The term “DeFi” has gained significant popularity in the cryptocurrency space since the beginning of 2020. Over hundreds of projects have already been implemented on Ethereum based on the intersection of blockchain and decentralized financial systems. The appealing ones being collateralized stablecoins and derivatives products.
Given that the ecosystem can be feasibly built on a smart contract using Ethereum, the concept of open finance cannot be excluded from Bitcoin. For instance, sidechains like RSK (rootstock) can upgrade their smart contract capabilities, enabling more advanced financial products to build on Bitcoin.
That said, there are some other enthralling ideas on extending the Bitcoin’s structure to more sophisticated financial applications. Out of which, one exciting proposal that is in the talks over a few years is the discreet log contracts.
Bitcoin for DeFi – A Sustainable Approach?
Developers are uncertain about bringing in DeFi applications on Bitcoin. People believe that the reason for its significant value to date is due to its simple, stripped-down reliable design.
Contrariwise, ideas such as the lightning network for Bitcoin has resulted in an entirely new design for it. With the feature of layered scaling, applications can be still be created without hindering the security model of bitcoin’s core protocol.
The success has hence opened doors for exploring applications that help leverage bitcoin without having to compromise on its existing design.
But limitations exist…
The most significant trade-off is the complexity of DeFi applications. RSK could no doubt prove to be a valuable sidechain for Bitcoin, but federated peg sidechain essentially requires trust in controlling the chain.
Additional improvements in the underlying technology can reduce trust even further. The compelling DeFi projects on the Ethereum protocol is not possible to incorporate on Bitcoin’s protocol without compromising trust.
Cutting through the interesting project ideas, let’s get our feet wet to understand and generalize the concept of Discreet Log Contracts.
What are Discreet Log Contracts?
Proposed by Thaddeus Dryja, discreet log contracts are an ecosystem for minimizing the trust in blockchain oracles – assimilating data from external sources to the blockchain. Discreet log contracts pivot using Schnorr signatures to disguise the agreed upon contract information from the oracles.
This creates a scenario where payouts on data (public) are possible between three parties. The advantages of it being better security and flexible contracts without having to compromise on the trust.
When applied to DeFi, the two parties can maximize their discreet log contracts and unleash the potential of derivatives, futures, and several other financial instruments. More advanced financial products when knotted to bitcoin, institutional practices like hedging risk on assets can become viable through the Bitcoin’s network. With the reliance on oracle-sourced data for payouts, micro-insurance contracts are possible using the discreet log contracts.
The prevalence of DeFi systems built on the Ethereum is hindering the notion of open financial products for Bitcoin. But considering the robust security model and consensus rules, the Bitcoin network does put forth a captivating medium for decentralized finance. And discreet lot contracts are an appealing tool that can help developers develop a more advanced open finance ecosystem with Bitcoin.