders to earn yield on BTC or use it in DeFi applications.

Essentially, BTCFi aims to achieve for Bitcoin what DeFi has achieved for Ethereum: transforming static assets into income streams and serving as a foundation for further innovation.

Institutional demand for yield is growing

Historical development of Bitcoin ETF. Data source: Fioderers

Institutional demand may be the strongest catalyst for BTCFi's growth, and this trend has already emerged. From the end of 2023 to 2024, several large asset management companies applied for and were approved to launch spot Bitcoin ETFs, eventually introducing BTC into mainstream investment portfolios.

Institutions have embraced Bitcoin as a strategic reserve asset, but they are also sensitive to yield. In traditional finance, capital never sits idle: bonds pay interest, stocks pay dividends, and even cash is deposited in money market funds. Until recently, Bitcoin generated no yield.

BTCFi is changing this. Institutions are now asking a logical question: what can we do with our BTC holdings? More and more institutions are exploring ways to unlock yield by lending, staking, or using Bitcoin as collateral, similar to traditional finance models.

With the emergence of these options, 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 extremely valuable.

As BTCFi matures, BTC holders can now earn annualized returns of 10%-20% through decentralized protocols, making the opportunity even more attractive. If BTC can provide stable, low-risk returns while retaining its price growth potential, it will become not only 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 yield on idle assets is becoming increasingly clear. Yield generation is evolving from a niche strategy to a fundamental component of asset management.

Just as U.S. Treasuries underpin traditional capital markets, Bitcoin could become the underlying yield asset in crypto finance, setting the benchmark for everything from lending rates to DeFi protocol valuations.

Infrastructure is in place

The BTCFi ecosystem is moving quickly to launch new products and frameworks designed for institutional adoption:

Compliant custody and liquidity wrapping

Fidelity Digital Assets, Coinbase Custody, and BitGo, among others, now support participation in DeFi with strict custody compliance. Emerging solutions such as Liquidity Custody Tokens (LCTs) such as BounceBit’s BBTC enable institutions to hold BTC in compliant custody while deploying it on-chain to earn yield. Institutions can enjoy the yield potential of DeFi while maintaining regulatory compliance.

ETF and income integration products

Europe's first interest-bearing Bitcoin ETP. Data source: CoreDAO

The interest-bearing Bitcoin ETP has been launched in Europe. Valour's BTCD ETP pledges BTC to Bitcoin Layer-2, with an annualized yield of approximately 5.6% by the end of 2024. At the same time, institutions began to explore BTC-linked structured notes, dual-income products, and basis trading strategies, combining traditional financial instruments with crypto-native yield engines.

BounceBit's goal is to allow institutions to earn income through BTC. Data source: BounceBit

For example, BounceBit Prime combines tokenized U.S. Treasuries with BTC income strategies in one product, providing double returns familiar to traditional investors such as family offices and hedge funds, which is a Bitcoin income product designed for Wall Street.

Another example is SatLayer, which launched a decentralized insurance tool backed by interest-bearing BTC. Often called "Bitcoin's Berkshire Hathaway," SatLayer allows any BTC holder to re-collateralize their assets in an on-chain insurance pool and earn a share of premium income. SatLayer is collaborating with crypto-native and traditional underwriters such as Nexus Mutual and Relm to build a new class of decentralized BTC insurance products.

Protocol Maturity and Institutional Trust

BTCFi protocols such as Babylon and Lombard have surpassed billions of dollars in total value locked (TVL), passed security audits, and are progressing towards SOC2 compliance. Many protocols also employ Wall Street veterans as advisors and prioritize risk management by design. These initiatives have established credibility with 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 are in traditional markets. This shift will also have a cascading effect: Institutional capital inflows into BTCFi not only benefit Bitcoin holders, but also enhance cross-chain liquidity, promote more DeFi standards, and provide a trusted, 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 high-quality asset, and the opportunity to earn yield.

Why now? The technology stack that drives the BTCFi explosion

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, market demand growth due to improved infrastructure, and institutional interest driven by regulatory clarity.

From Taproot to BitVM

Taproot upgrade improves Bitcoin privacy and efficiency. Data source: chaindebrief

Recent upgrades to the Bitcoin protocol and ecosystem have laid the foundation for more complex financial applications. For example, the 2021 Taproot upgrade improves Bitcoin's privacy, scalability, and programmability, and even "encourages 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.

BitVM. Data source: Bitcoin Illustrated

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

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

Stacks makes Bitcoin more programmable and productive for developers and institutions by supporting smart contracts through Bitcoin hashrate, cross-chain tokenization through sBTC, and native BTC yield through Proof of Transfer (PoX) staking.

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

Merlin's TVL currently exceeds that of many ETH Layer-2 protocols, such as ZkSync, Linea, and Scroll. Data source: Merlin

Meanwhile, the Babylon protocol introduced Bitcoin staking to secure other chains and has attracted tens of thousands of BTC. By the end of 2024, Babylon had staked over 57,000 BTC (approximately $6 billion), making it one of the top DeFi protocols by TVL. Merlin, once the platform with the highest TVL among Bitcoin's Layer-2 platforms, reached approximately $3.9 billion in TVL within 50 days of its launch, significantly expanding the reach of BTCFi. The combination of these upgrades and new layers addresses many early hurdles, allowing Bitcoin to modularly support tokens, smart contracts, and cross-chain interactions.

From Ordinals to BRC-20

2023 will be a breakout year for Ordinals and BRC-20 tokens. Data source: Dune @dataalways

Over the past two years, market demand for more expressive uses for Bitcoin has grown significantly. A prime example is the explosive growth of Ordinals and BRC-20 tokens in 2023. Users began burning assets and NFTs in satoshis (sats), driving a surge in on-chain activity. By the end of 2023, over 52.8 million Ordinals inscriptions had been created, growing to approximately 69.7 million by the end of 2024. Meanwhile, miners collected hundreds of millions of dollars in fees, exceeding 6,900 BTC (approximately $405 million) by the third quarter of 2024. This surge demonstrates that users are willing to use Bitcoin block space for more than simple holding or payments, and that market demand for Bitcoin NFTs, tokens, and DeFi applications is already emerging. The emergence of the Ordinals protocol fundamentally enables Bitcoin to host these new types of assets, while the BRC-20 standard provides a framework for tokenization. While technically different from Ethereum's ERC-20, it serves a similar purpose in expanding Bitcoin's utility. All of these advancements constitute a technology stack that didn't exist just a few years ago. The Bitcoin ecosystem is now ready to build a complete DeFi infrastructure around its core asset.

Together, these catalysts work together to make BTCFi mature, and this trend is likely to accelerate in the next few years.

5. BTCFi Ecosystem Scenario

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

Introducing Bitcoin into DeFi

The BTCFi lifecycle typically begins with a BTC holder transferring their assets to a bridge or custodian. The original BTC is locked up, and a 1:1 tokenized version is issued. This wrapped BTC enters the ecosystem's asset layer, enabling integration with smart contracts and DeFi protocols.

Exploring the BTCFi Tech Stack

After tokenization, BTC flows through the BTCFi tech stack via structured layers. At the asset level, Solv Protocol enables BTC to be used as interest-bearing collateral across chains through SolvBTC and the Collateral Abstraction Layer (SAL), supporting structured products and capital-efficient use cases.

Institutional adoption is supported by products such as lstBTC. lstBTC, launched by Maple Finance in partnership with CoreDAO, leverages Core's dual-collateralization mechanism. BitLayer provides a trust-minimized Bitcoin native Layer-2 environment where Peg-BTC can support smart contract activities.

On the compliance side, IXS provides real-world returns based on BTC through compliant financial structures. At the same time, infrastructure projects such as Botanix extend Bitcoin's programmability by introducing EVM compatibility, enabling BTC to support smart contracts as Gas.

Using BTC as collateral and pledge assets

As infrastructure improves, BTC can be used as collateral. For example, on bitSmiley, BTC can be used to mint stablecoins, enabling yield generation or stablecoin strategies. Emerging staking models are also expanding the use of BTC: protocols like Babylon allow native BTC to participate in protecting 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 movements while earning the yield of the DeFi protocol. These positions are reversible: users can exit at any time by closing their positions, redeeming the wrapped BTC, and getting back the original Bitcoin (minus fees or yield).

Protocol Incentives and Revenue Models

Underpinning these flows are diverse profit models. Lending platforms earn revenue by originating and leveraging fees, capturing the spread between borrowers and lenders. DEXs charge liquidity fees on each trade, typically shared with liquidity providers and protocol treasuries. Staking and bridging services take commissions from earned rewards, incentivizing them to maintain uptime and network security.

Some protocols use native tokens to subsidize usage, bootstrap activity, or manage treasuries. Custodial products typically follow a traditional asset management model, charging an annual fee (e.g., 0.4%-0.5%) on assets held or managed.

In addition, interest rate capture provides a less visible but important source of revenue: protocols can profit from interest rate differentials and basis trades through cross-chain arbitrage or structured yield strategies.

Together, these models show how the BTCFi protocol can activate idle Bitcoin while building a sustainable revenue base. As more BTC enters this layered system, it not only circulates, but also compounds, generating income and supporting a parallel economy centered on Bitcoin.