IOSG Ventures: Early Exploration of the BTC-LST Ecosystem

Original source: IOSG Ventures

Special thanks to yandhii at Hashkey for valuable insights.

1. Introduction

Why choose BTC-LST?

With the birth of Babylon, it adds additional benefits to BTC by providing a security service called timestamping. This re-staking service protects the protocols built on Babylon by increasing the cost of attacks and makes staking of BTC possible through the time lock mechanism.

While there are no actual staking rewards in the first phase, instead points are awarded, the potential for BTC earnings has inspired a wave of BTC Liquidity Restaking Tokens (BTC-LST) such as Lombard, babypie, FBTC, and SolvBTC.

Compared to wrapped BTC, which acts as a cross-chain representation of native BTC, BTC LST leverages the Babylon protocol to introduce a cross-chain BTC representation with yield.

As of this writing, the BTC LST market has reached $1.07 billion (excluding the 9 BWBTC assets on Ethereum). The market is mainly dominated by SolvBTC and Lombard, and the growth momentum shows no signs of slowing down.

Source: @yandhii, dune dashboard

On the other hand, many DeFi or re-staking platforms on Ethereum (such as Symbiotic, Karak, etc.) saw the opportunities brought by the influx of BTC assets with yields and began to integrate these assets into their protocols to guide the total locked value (TVL) and transaction volume.

This phenomenon is extremely bullish as the inflow of assets can strengthen Ethereum’s position as a liquidity center in the DeFi space and continue to create a flow of economic activity.

As BTC becomes more accepted by institutions and the public, as can be observed from recent news such as BTC ETF, cbBTC, not to mention BTCs dominance (about 58%), it is expected that BTCs adoption will continue to grow until new innovations emerge. Therefore, it is necessary to have a clear understanding of the current BTC LST-fi landscape.

Source: Henry

This study aims to comprehensively sort out the existing BTC-LRT, BTC wrappers, and DeFi protocols that are following the emerging trend of the BTC wave on Ethereum, so that it can be easier to navigate in the future.

2. BTC-LST Ecosystem

Source: IOSG

Bitcoin LST Wrapper is the “new kid on the block” for this cycle, designed specifically to unlock liquidity for staked tokens in the BTC re-staking protocol Babylon.

BTC liquidity packaging usually comes in three forms:

• One is a one-way cross-chain wrapper, backed by BTC staked by Babylon in the BTC mainnet at a 1: 1 ratio. The “yield-generating tokens” minted on ETH serve as receipts for the staked BTC.

  Examples: LBTC, pumpBTC, babypie’s mBTC, etc.

• On Ethereum, use LBTC or regular BTC (such as WBTC) as collateral and re-pledge the assets to wrappers on re-pledge platforms such as Symbiotic and Karak.

  Examples: Etherfi’s eBTC, Swell’s swBTC

• Reverse mode, using WBTC as collateral on ETH and passing proof of stake to Bitgo via an oracle, allows BTC unlocked from Bitgo to be staked on Babylon to generate yield. Reverse mode users can use WBTC as collateral to unlock native BTC on the Mainnet and stake it on the Babylon platform. They pass the proof of stake to Bitgo via an oracle, which unlocks the BTC and uses it for staking on Babylon, thereby generating yield.

  Example: Bedrock

While the first two types focus on bridging or unlocking more BTC assets from the BTC mainnet to the ETH ecosystem, the latter type extracts WBTC assets from ETH and reversely pledges the assets to the Babylon protocol. In terms of architecture, one thing these wrappers have in common is that BTC is stored at a custodian (such as Cobo or Copper) on the BTC mainnet to protect its assets, which is the cheapest and most convenient way. To show the entire BTC LST/LRT landscape more clearly, here is a summary of how some BTC LST/LRTs work:

Source: Henry

BTC LST Market Size

As of this writing, LBTC dominates with a 37% market share, followed by solvBTC at 26% and pumpBTC at 9.5%. 79.6% of BTC LST is on the Ethereum mainnet, while the remaining 21.4% is scattered across networks such as BNB Chain, Arbitrum, Avalanche, etc.

The two major players in the BTC LST market have taken different approaches. Lombard focuses on Ethereum, while SolvBTC takes a multi-chain approach, opening up various networks including BNB, ARB, and others.

Source: @yandhii, dune dashboard

2.1 ETH BTC Derivatives (Wrappers and Synthetics)

ETH BTC derivatives are wrapped BTC that are bridged from the BTC mainnet to the ETH network, usually through a custodian. These wrappers are not competitors to BTC LST, but rather serve as a key factor in driving LST growth.

Unlike BTC LST, these derivatives are not staked into the Babylon protocol and do not inherently generate yield. Instead, they are ordinary representations of BTC on the ETH blockchain. Despite not being yield-generating assets in nature, ETH BTC derivatives have become a key component of todays ETH DeFi landscape.

Most DeFi and re-staking platforms accept WBTC because:

• They are battle-tested

• High market dominance in the 2024 cycle

As of this writing, Bitgo’s WBTC has bridged over $9 billion in assets from BTC to ETH since 2018. Of this, 21.5% (about $1.9 billion) has been deposited with Aave for lending, accounting for about 20% of Aave’s total assets on ETH.

Most DeFi and re-staking platforms accept WBTC because:

• They are battle-tested

• Maintained a high market dominance for many years

Source: @yandhii, dune dashboard

On the other hand, the new generation of Wrapper (Eg, FBTC), has also accumulated more than $152 million on ETH, with a monthly growth rate of 38% according to DeFillama. Another wrapper, SolvBTC, has also attracted more than $800 million in TVL on BSC and BTC L2 such as Merlin.

These figures not only demonstrate the importance of BTC assets in the ETH ecosystem, but also highlight the huge potential of ETH DeFi to take advantage of this opportunity.

As mentioned above, the main problem with WBTC is trust in the custodian.

Recently, there have been growing concerns about WBTC’s relationship with Justin Sun, leading Sky (formerly Maker) to consider removing WBTC variants from their vaults. BA Lab outlined the main concerns, mainly around the argument that Justin Sun may have significant influence or control over the joint venture that manages WBTC. However, Justin Sun himself claims that he does not have any control over WBTC or its holdings. This transfer should also be considered a risk for WBTC.

2.2 BTC Re-staking

BTC re-staking refers to BTC-related assets on ETH (in the form of wrapped BTC or BTC LST) that have been re-staking to generate yield.

The following table shows each asset accepted on the staking platform and their respective TVL:

Source: Henry

In total, there is about $150 million of BTC being re-staked on ETH, most of which belongs to Symbiotic, and some is deposited in SatLayer. Symbiotic alone holds $124 million worth of BTC products, including WBTC and tBTC, and $10 million worth of staked BTC LST. Karaks BTC assets are only about $100,000. These BTC assets together contribute 7% to Symbiotics TVL.

On the other hand, Pell Network has successfully attracted a large amount of BTC LST to be re-collateralized through various BTC second-layer solutions such as Bitlayer and B 2 network. These assets will be used to provide shared security services and generate income, similar to the model adopted by Babylon Finance and Eigenlayer.

While BTC LST has been earning first-layer yields from Babylon, some protocols like EtherFi are leveraging BTC-LST to generate second-layer yields by re-staking LST on other re-staking platforms like Eigenlayer, Symbiotic, and Karak.

While this strategy allows stakers to enjoy leveraged returns and maximize capital efficiency on a single asset, they also face the same risk as ETH LST, namely being slashed by multiple platforms at the same time) Babylon, Symbiotic slashed).

Anti-slashing policies can prevent a certain level of slashing on ETH, but further information on Babylon is unclear.

2.2.1 BTC-DeFi

DeFi has undoubtedly been one of the most important areas driving economic activity on the blockchain. With the growth of the $9.5 billion BTC asset market on ETH, DeFi on ETH can benefit from the stability, institutional recognition, and potential returns provided by BTC.

In general, in addition to exchanges, BTC/BTC-LST related DeFi can be divided into two main areas:

• Money Market Interest Rate Swaps: Morph Blue, Aave, Pendle, Zerolend, Curve

• BTC staking/points strategies: Corn, Meso, Gearbox, Mellow

Source: IOSG

2.2.2 Money Market

BTC, as the most “safe” asset, is commonly used as collateral in the ETH DeFi landscape. Aave, the oldest and most reputable money market, has over $2 billion in WBTC deposits but only $218 million in borrowings, a relatively low utilization rate (7.69%) relative to stablecoins (86.7%) or WETH (85%).

Source: @KARTOD, Dune dashboard

On the other hand, Morpho Blue has achieved higher utilization despite having a smaller deposit base (20% of Aave). The most popular market on Morpho Blue is WBTC/USDC, which has a utilization rate of 90%.

Source: WBTC/USDC Vault, Morphblue

So far, Aave and Morph only accept WBTC. To stand out in the competitive lending market, zeroland is the first market dedicated to BTC LST tokens and supports PT-eBTC. To date, they have $17 million worth of eBTC supply, about $3.28 million has been lent, and the utilization rate is 20%.

In addition, Curve is not only a safe haven for stablecoin exchange, but also a popular destination for BTC-related assets to store assets. On Curve, BTC suppliers can do two things: first, they can provide liquidity to the three pools. Second, they can use tBTC and WBTC as collateral to borrow crvUSD.

As of this writing, about $50 million worth of BTC assets have been deposited to borrow crvUSD. On the other hand, among the available pools, the tBTC-WBTC pool stands out with $25 million in assets and $2.24 million in daily trading volume. Unfortunately, despite the active BTC-related assets on Curve, $CRV incentives have not yet been offered to attract users.

2.2.3 Interest Rate Swap (IRS)

In addition to the money market, the interest rate swap (IRS) product provided by Pendle is also one of the most popular places for BTC LST DeFi.

Pendle leverages the future earnings of BTC LST and speculation on points to create multiple dedicated markets: SolvBTC.BBN, PT/YT for LBTC and eBTC, etc. These markets have attracted a total of over $136 million in funding, a 150% month-over-month increase driven by points and incentive farming.

The new round of voting incentives also marks a growing interest in BTC LRT. For example, SolvVBTC in Corn was selected to attract the most Emission from Pendle. Therefore, it is expected that the supply of BTC LRT assets will continue to grow in the near future, taking into account emission incentives.

Source: Pendle Dashboard

While Money Market and IRS products generate additional yield for BTC assets based on the demand and supply of BTC on the ETH mainnet, TVL guides vaults to prioritize using BTC to increase the TVL of their respective chains to promote the growth of the ecosystem. In addition, some vaults provide leveraged point farming strategies by recycling or borrowing BTC to maximize returns with the same capital.

Gearbox offers up to 27x lombard points to borrow WBTC via leverage (up to 7x). However, this service is not popular because the supply in gearbox is very limited (only about $3 million).

Source: gearbox.fi

In addition to the points strategy, some second-layer networks, such as Thesiss Mezo and Binance Labs-backed Corn, are leveraging the value of BTC by allowing nodes to stake bridged BTC LSTs as collateral. In return, nodes earn $BTC fees by participating in the verification process, which is a good attempt to leverage BTC and guide the TVL of these networks to promote future ecosystem growth. So far, mezo has attracted $121 million in BTC-related assets and $20 million in corn.

So far, it is clear that most DeFi activities related to BTC LSTs are primarily incentive-driven. While BTC adoption is growing, in the long run, the actual demand for generating BTC LSTs will be highly dependent on Babylons yield performance, which may make BTC LSTs a more attractive asset than ETH.

2.2.5 Liquidity Issues

Despite having $300 million TVL, the deepest pool has only about $10 million in liquidity in the Uni v3 pool (according to nansen). Swapping $345,000 of ETH for LBTC would result in a 1.06% slippage, which is 4 times that of WBTC (about 0.4%). This difference reflects a key problem that BTC LSTs must overcome: liquidity issues when exiting large quantities from LBTC positions.

Source: Uniswap

3. Conclusion

Bridged BTC can mainly take two forms: regular BTC, such as Wrapped BTC (WBTC), and BTC re-collateralized in Babylon, called BTC-LST.

The BTC LST/LRT-Fi landscape is still in its early stages but shows healthy signs of bridging more TVL from BTC to the ETH DeFi ecosystem.

Due to BTC’s growing recognition and market dominance in the current cycle, BTC adoption is expected to increase. The opportunity to generate yield for BTC is also creating a market on ETH for speculative and trading activities.

WBTC remains one of the most widely adopted forms of BTC on ETH. However, due to the recent challenges associated with Justin Sun, tBTC or LBTC is expected to gain more adoption.

It is increasingly common to see BTC re-collateralized tokens being re-collateralized in Symbiotic or Karak for leveraged farming. While this may generate higher yields, users must bear the risk of facing multiple slashing events.

Money markets and interest rate swaps are the most in-demand BTC DeFi activities on ETH, while attempts from layer 2 to use BTC as fees in the validation process are also interesting.

Currently, most BTC-related DeFi activities on ETH are primarily incentivized by points or rewards. In order to generate actual demand, BTC LSTs need to create value (possibly in the form of earnings) that is greater than ETH LSTs.

Custody risk, slashing risk, and liquidity risk are the main concerns in the BTC LST landscape.

*Note: This study aims to provide a high-level overview of the trend of the rise of BTC LSTs on ETH, and hopes to raise awareness of the opportunities and risks involved in dealing with the new generation of BTC assets. Future assessments of the potential for cross-chain finance will require further research on the impact of BTC assets on ETH and other chains.

If Ive missed anything, please reach out to me on Twitter at @poopmandefi and Ill do my best to keep this research up to date.

Quote:

https://www.diadata.org/bitcoin-ecosystem-map/

https://dune.com/yandhii/btc-lrt-evm

Dashboard:

https://www.footprint.network/@Higi/Bitcoin-Bridge-BTC-to-Ethereum-WBTC?%253E%253D_date-98774 = 2022-01-01% 253 C_date-98777 = 2024-09-09