Piggybacking on the notion that discrete log contracts can extend Bitcoin’s DeFi ecosystem to trust-minimized derivatives products, it is worth evaluating Kava, and its relationship to Cosmos — both of which can actually help supplement Bitcoin’s liquidity and overall DeFi standing.
The primary issues in addressing DeFi with Bitcoin still center on how to adequately extend Bitcoin’s design space (i.e., smart contracts with RSK) without prohibitive trade-offs in the assurances afforded by Bitcoin’s security model.
Currently, efforts like Blockstream’s Liquid and RSK are the beginnings of what could become a lucrative market for expanding Bitcoin’s capabilities, but for now, the technology (e.g., federated peg sidechains) does not confer the same trust-minimized assurances as Bitcoin’s blockchain.
Eventually, projects like Liquid may ultimately become much less reliant on trust in a federation, but it is not the only extension of Bitcoin’s functionality worth viewing.
That’s where some intriguing projects come in, striving to minimize the costs of the trade-off between security and functionality by tapping networks outside of Bitcoin.
In particular, Cosmos has raised excitement as a potential experimentation ground for expanding DeFi on Bitcoin. And one of the projects breaking ground, Kava, presents an attractive solution.
A Brief Overview of Cosmos and its Congruency With Bitcoin
Cosmos is an interoperable framework for blockchains featuring “hubs” and “zones” where permissioned or public blockchains, using fast-finality consensus mechanisms (i.e., PoS), can be spun up or integrated into its ecosystem.
These blockchains can transfer value and messages seamlessly between each other utilizing Cosmos’ IBC protocol, which is supplemented by a blockchain-agnostic SDK for building applications.
Cosmos is designed to be interoperable, scalable, and user-friendly, which has already spawned a diverse blend of applications in its ecosystem. Ranging from the Binance Chain DEX to Kava, Cosmos has some fascinating potential for the broader cryptocurrency ecosystem.
However, it does have some limitations in the context of Bitcoin. For example, Cosmos ecosystem networks (i.e., blockchains) need to have fast-finality consensus, meaning that proof-of-work (PoW) blockchains, like Bitcoin, are not congruent with the hub and zone model natively.
As a result, bridges need to be constructed between Bitcoin and other PoW chains, like currently ongoing with Cosmos and Ethereum — called Peggy.
There is wiggle room in this design consideration, however.
How Bitcoin can be incorporated into the Cosmos ecosystem is highly dependent on the working iteration of Cosmos’ IBC protocol. But we can already project some early iterations of Bitcoin-oriented DeFi on the platform.
For example, Cosmos enables “Peg Zones” that are a special kind of proxy chain. According to Cosmos:
“A Peg-Zone is a blockchain that tracks the state of another blockchain. The Peg-Zone itself has fast-finality and is therefore compatible with IBC. Its role is to establish finality for the blockchain it bridges.”
The peg zone functions as a bridge between a PoW blockchain (e.g., Ethereum) and the Cosmos hub. However, a bridge between Cosmos and Bitcoin presents some unique technical challenges, although it is possible and under current exploration.
A Bitcoin peg zone would theoretically make transaction fees payable in the pegged currency, Bitcoin, rather than the native ATOM token, or other supported tokens, of Cosmos, which enables Bitcoin to benefit from faster finality of Cosmos without becoming reliant on its token.
At a high level, this circumvents the need for wrapping and unwrapping assets in the conventional peg model — diminishing the implicit trust trade-off.
How does this relate to Kava?
Developers built Cosmos with Bitcoin in mind, and some of whom have been cited as being close to Bitcoin maximalists. Kava is a project focusing on the cross-chain settlement of assets, working to support various assets, including BTC, under a Cosmos multi-collateral CDP system.
Kava and Bitcoin
Kava’s first project is extending Cosmos DeFi to XRP, but already has performed some work on evaluating how to support Bitcoin using its “Switch” swap protocol based on Interledger.
The concept of Kava is similar to MakerDAO, and its Dai stablecoin, using a Collateralized Debt Position (CDP) model for multi-collateral leverage, stability, and governance. Kava is a PoS blockchain built on Cosmos, with its own native KAVA token that is deployed in its governance model along with its multi-collateral backed USDX stablecoin.
“Today, Kava’s primary goal is to bring DeFi to assets that otherwise wouldn’t have access,” details the Kava blog post on DeFi.
In the context of Bitcoin, Kava’s aim is to extend Bitcoin’s DeFi capacity via decentralized leverage (e.g., margin trading) and hedging, using the USDX stablecoin as a store of value.
Whereas projects like TradeLayer and the potential of Discrete Log Contracts can offer similar projections for Bitcoin, Kava is an extension of Bitcoin to a multi-chain framework where the liquidity of other assets supported by Cosmos will be available side-by-side with BTC.
Within a user-friendly interface, this can make accessing DeFi for Bitcoin among other assets much more trivial, although there may be some trade-offs in security.
It is important to understand that the overarching model is highly dependent on the IBC and how Kava chooses to roll BTC into their platform. Concerning the success of Cosmos’ DeFi extension of Bitcoin, Mohamed Fouda articulated in a medium piece in the Token Daily publication:
“Success in this regard is to be able to attract sufficient liquidity to the peg zone and to maintain a reasonable level of decentralization by attracting a large enough number of validators.”
Kava Labs has the framework for their multi-collateral asset and USDX environment built, but are now working on onboarding validators to their PoS network.
For hardcore PoW proponents, the reliance on a bootstrapped PoS-validated network for security assumptions is probably a non-starter, but it is impossible to project how minimal the trade-off can reach should Cosmos garner widespread liquidity and successful implementation of a two-way permissionless Bitcoin peg zone.
We are still in the very early stages of interoperability among blockchains, and even more so concerning their congruency with DeFi applications.
Ultimately, the flexibility of Cosmos for building applications with its SDK should serve as a valuable instrument for bringing value to the network’s ecosystem.
And should Cosmos become a highly liquid medium for DeFi, expect some Bitcoin proponents to accept the trade-off of a PoS network’s security assurances for accessible Bitcoin DeFi.
The term DeFi encompasses a broad range of topics and value propositions, many of which focus on financial instruments for coins people don’t care about and are unsustainable.
Extending DeFi to Bitcoin is the ultimate goal, but the assurances in implicit trust trade-offs remain the lingering question facing its massive potential.