While an in-depth discussion of BTCFi might be tough for everyday investors to follow, as the topic is quite technical and unexciting, it’s been exciting to see more and more people getting curious about #BTCF lately.

I receive many questions from industry peers every day, especially about BTCFi, since there’s a lot of confusion. So, let’s dive into it and explore what BTCFi is and what it can solve.

First: Is it native #Bitcoin？

This question may sound a bit silly, but it’s an important one. Many people mistakenly think that second-layer networks for #BTC or BTC staking are part of BTCFi. The real question here is whether the supported asset is a native BTC or a wrapped version of BTC.

This question matters because it comes down to who controls the core asset of BTC in the ecosystem, and whether that control is secure enough. Some people argue decentralization is key, but in the financial world, security is often a non-negotiable requirement for large-scale investment.

In simple terms, it’s about who’s holding the BTC in custody. Right now, almost all decentralized BTCFi protocols treat BTC like WBTC, which, although controversial, is widely recognized. However, we need to understand that once SAB121 passes, banks will only support native BTC.

The takeaway here is that, in practice, BTCFi cannot guarantee the security, acceptability, or liquidity of anything other than native BTC, especially after SAB121. The real “second-layer network” for BTCFi will be the reserves held by banks, and BTC-backed notes guaranteed by banks are the only kind that will be able to circulate on the blockchain as “BTC TOKEN.”

Second: Is native #Bitcoin just Bitcoin?

The answer is no. In different contexts, “native” can be understood differently. In the blockchain world, BTC is BTC, which is why we said banks only recognize native BTC. However, in the financial world, BTC financial assets, as long as they comply with regulations, are also considered BTC.

For example, BTC spot ETFs can’t be used as actual assets by major U.S. banks, but they are legally recognized. For instance, BlackRock’s $IBIT tracks BTC’s price. Even though BTC-based settlements aren’t supported in the current ETF structure, the fact that there needs to be enough BTC to back the ETFs means we can consider them as BTC.

Also, while not every institution can directly buy BTC or BTC ETFs, $MSTR, which holds a large amount of BTC, is the only compliant way to hold BTC through U.S. stock exchanges.

Before SAB121 passes, not only is BTC itself unable to be custodied or used for collateral in banks, but even BTC ETFs can’t be refinanced. However, MSTR can be custodied and refinanced in banks.

In broader terms, native BTC should be assets that are legally recognized and linked to BTC within the blockchain space. Legal recognition is crucial, as it’s a major barrier for large funds wanting to enter. Only with adequate compliance will more capital be willing to come in. This is why, after the spot ETF’s approval, funds are pouring in. Compliance is a must-have for BTCFi.

Third: Who provides liquidity for staking #Bitcoin?

This question might seem strange, but consider this: right now, staked BTC is often backed by stablecoins from the crypto world. But, outside of specific channels, these stablecoins aren’t easily moved into the Web2 world. Simply put, can assets earned from staking BTC be easily converted into investments in Web2?

The answer is yes, but only if you can prove the source of funds properly. The bigger the asset, the higher the risk. In the current BTCFi ecosystem, if you take away asset acceptability, it’s like chasing shadows.

But here’s the crucial point: most BTC lending protocols involve collateralizing BTC. Agreements or liquidity providers fund the loan, while the borrower pledges BTC. Is that correct?

So for those who want to keep their BTC but don’t want to sell, does that mean their BTC has no liquidity? That’s not what BTCFi is meant to do. BTCFi should offer liquidity for all BTC holders to earn income, not just limit it to collateral lending.

Simply put, liquidity providers should not be restricted by whether it’s Web2 or Web3. Both require addressing KYC concerns. However, in the current system, simply borrowing based on funds doesn’t mean BTC is getting liquidity.

Fourth: How to Provide Liquidity for #Bitcoin？

Liquidity isn’t just about collateralized lending. One of the best liquidity providers in crypto is Curve. Curve’s mechanism operates much like a central bank system. If we think of Curve’s 3 Pool as a real-world model, it’s essentially an exchange between different fiat currencies, rather than lending or borrowing.

Uniswap also provides liquidity, but most of the time, it’s based on the relationship between assets and stablecoins. For BTCFi, liquidity should go beyond just borrowing and lending. It should involve converting BTC into tokenized assets, allowing liquidity to flow between different types of BTC. This way, BTC holders can earn income from their BTC holdings, without needing to sell or stake them.

This approach gives BTC a true source of income. In the #BTCFi framework I designed, #BTC, $MSTR, and $IBIT are all native BTC. Whether it’s BTC, MSTR, or IBIT, all provide liquidity for BTC. The relationship between these assets isn’t just about collateralized lending—it’s about enabling users to exchange between different kinds of BTC, depending on the situation.

Therefore, whether you hold BTC, MSTR, or IBIT, you can earn profits without reducing your BTC holdings. This system works similarly to Curve’s 3 Pool, where Bitcoin, MSTR, and IBIT form a liquidity pool together.

When you inject BTC, you essentially get 33.33% BTC, 33.33% MSTR, and 33.33% IBIT. You can also directly convert it into 100% BTC, MSTR, or IBIT, offering users a seamless way to switch between virtual and real assets.

Fifth: On-chain or Off-chain? And What About Proof of Rights?

This may seem like a trivial question, especially if you haven’t read the earlier sections. How can decentralized finance even exist without being on-chain? However, after reading the previous sections, you might think that being on-chain isn’t as critical as it seems. After all, neither MSTR nor IBIT are native blockchain assets, and according to SEC regulations, you can’t issue MSTR or IBIT tokens directly on-chain.

Still, going on-chain is essential, especially to offer liquidity and hedging options for smaller investors. Moreover, putting the BTC “note” on-chain is the core verification method for BTCFi. This protocol doesn’t need to be directly supported by BTC or its second-layer network. As long as there’s a “native BTC” note, BTCFi will function. This is similar to how USDC isn’t tied to #Ethereum—it just needs to be a native asset.

Of course, if true native BTC can be provided, there’s no issue operating within the BTC network.

Sixth: The Relationship Between BTCFi, RWA, and RWAFi

As you dive deeper into BTCFi, you’ll likely see that its underlying logic is based on RWA (Real World Assets). By putting RWA on-chain, it becomes RWAFi (Real World Asset Finance). Essentially, BTCFi is part of RWA, but it’s a more complex approach than traditional tokenization of assets like U.S. stocks or bonds. BTCFi serves as a bridge between virtual and real assets.

The most interesting part is that both virtual and real assets share the same underlying object. This is why BTCFi and RWAFi can integrate seamlessly. From a regulatory perspective, U.S. compliance is more challenging, but places like Singapore, Switzerland, and Germany have simpler frameworks, making it easier to implement these models.

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