What is DeFi? What are the benefits and risks?

DeFi stands for "decentralized finance" and represents a category of financial products and services built on blockchain technology. DeFi does not use intermediaries like traditional financial products and services, and therefore has the potential to make financial systems more accessible to the people of the world. The development of the DeFi ecosystem further removes the traditional barriers of access to financial services, such as preferential terms, identity requirements, credit scores, and arduous pre-qualification paperwork, thus making participation in financial systems more accessible globally to anyone with an internet connection and access to crypto assets.

Participation in DeFi is booming, with DeFi Pulse data showing that over $13 billion USD is locked in Ethereum-based DeFi applications as of November 2020. Over the course of 2020, the average Ethereum block size has nearly doubled, increasing from approximately 22,415 bytes to 40,265 bytes. This increase is partially attributable to the boom of participation in DeFi—as an increased volume of complex DeFi transactions leads to miners setting higher gas prices, which results in larger block sizes.

With the emergence of DeFi, there are two sets of tools that are quickly becoming ubiquitous in nearly every instantiation of DeFi: yield farming and wrapped tokens.

Yield Farming

Yield farming, also referred to as liquidity mining, describes the process of generating rewards by contributing assets to liquidity pools or locking assets in to new protocols in exchange for rewards. In its essence, yield farming is the first “native DeFi” growth-hacking strategy. In order to attract the capital necessary to seed the supply side of the financial marketplaces that largely compose DeFi in 2020, new protocols may offer rewards—in the form of a native protocol token—to incentivize capital migration onto their platform.

Wrapped Tokens

Wrapped tokens are tokenized representations of some other asset, such that their value is targeting a 1:1 peg to the asset that they represent. Examples of each of these methods include USDC, an ERC-20 token pegged 1:1 to the value of the USD, and WETH, which a user can receive by trading ETH against a smart contract that maintains a 1:1 ratio of the two tokens. These new tokens then allow non-native Ethereum asset holders to participate in decentralized applications within the Ethereum ecosystem as if their assets were native—without needing to process their transaction across multiple blockchains, such as by using a bridge application. A further innovation of wrapped token technologies is their implications for the opportunity cost of capital investment, a feature of their programmable nature.

Risks

Yield farming and wrapped tokens still carry significant risks for participants. Yield farming carries a liquidation risk, if the asset staked no longer has enough value to act as collateral for the investment. Though some of the liquidity risks of yield farming can be mitigated by utilizing tokens that are staked to stable currencies, the smart contracts that hold the staked assets must also be secure in order to ensure that they cannot be compromised. In the case of wrapped tokens, most rely on custodians to hold the underlying asset represented by the wrapped token, also minting the new tokens and maintaining governance as necessary. If a custodian were to be compromised the value of the underlying asset could be lost.

What is Keep?

Keep was developed to bridge the worlds of secure private data and public blockchains. Small amounts of sensitive data, such as private keys, can be stored off-chain but used in smart contracts on-chain in a trustless manner. This trustless aspect is made possible due to the development of Keep’s Random Beacon, a source of true randomness for selecting signers that makes collusion between signers virtually impossible. Keep also allows for private data to be held offline but stored online in nodes, enabling a variety of functions such as proxy re-encryption.

tBTC is the first DApp developed on Keep. It enables BTC to be wrapped and issued on the Ethereum blockchain in a trustless manner, abstracting away the need for a centralized custodian that secures the underlying asset.

What is tBTC?

tBTC is a 1:1 representation of BTC on the Ethereum blockchain, such that one tBTC can be redeemed for 1 BTC. By merit of being a representation of BTC in an ERC-20 format, tBTC enables BTC holders to access the utility that various DeFi applications offer. tBTC is only possible because of the innovations within Keep that allow for private keys to remain secret while also participating on a public blockchain.

tBTC functions in a two-sided marketplace. As with most financial products, tBTC needs usage and liquidity to be useful. First and foremost, there have to be BTC deposits and ETH stakers. Essentially, on one end a group of signers stake their ETH to a Keep node at 150% of the value of BTC to be bonded, and thus create a wallet mechanism for tBTC to be minted. On the other, a BTC holder bonds their BTC into a smart contract to mint tBTC within the wallet created by the signers. The ETH is used as collateral to secure the BTC, using a market incentive process similar to how Dai is created using ETH on MakerDAO.

To learn in more detail about how tBTC functions, read our guide.

Why are people so interested in participating in DeFi generally and tBTC specifically?

Participating in DeFi applications allows holders of crypto assets to access greater liquidity for their assets, earn yields by lending them out, and in many cases enables them to become stakeholders in value-creating networks.

Tokenized bitcoin projects like tBTC bridge the gap between the Bitcoin and the Ethereum blockchains, allowing Bitcoin’s accessibility and liquidity to be utilized within Ethereum-based DeFi applications.

On one side of the equation, tBTC has the potential to support the growth, and therefore value, of the Ethereum ecosystem as a whole. While ETH has its own liquidity and value as an asset, the liquidity of BTC is much higher than the liquidity of ETH. Allowing the large market of Bitcoin users to participate in the Ethereum ecosystem promises to provide a larger pool of potential value for DeFi projects to utilize and spark growth.

Conversely, the programmable nature of Ethereum, along with the liquidity and participation opportunities offered by DApps and ERC-20 tokens, greatly exceeds that of the Bitcoin network. tBTC enables Bitcoin holders to leverage the universe of DeFi DApps built on the Ethereum blockchain—for example, a Bitcoin holder could use tBTC to utilize their BTC as the collateral for a loan issued using a smart contract-based DApp built on Ethereum.

Most importantly, as opposed to other tokenized Bitcoin projects, tBTC prioritizes decentralization and self-ownership above all.

tBTC is uniquely a permissionless network, meaning that there are no intermediaries for the transfer of funds between BTC, tBTC, and ETH—whereas most other tokenized Bitcoin projects rely on centralized custodians or trusted parties to hold the locked funds. This non-custodial nature is the primary appeal and innovation of tBTC. As tBTC utilizes a network of signers bound by a threshold signature protocol to protect the funds that have been staked, people wrapping their holdings in tBTC have a high level of control over their assets.

How can ETH holders get involved?

In order for tBTC to function, there must be ETH stakers in addition to BTC deposits. Staking ETH by running Keep nodes allows ETH holders to help build tBTC as a product while also earning KEEP rewards and tBTC + ETH signer fees in exchange for their participation on the network. In these first stages of tBTC development, the tBTC team is running an incentive program dubbed the “StakeDrop” to allow participants with ETH, but no KEEP, to run a tBTC Keep Node (ECDSA Node) and thus participate in the KEEP Network and earn rewards.

The StakeDrop will allow people to act as tBTC signers using only ETH, with KEEP tokens “dropped” as rewards for participating. While participants only need to stake ETH during this initial StakeDrop period, the rewards are calculated as a ratio of the amount of ETH locked and KEEP staked over time, so additionally staking KEEP during this period will increase the potential rewards earned. After the Stake Drop period ends participants will need to stake both ETH and KEEP to continue acting as tBTC signers.

You can learn more in our guide to Keep active participation.

Running a Keep Node with Bison Trails

Bison Trails was one of the first infrastructure providers spinning up nodes on Keep; we started building on Keep in June 2019. Since then we have provided feedback that resulted in protocol parameter changes for infrastructure uptime requirements and improvements to how the system’s infrastructure is configured. Our pull request was merged here.

Our platform is purpose-built to run multiple nodes securely and reliably—perfect for a work token network like Keep that needs node diversity and high availability.

In addition, there are three roles, with a related address, used for the set-up and management of a Keep node:

• The owner/authorizer non-custodially delegates KEEP or ETH to the node
• The operator runs and maintains the node.
• The beneficiary receives the participatory rewards and signing fees.
• This delineation allows using non-custodial infrastructure providers, such as Bison Trails, to run nodes with a simple and straightforward process.

Contact Bison Trails today to start participating in tBTC by operating a Keep tBTC node.

About Bison Trails

Pioneering Blockchain Infrastructure®

Bison Trails is a blockchain infrastructure platform-as-a-service (PaaS) company based in New York City. We built a platform for anyone who wants to participate in 20 new chains effortlessly.

We also make it easy for anyone building Web 3.0 applications to connect to blockchain data from 30 protocols with QT. Our goal is for the entire blockchain ecosystem to flourish by providing robust infrastructure for the pioneers of tomorrow.

In January, 2021, we announced Bison Trails will be joining Coinbase to accelerate our mission to provide easy-to-use blockchain infrastructure, now as a standalone product line as part of Coinbase. The Bison Trails platform will continue to support our customers. With Coinbase’s backing, we will enhance our infrastructure platform and make it even easier to participate in decentralized networks and build applications that connect to blockchain data. Read more.

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