2020 was unequivocally the twelvemonth of decentralized finance. Driven by surging interest and striking breakthroughs, DeFi protocols accelerated financial innovation while reshaping the blockchain landscape. Buoyed by innovations in cross-concatenation nugget gateways and DeFi protocols, Ethereum has attracted a substantial amount of Bitcoin (BTC) assets, thus cutting into Bitcoin's on-concatenation transfers.

Moving forrard, this trend will pose severe challenges for Bitcoin'due south network security, particularly as BTC continues to phase out block rewards, leaving miners increasingly unable to generate income. Prior to the explosion of DeFi, BTC supporters were confident in their power to generate income through the platform'due south transaction fees — nonetheless this appears to no longer be the instance. Moving forward, I'd like to explore the future of BTC and its implications for the blockchain sector.

As blockchain adoption enters a new phase, decentralized finance is facilitating an irreversible shift abroad from centralized finance as users comprehend self-custody. Since liquidity farming took off in July 2020, mainstream crypto assets such as Ether (ETH) have increasingly shifted toward decentralized platforms over the past four months. Decentralized exchange trading volumes now constitute 10% of the total market trading volume compared to simply 1% during the same period last year, while MetaMask'due south user base exceeded one million this year. Driven away by CeFi's persistent issues with security and regulatory pressure, users are embracing self-custody solutions despite expensive gas fees, network congestion and nascent products. In brusque, 2020 has been marked by the triumph of an open-source approach to blockchain, with users embracing both the unique risks and rewards of DeFi.

Starting March 2020 and onwards, centralized exchanges' transaction book dropped while the number of newly registered Ether wallet addresses rapidly rose. In short, Ethereum fundamentally transformed the utility of crypto exchanges. Users are now increasingly storing and trading assets in custody, thus prompting more than platforms to develop DeFi products.

Ethereum overtakes Bitcoin with lead in DeFi

Perhaps ane of the most notable shake-ups to occur in 2020 was Ethereum overtaking Bitcoin as the leading DeFi protocol infrastructure and general settlement network. Ethereum is now expected to surpass Bitcoin's transaction volume for the commencement time and also go the commencement blockchain to record over $1 trillion in transactions. Moreover, the Ethereum network'due south cumulative fees accept surpassed Bitcoin's this year, signaling the former's ability to deliver higher returns for users.

Bitcoin and the ascent of DeFi

Bitcoin will face a decrease in on-concatenation action equally well as a transaction fee insufficiency due to the ascension of DeFi. Given that Ethereum has surpassed Bitcoin as a settlement network, there is now a very real possibility that Bitcoin-based transactions may disappear in the future.

Recently, the daily trading book of BTC trades on Ethereum-based decentralized exchanges exceeded $100 million, thus accounting for over 1% of BTC'southward total trading book even though just 0.71% of BTC's 21 million volume is traded on Ethereum.

In short, Ethereum's BTC turnover is college than the vice versa. Moreover, the trading volume of BTC assets on Ethereum has grown exponentially; information technology is now expected that over iv% of BTC'due south total volume volition be deposited on the Ethereum ecosystem by next year should this trend hold.

Given the growing number of Ethereum use cases and advances in cross-chain protocols, BTC is now migrating to Ethereum while Ethereum poaches Bitcoin's on-chain transactions.

Thus, the path forward for Bitcoin is fraught. Equally Bitcoin continues to halve, miners are increasingly reliant on transaction fees, however the fees are making up a smaller and smaller share of income as time goes by. Currently, information technology is estimated that transaction fees just cover 30% of mining costs — an insufficient amount, specially as halvings continue and cake rewards subtract.

Moving forward, the value of mining Bitcoin may drop down to the tens of thousands per 60 minutes, an corporeality that might not exist able to support a network that hosts hundreds of billions in assets.

Related: Jumping into the puddle: How to earn a profit mining Bitcoin and Ether

In light of this claiming, the Bitcoin customs has 3 options moving forward, namely increasing network fees, introducing Bitcoin-based DeFi, or implementing moderate inflation policies. Let's analyze and discuss each method in greater detail.

Related: DeFi won't last long without unlocking Bitcoin's $250B treasure chest

Maintaining network security and BTC's path forwards

I would at present like to hash out BTC'south futurity market size, model and the cost of maintaining the BTC network in conjunction with the phasing-out of block rewards. To begin, I volition outset notation that there is a certain toll that goes into maintaining the network's safety. This toll is deducted from miners' revenue (including block rewards and network fees), which in plow is used to provide the cost of hardware, electricity, operations and labor. This deduction effectively functions as a "tax" that functions similarly to a country's military and security expenditures. In short, while the amount may fluctuate to a degree depending on environmental factors, it will remain relatively stable in the long term.

Beneath are two graphs comparing armed services expenditure as a share of GDP to Bitcoin's annual network security spending of the BTC marketplace cap.

As demonstrated by the graphs, overall global defence force expenditure every bit a part of gross domestic product has stabilized following a abrupt turn down after the 1960s. Similarly, equally BTC's telescopic of consensus expands, the amount being invested in network security is likewise decreasing on an almanac footing — a trendline that will somewhen examination the platform.

Based on current figures, the "security tax" for BTC in 2020 is 2.42%. Using this as our benchmark, it is too articulate that BTC'south security costs are positively correlated with BTC's annual aggrandizement charge per unit, thus it follows that as BTC's annual inflation charge per unit falls, and then also will security costs. While today'south BTC safety and aggrandizement rate are fairly fifty-fifty, if I factor in time to come BTC halvings, BTC must exist able to maintain an average security tax of ane.37% moving forrad to ensure the network'due south sustainable growth.

To that end, I must analyze BTC's future growth rate by examining the annual output of mined BTC and the network value of BTC by using the gold market place cap every bit our reference point. As of 2020, the total market value of golden is approximately $10 trillion, making the electric current market value of BTC shut to 4% of gilded. Suppose that in 2040 (that is, when BTC is halved to 0.195 per block), the total value of aureate will proceed growing at the same rate as GDP (the two are highly correlated, with an boilerplate growth rate of 2.18% over the past 20 years), thus reaching $13 trillion in value.

Let'south now examine BTC'south security costs from iii different outlooks — negative, neutral and positive, or in other words, BTC market cap takes 4%, 20% and 100% of golden value.

By examining the table, BTC's security costs to maintain current levels can accomplish $100 billion under the "optimistic prospects" column in the future. Fifty-fifty in the "negative prospects" column, security costs will still come in at a petty nether $1 billion. Yet, with BTC production dropping and block rewards accounting for only 2.vii% of miners' income, BTC will demand to primarily rely on on-chain transactions to cover security costs.

BTC's influence on DeFi

Thus, returning to our original discussion nigh DeFi's bear on on BTC's economic model, BTC is currently nether heavy pressure to dramatically increase on-chain transactions as long equally halvings go along. Based on 2020 on-chain transactions, BTC processed 110 one thousand thousand transactions with an average transaction fee of $5. Moving forrad, information technology is currently expected that BTC volition move to increment fees to offset brackish growth in terms of native transactions. Even based on the near conservative growth predictions, transaction fees must be increased to over $threescore (approximately equal to today's $40), while neutral and optimistic outlooks will require fees exceeding $300 and $ane,600, respectively. For ordinary users, this cost is just also high and will bulldoze more layer-two solutions like Ethereum as users look for culling transaction systems.

Alternatively, BTC could maintain current fee levels, but then its native transaction volume would need to exceed $1 billion based on conservative estimates. Without factoring in functioning, BTC'southward on-chain action needs to be multiplied by 12 times and reach anywhere from $7 billion to 37 billion based on neutral and positive prospects, respectively.

Simply put, BTC is architecturally incapable of keeping up with such growth and volume. Based on BTC's i megabyte block size, the annual transaction volume limit is nigh 190 million transactions. Moreover, the emergence of more than DeFi protocols and asset bridges may issue in BTC continuing to drift elsewhere, thus making BTC's future path all the more uncertain.

3 possible solutions

Faced with such a situation, here is Bitcoin'southward first path forrard, namely vis-a-vis increases of transaction fees. Every bit previously discussed, this move is only impractical, as information technology would require multiplying fees by hundreds of times to cover security costs. BTC's cadre claiming is not structural, rather it is rooted in its native transaction book. While miners' private incomes may increase, this approach would not solve BTC's homo problem.

The second solution is to upgrade Bitcoin to support smart contracts and found a native DeFi ecosystem, thereby keeping transactions inside the BTC concatenation. This is not a new topic of discussion — despite Ethereum's rich DeFi ecosystem, there is growing demand for solutions incorporating Bitcoin. BTC is still the nigh important asset in the crypto market place, with a 60% market share, pregnant information technology already has the user base necessary for a successful DeFi project. Moreover, Bitcoin boasts the most robust network, the most optimal security system and the most all-encompassing consensus organization. Finally, through innovations such as scripting languages, side chains or joint mining, Bitcoin could easily support smart contracts and, in turn, DeFi. Nonetheless, BTC migration is already accelerating despite asset gateways still existence in their nascency. While BTC participates in open fiscal and currency markets, various DeFi projects are now facilitating this migration from the application layer.

Moreover, Bitcoin notwithstanding lacks the ability to go on up with massive DeFi transaction volumes from a performance perspective. Finally, Bitcoin's ability to successfully integrate smart contracts into its mainnet remains in heavy doubtfulness. Its current attempts at supporting smart contracts accept not risen to the challenge of maintaining the mainnet's security level without creating a consensus split, while expansion plans that started five years agone have nevertheless not panned out. In short, the possibility that Bitcoin will dramatically transform to be compatible with smart contracts is depression — it is far more than probable that BTC will continue to be circulated in DeFi ecosystems as a passive asset.

The third — and about reasonable solution — is to increase the total supply of BTC. Through DeFi, BTC volition depart from Bitcoin in diverse forms as a value symbol and circulate in other cheap and like shooting fish in a barrel-to-employ Bitcoin layer-two solutions. Through this method, BTC tin can maintain network security while also increasing the total amount of BTC to comprehend basic network security costs by moving from deflation to moderate aggrandizement. Through this method, BTC will be able to stabilize miners' income while maintaining more reasonable and less variable transaction fees.

In conclusion, I believe that transaction fees will become the master source of income for BTC miners if DeFi continues to speedily grow. In plow, this will negatively bear upon BTC's network security, with Ethereum overtaking Bitcoin in transaction book. There are iii solutions to take: increasing transaction fees, supporting DeFi or increasing the amount of BTC in apportionment and adopting a moderate inflation program.

This commodity does not contain investment communication or recommendations. Every investment and trading motility involves chance, and readers should conduct their ain research when making a conclusion.

The views, thoughts and opinions expressed here are the author's lone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

Da Hongfei is best known for co-founding the blockchain-based "Smart Economy" network Neo with Erick Zhang in 2014. Da received his education at the South Mainland china University of Applied science, receiving degrees in technology and English. He worked at a consulting firm until 2013, subsequently which he learned how to code before founding Neo. Along with Zhang, Da likewise founded OnChain — a commercial blockchain firm that provides services to individual companies.