The decentralized finance (DeFi) landscape is witnessing a burgeoning battle for collateral supremacy. While Ethereum (ETH) and its liquid staking derivatives currently dominate, Bitcoin-backed DeFi protocol Lombard Finance aims to disrupt the status quo with its liquid bitcoin token, LBTC. Could Bitcoin become the preferred collateral in the on-chain economy?
DeFi protocols currently hold nearly $132 billion in locked value, according to DeFiLlama, approaching the 2021 peak of $175 billion. ETH and its yield-bearing derivatives like staked ether liquid tokens (stETH) and wrapped eETH (weETH) constitute the majority of this collateral. Wrapped bitcoin (wBTC) and stablecoins trail behind.
Lombard Finance envisions a future where Bitcoin reigns supreme. Co-founder Jacob Philips questions why Bitcoin, the undisputed collateral king in centralized finance, hasn’t achieved the same status in DeFi. He argues that Bitcoin’s inherent stability makes it the ideal collateral, advocating for building DeFi directly on top of the Bitcoin network.
Bitcoin’s remarkable 133% surge this year, fueled by favorable political developments and the success of Bitcoin spot ETFs, contrasts with ETH’s 54% gain. This performance disparity, coupled with growing discussions about a potential U.S. strategic bitcoin reserve, strengthens the case for Bitcoin’s expanded on-chain role.
Philips believes Bitcoin’s entry into DeFi could unlock a massive influx of new capital, potentially rivaling the liquidity of centralized exchanges. He envisions Bitcoin as the primary liquidity source for DeFi protocols across all blockchains.
Yield: The Differentiator
A key distinction between Bitcoin and ETH lies in staking. ETH holders can stake their assets to secure the Ethereum network and earn interest, currently around 3.12% annually according to CoinDesk’s composite ether staking rate (CESR) index. Bitcoin lacks this native staking mechanism.
Lombard aims to bridge this gap with LBTC and its underlying protocol, Babylon. Users deposit Bitcoin with Lombard, which then stakes it through Babylon to secure other blockchains. For each staked BTC, Lombard mints one LBTC token, adhering to the ERC-20 standard for compatibility with Ethereum and its protocols. The yield on LBTC will purportedly be paid by the blockchains secured via Babylon. Nine projects are currently integrating with Babylon’s devnet, with anticipated launches next year.
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Despite lacking staking rewards, Babylon has amassed $5.6 billion in locked value, ranking as the 10th largest DeFi protocol. This impressive figure is likely attributed to a points program hinting at a future airdrop, although the Babylon team remains silent on token issuance plans.
Navigating a Competitive Landscape
Over $1.5 billion in Bitcoin has been staked through Lombard to mint LBTC, representing a significant portion of Babylon’s total value locked. However, without active Babylon staking rewards, LBTC currently offers no yield. Philips argues that factors beyond staking yield, such as regulatory considerations and the potential U.S. bitcoin reserve, influence investor preferences. He views yield as a bonus rather than the primary driver.
Wrapped bitcoin (wBTC) already enables Bitcoin’s use as collateral in DeFi, albeit without yield. Despite a $13.1 billion market capitalization, wBTC’s collateral usage in major DeFi protocols lags behind ETH and stETH. Concerns surrounding BitGo’s custodial arrangement with BiT Global, partially owned by the controversial TRON founder Justin Sun, may contribute to this disparity.
Furthermore, stETH and weETH are steadily gaining market share. ARK Invest suggests that the DeFi economy is restructuring around stETH and the benchmark yield of staked ETH. Higher-yielding tokens like Solana’s SOL and Avalanche’s AVAX are perceived as riskier due to their volatility.
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Stablecoin lending also faces pressure from stETH’s rise, with platforms like MakerDAO and Aave adjusting interest rates to remain competitive. The emergence of tokenized money market funds from institutions like BlackRock and Franklin Templeton further complicates the landscape, potentially introducing U.S. Treasury bill-backed tokens as collateral options.
LBTC faces formidable challenges, but Philips believes its eventual yield, projected to be comparable to ETH staking rewards, will provide a crucial advantage over wBTC. He emphasizes Lombard’s goal of onboarding Bitcoin holders into on-chain finance, showcasing the potential of DeFi protocols. Even without substantial yield, Philips contends that LBTC remains an attractive asset. Lombard’s successful $16 million fundraising, backed by prominent investors including Polychain Capital and Franklin Templeton, underscores the industry’s interest in this ambitious project. The battle for DeFi collateral dominance is just beginning.
