A More Than $1T Bitcoin DeFi Opportunity

Since its inception in 2009, bitcoin (BTC) has steadily gained adoption and now has a market capitalization of over $1.3 trillion. It was designed to be a decentralized currency and real-time gross settlement system. The decentralized, protocol-based approach enables holders to shift trust from a centralized actor to a decentralized, code-enforced protocol.

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Despite bitcoin being the original cryptocurrency and corresponding blockchain, its functionality has been extremely limited up to this point relative to the smart contracts and decentralized finance (DeFi) functionality offered by Ethereum, Solana and other blockchains. However, this dynamic is set to change with the emergence of Bitcoin Layers, the meta-protocols, sidechains, layer 2’s and other technologies currently being built on the Bitcoin blockchain. These layers will enable faster payments, as well as lending, enhanced functionality of fungible and non-fungible tokens, decentralized exchanges, GameFi, SocialFi and many other use cases. Holders of bitcoin will soon be able to increase the productivity of their asset via a protocol-based decentralized financial system. The primary differentiator between DeFi on Bitcoin and DeFi on other chains is the underlying asset (native token). Whereas Ethereum, Solana and next-gen blockchains compete on the merits of their respective technologies, DeFi on Bitcoin is purely focused on increasing the productivity of bitcoin, placing the Bitcoin DeFi ecosystem in a league of its own.

The case for value creation via a Bitcoin-based decentralized financial system is driven by three assumptions:

• preference for the Bitcoin blockchain as the base layer for other tokenized assets
• demand for greater productivity of bitcoin, the asset
• demand for a financial system that reflects the decentralized principles of Bitcoin

We already see strong demand signals for the Bitcoin blockchain as a base layer for other tokenized assets. The market for non-fungible tokens on Bitcoin, called Ordinals, grew from less than $100 million to over $1.5 billion in less than six months.

However, the largest opportunity is still ahead. Most of the market value of Bitcoin’s decentralized finance system will show up in the value of fungible tokens on Bitcoin. Fungible tokens will power greater productivity of bitcoin (the asset) via yield-bearing instruments and decentralized financial systems via protocols and layer 2s. Relative to Ethereum, Solana and other chains, the value of fungible tokens on Bitcoin is still minuscule, largely because we are in the early innings of programmable functionality on that blockchain.

Bitcoin’s leading non-fungible token protocol, Ordinals, wasn’t released until January 2023. BRC20s and Runes, Bitcoin’s leading fungible token protocols, were launched in March 2023 and April 2024, respectively. Even with these recent releases, additional functionality is required for a robust decentralized finance ecosystem to exist on Bitcoin.

Additional functionality is being introduced to Bitcoin in two ways:

• Bitcoin Improvement Proposals (BIPs): Upgrades to Bitcoin’s core software are being pursued through BIPs, such as OP_CAT, which aims to enhance smart contract functionality and increase efficiency on Bitcoin.
• Technological Developments: Innovations like BitVM, pegs and bridges are being developed to provide users with enhanced programmability and efficiency without requiring an upgrade to Bitcoin’s core software.

As previously mentioned, Bitcoin’s decentralized finance ecosystem is still in the early stages of its life cycle. However, strong indicators of future growth can be seen via growing developer and DeFi activity in the space. In 2023, 40% of Bitcoin open-source developers were focused on Bitcoin L2s and scaling solutions. Then, in the first quarter of 2024, Bitcoin ecosystem total value locked (TVL) grew over six times from $492 million to over $2.9 billion. Given these early indicators, coupled with what we’ve seen transpire across other ecosystems, we believe over $1 trillion in value could be created in the Bitcoin DeFi ecosystem within the next five to 10 years.

Disclaimer from Franklin Templeton:

All investments involve risk, including the loss of principal.

Investments in Digital Assets are subject to many specialized risks and considerations, including but not limited to risks relating to:

(i)immature and rapidly developing technology underlying Digital Assets, (ii) security vulnerabilities of this technology, (iii) credit risk of Digital Asset exchanges that may hold an Account's Digital Assets in custody, (iv) regulatory uncertainty around the rules governing Digital Assets, Digital Asset exchanges and other aspects and parties involved with Digital Asset transactions, (v) high volatility in the value/price of Digital Assets, (vi) unclear acceptance of some or all Digital Assets by users and global marketplaces, and (vii) manipulation or fraud resulting from the pseudo-anonymous manner in which ownership of Digital Assets is recorded and managed.

This communication is general in nature and provided for educational and informational purposes only. It should not be considered or relied upon as legal, tax or investment advice or an investment recommendation, or as a substitute for legal or tax counsel. Prospective investors should always consult a qualified financial professional for personalized advice or investment recommendations tailored to their specific goals, individual situation, and risk tolerance. Views expressed are those of the author and do not reflect views of other managers or the firm overall. Views are current as of the date of this publication and are subject to change. The information is based on current market conditions, which will fluctuate and may be superseded by subsequent market events. References to specific securities, asset classes and financial markets are for illustrative purposes only and should not be interpreted as recommendations.

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