BTCFi Awakening: The Race to Bring DeFi to Bitcoin
Bitcoin has sat on the sidelines of the DeFi revolution for years. While Ethereum and its Layer 2 ecosystem accumulated over $100 billion in total value locked, Bitcoin—the original cryptocurrency with a $1.7 trillion market cap—remained largely idle. Only 0.8% of all BTC is currently utilized in DeFi applications.
That's changing fast. The BTCFi (Bitcoin DeFi) sector has exploded 22x from $300 million in early 2024 to over $7 billion by mid-2025. More than 75 Bitcoin Layer 2 projects are now competing to transform BTC from "digital gold" into a programmable financial layer. The question isn't whether Bitcoin will have DeFi—it's which approach will win.
The Problem BTCFi Solves
To understand why dozens of teams are racing to build Bitcoin Layer 2s, you need to understand Bitcoin's fundamental limitation: it wasn't designed for smart contracts.
Bitcoin's scripting language is intentionally simple. Satoshi Nakamoto prioritized security and decentralization over programmability. This made Bitcoin incredibly robust—no major protocol hack in 15 years—but it also meant that anyone wanting to use BTC in DeFi had to wrap it first.
Wrapped Bitcoin (WBTC) became the de facto standard for bringing Bitcoin to Ethereum. At its peak, over $14 billion worth of WBTC circulated through DeFi protocols. But wrapping introduced serious risks:
- Custodian risk: BitGo and other custodians hold the actual Bitcoin, creating single points of failure
- Smart contract risk: The March 2023 Euler Finance hack resulted in $197 million in losses, including significant WBTC
- Bridging risk: Cross-chain bridges have been responsible for some of the largest DeFi exploits in history
- Centralization: The 2024 WBTC custody controversy, involving Justin Sun and multi-jurisdictional restructuring, shook user confidence
BTCFi promises to let Bitcoin holders earn yield, lend, borrow, and trade without surrendering custody of their BTC to centralized parties.
The Major Contenders
Babylon: The Staking Giant
Babylon has emerged as the dominant force in BTCFi, with $4.79 billion in TVL as of mid-2025. Founded by Stanford professor David Tse, Babylon introduced a novel concept: using Bitcoin to secure Proof-of-Stake networks without wrapping or bridging.
Here's how it works: Bitcoin holders stake their BTC using "Extractable One-Time Signatures" (EOTS). If a validator behaves honestly, the stake remains untouched. If they act maliciously, the EOTS mechanism enables slashing—automatically burning a portion of the staked Bitcoin as punishment.
The genius is that users never give up custody. Their Bitcoin stays on the Bitcoin blockchain, timestamped and locked, while providing economic security to other networks. Kraken now offers Babylon staking with up to 1% APR—modest by DeFi standards, but significant for a trustless Bitcoin yield product.
In April 2025, Babylon launched its own Layer 1 chain and airdropped 600 million BABY tokens to early stakers. More importantly, a partnership with Aave will enable native Bitcoin collateral on Aave V4 by April 2026—potentially the most significant bridge between Bitcoin and DeFi yet.
Lightning Network: The Payment Veteran
The oldest Bitcoin Layer 2 is experiencing a renaissance. Lightning Network capacity hit an all-time high of 5,637 BTC (roughly $490 million) in late 2025, reversing a year-long decline.
Lightning excels at what it was designed for: fast, cheap payments. Transaction success rates exceed 99.7% in controlled deployments, with settlement times under 0.5 seconds. The 266% year-over-year increase in transaction volume reflects growing merchant adoption.
But Lightning's growth is increasingly institutional. Large exchanges like Binance and OKX have deposited significant BTC into Lightning channels, while the number of individual nodes has actually declined from 20,700 in 2022 to around 14,940 today.
Lightning Labs' Taproot Assets upgrade opens new possibilities, allowing stablecoins and other assets to be issued on Bitcoin and transferred via Lightning. Tether's $8 million investment in Lightning startup Speed signals institutional interest in stablecoin payments over the network. Some analysts project Lightning could handle 30% of all BTC transfers for payments and remittances by the end of 2026.
Stacks: The Smart Contract Pioneer
Stacks has been building Bitcoin smart contract infrastructure since 2017, making it the most mature programmable Bitcoin layer. Its Clarity programming language was specifically designed for Bitcoin, enabling developers to build DeFi protocols that inherit Bitcoin's security.
TVL on Stacks exceeded $600 million by late 2025, driven primarily by sBTC—a decentralized Bitcoin peg—and the ALEX decentralized exchange. Stacks anchors its state to Bitcoin through a process called "stacking," where STX token holders earn BTC rewards for participating in consensus.
The trade-off is speed. Stacks block times follow Bitcoin's 10-minute rhythm, making it less suitable for high-frequency trading applications. But for lending, borrowing, and other DeFi primitives that don't require split-second execution, Stacks offers battle-tested infrastructure.
BOB: The Hybrid Approach
BOB (Build on Bitcoin) takes a different approach: it's simultaneously an Ethereum rollup (using the OP Stack) and a Bitcoin-secured network (via Babylon integration).
This hybrid architecture gives developers the best of both worlds. They can build using familiar Ethereum tools while settling to both Bitcoin and Ethereum for enhanced security. BOB's upcoming BitVM bridge promises trust-minimized BTC transfers without relying on custodians.
The project has attracted significant developer interest, though TVL remains smaller than the leaders. BOB represents a bet that the future of BTCFi will be multi-chain rather than Bitcoin-native.
Mezo: The HODL Economy
Mezo, backed by Pantera Capital and Multicoin, introduced an innovative "Proof of HODL" consensus mechanism. Instead of rewarding validators or stakers, Mezo rewards users for locking BTC to secure the network.
The HODL Score system quantifies user commitment based on deposit size and duration—locking for 9 months yields 16x rewards compared to shorter periods. This creates natural alignment between network security and user behavior.
Mezo's TVL surged to $230 million in early 2025, driven by its EVM compatibility, which allows Ethereum developers to build BTCFi applications with minimal friction. Partnerships with Swell and Solv Protocol have expanded its ecosystem.
The Numbers: BTCFi by the Data
The BTCFi landscape can be confusing. Here's a clear snapshot:
Total BTCFi TVL: $7-8.6 billion (depending on measurement methodology)
Top Projects by TVL:
- Babylon Protocol: ~$4.79 billion
- Lombard: ~$1 billion
- Merlin Chain: ~$1.7 billion
- Hemi: ~$1.2 billion
- Stacks: ~$600 million
- Core: ~$400 million
- Mezo: ~$230 million
Growth Rate: 2,700% increase from $307 million in early 2024 to $8.6 billion by Q2 2025
Bitcoin in BTCFi: 91,332 BTC (approximately 0.46% of all Bitcoin in circulation)
Funding Landscape: 14 public Bitcoin L2 financings totaling over $71.1 million, with Mezo's $21 million Series A being the largest
The TVL Controversy
Not all TVL claims are created equal. In January 2025, leading Bitcoin ecosystem projects including Nubit, Nebra, and Bitcoin Layers published a "Proof of TVL" report exposing widespread problems:
- Double counting: The same Bitcoin counted across multiple protocols
- Fake locking: TVL claims without actual on-chain verification
- Opaque methodology: Inconsistent measurement standards across projects
This matters because inflated TVL numbers attract investors, users, and developers based on false premises. The report called for standardized asset transparency verification—essentially, proof of reserves for BTCFi.
For users, the implication is clear: dig deeper than headline TVL numbers when evaluating Bitcoin L2 projects.
What's Missing: The Catalyst Problem
Despite impressive growth, BTCFi faces a fundamental challenge: it hasn't found its killer application yet.
The Block's 2026 Layer 2 Outlook noted that "launching the same existing primitives seen on EVM-based L2s on a BTC chain is not enough to attract liquidity or developers." Bitcoin L2 TVL actually declined 74% from its 2024 peak, even as headline BTCFi numbers grew (largely due to Babylon's staking product).
The Ordinals narrative that sparked the 2023-2024 Bitcoin L2 boom has faded. BRC-20 tokens and Bitcoin NFTs generated excitement but not sustainable economic activity. BTCFi needs something new.
Several potential catalysts are emerging:
Native Bitcoin Lending: Babylon's BTCVaults initiative and the Aave V4 integration could enable Bitcoin-collateralized borrowing without wrapping—a massive market if it works trustlessly.
Trustless Bridges: BitVM-based bridges like BOB's could finally solve the wrapped Bitcoin problem, though the technology remains unproven at scale.
Stablecoin Payments: Lightning Network's Taproot Assets could enable cheap, instant stablecoin transfers with Bitcoin's security, potentially capturing remittance and payments markets.
Institutional Custody: Coinbase's cbBTC and other regulated alternatives to WBTC could bring institutional capital that has avoided BTCFi due to custody concerns.
The Elephant in the Room: Security
Bitcoin L2s face a fundamental tension. Bitcoin's security comes from its simplicity—any added complexity introduces potential vulnerabilities.
Different L2s handle this differently:
- Babylon keeps Bitcoin on the main chain, using cryptographic proofs rather than bridges
- Lightning uses payment channels that can always be settled back to Layer 1
- Stacks anchors state to Bitcoin but has its own consensus mechanism
- BOB and others rely on various bridge designs with different trust assumptions
None of these approaches are perfect. The only way to use Bitcoin with zero additional risk is to hold it in self-custody on Layer 1. Every BTCFi application introduces some trade-off.
For users, this means understanding exactly what risks each protocol introduces. Is the yield worth the smart contract risk? Is the convenience worth the bridging risk? These are individual decisions that require informed evaluation.
The Road Ahead
The BTCFi race is far from decided. Several scenarios could play out:
Scenario 1: Babylon Dominance If Babylon's staking model continues to grow and its lending products succeed, it could become the de facto BTCFi infrastructure layer—the Lido of Bitcoin.
Scenario 2: Lightning Evolution Lightning Network could evolve beyond payments into a full financial layer, especially if Taproot Assets gains traction for stablecoins and tokenized assets.
Scenario 3: Ethereum Integration Hybrid approaches like BOB or native Bitcoin collateral on Aave V4 could mean BTCFi happens primarily through Ethereum infrastructure, with Bitcoin serving as collateral rather than execution layer.
Scenario 4: Fragmentation The most likely near-term outcome is continued fragmentation, with different L2s serving different use cases. Lightning for payments, Babylon for staking, Stacks for DeFi, and so on.
What This Means for Bitcoin Holders
For the average Bitcoin holder, BTCFi presents both opportunity and complexity.
The opportunity: Earn yield on idle Bitcoin without selling it. Access DeFi functionality—lending, borrowing, trading—while maintaining BTC exposure.
The complexity: Navigating 75+ projects with varying risk profiles, understanding which TVL claims are legitimate, and evaluating trade-offs between yield and security.
The safest approach is patience. BTCFi infrastructure is still maturing. The projects that survive the next bear market will have proven their security and utility. Early adopters will earn higher yields but face higher risks.
For those who want to participate now, start with the most battle-tested options:
- Lightning for payments (minimal additional risk)
- Babylon staking through regulated custodians like Kraken (institutional custody, lower yield)
- Stacks for those comfortable with smart contract risk on a mature platform
Avoid projects with inflated TVL claims, opaque security models, or excessive token incentives that mask underlying economics.
Conclusion
Bitcoin's DeFi awakening is real, but it's still early. The 22x growth in BTCFi TVL reflects genuine demand from Bitcoin holders who want to put their assets to work. But the infrastructure isn't mature, the killer application hasn't emerged, and many projects are still proving their security models.
The winners of the Bitcoin L2 race will be determined by which projects can attract sustainable liquidity—not through airdrops and incentive programs, but through genuine utility that Bitcoin holders actually want.
We're watching the foundation being laid for a potentially massive market. With less than 1% of Bitcoin currently in DeFi, the room for growth is enormous. But growth requires trust, and trust requires time.
The race is on. The finish line is still years away.
This article is for educational purposes only and should not be considered financial advice. Always conduct your own research before interacting with any DeFi protocol.