Inflated TVL Figures Could Pop a $30B Bitcoin Defi Ecosystem

Two startups are joining forces to introduce a solution to verify total value locked (TVL) claims by Bitcoin decentralized finance (Bitcoin defi) projects.

Why Bitcoin Defi Needs Proof-of-TVL

At more than $30 billion in total value locked (TVL), Bitcoin decentralized finance (Bitcoin defi) is quickly becoming a profitable trend, but exaggerated TVL numbers from questionable projects could undermine the entire sector.

The reason TVL is the de facto vanity metric in defi is because it signals a token’s liquidity. It also helps investors gauge a project’s popularity and trustworthiness. But Bitcoin defi is different. Assessing Bitcoin-based TVL is much trickier than it is with a protocol such as Ethereum.

Bitcoin’s unspent transaction output (UTXO) model tracks discrete chunks of bitcoin (BTC) that – as the name suggests – are yet to be spent. A protocol such as Ethereum simply provides a total balance of ether (ETH) in an account. And therein lies the problem – Bitcoin’s unconventional UTXO model allows projects to game the system and inflate TVL.

“You can make as many claims on the UTXO model as you want,” Professor Yu Feng told Bitcoin.com in an interview. “But at the end of the day, we only calculate the transaction that happens on the Bitcoin [blockchain] because that’s the number that nobody can alter,” Feng added.

Essentially, Bitcoin defi projects are advertising funds promised to them by liquidity providers (LPs) in the form of bitcoin UTXOs, but it’s unclear if those funds are subsequently provided to the projects. After all, as Feng explains, only the funds that can be demonstrably proven to be controlled by the project should count towards TVL.

Feng is a professor of computer science at the University of California at Santa Barbara (UCSB) and the founder of blockchain scalability startup Nubit. He has teamed up with former UCSB assistant computer science professor Shumo Chu, who founded Nebra Labs, a zero-knowledge proof (zk-proof) research firm.

ZK-Proofs to the Rescue

Instead of relying on falsifiable TVL claims, Chu and Feng told Bitcoin.com that they have designed a tool that leverages zk-proofs, which use cryptography to prove the validity of information without revealing the information itself, and BitVM, a Bitcoin-based smart contract framework, to reliably confirm TVL.

“The beauty of zk is that it’s programmable,” Chu said. “We can implement these protocols relatively easily using our technology so that people cannot cheat.”

Chu explained that his proof-of-TVL solution is very similar to the proof-of-reserves systems adopted by exchanges like Binance in the wake of FTX’s collapse.

“I was one of the original authors of the proof-of-reserves articles in the Ethereum community,” Chu explained. “It’s basically proof-of-reserves plus some Bitcoin adaptations,” Chu added, referring to how his proof-of-TVL system has additional requirements to accommodate Bitcoin’s UTXO model.

Just like proof-of-reserves, proof-of-TVL seeks to prevent catastrophic bank runs where a large number of investors with liquid staking tokens decide to withdraw the underlying bitcoin only to discover that a project had minted more tokens than it had bitcoin.

Proof-of-TVL also shows how much bitcoin is locked and slashable. The bitcoin that investors commit to a project ends up on proof-of-stake platforms where it’s used for lending and defi purposes. These platforms mitigate malicious activity by confiscating or “slashing” a portion of funds that a bad actor commits to a project. But in order to slash funds, the platform must have some form of control over the assets, which is something Chu’s solution can verify.

As per the proof-of-TVL Github repository, “The BTC that is not under the staking protocol nor slashable cannot be counted in the TVL.”

Chu and Feng said their proof-of-TVL system is still being tested, but it will be incorporated into Nubit’s upcoming product called Goldinals – a Bitcoin fungible token standard similar to Ethereum’s ERC-20 model – that is set to launch as early as next week.

“Right now we’re starting to build the first Bitcoin native access protocol called Goldinals on top of BitVM,” Feng said. “One of our top missions is to bring the world computer back to Bitcoin.”

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