From Peer-to-Peer to Peer-to-Pool

Financial asset transactions require at least two parties with opposite directions and matching needs. The core of financial services is to enhance the efficiency of matching these parties while reducing the frictional costs of participation.

P2P trading has been widely applied in spot markets, loans, and futures. ETHLend, the precursor to the largest lending protocol, AAVE, raised over $16 million through an ICO in 2017. Their goal was to achieve decentralized peer-to-peer lending matches through the Ethereum network. According to ETHLend’s product vision, borrowers and lenders could post their requirements on-chain, customizing loan rates, collateral types, and collateral-to-loan ratios. Borrowers and lenders could then find and match suitable orders directly on the platform.

However, the Peer-to-Peer lending model also revealed several critical issues:

• Difficulty in Matching Needs: As a two-sided market, users often spend significant time finding appropriate counterparts. Borrowers might find an order matching their loan amount but not their desired interest rates or loan durations.

• Fragmented Liquidity: The liquidity of both parties was fragmented across highly varied order requirements. Funds were often locked for extended periods due to unmatched orders, leading to inefficient capital utilization.

• High Loan Rates: Low efficiency in fund utilization translated into high frictional and temporal costs, which were passed onto the operational costs of both parties, leading to elevated loan interest rates.

Given that smart contracts can act as a trustless ledger while also managing interest rate calculations and asset custody, why not use them as a medium for liquidity between lenders and borrowers for more efficient demand matching?

ETHLend developers, learning from Compound, used smart contracts to create a liquidity pool. This allowed lenders to deposit assets for passive income based on market demand, while borrowers could secure loans by mortgaging assets and paying interest.

With the Peer-to-Pool design, the user experience for both parties improved dramatically:

• Flexible Loan Parameters: Both parties could independently decide their loan amounts and durations, with the liquidity pool automatically adjusting interest rates based on market conditions.

• Reduced Friction Costs: The bi-directional liquidity was effectively consolidated within the liquidity pool, allowing users to transact directly with the pool. This significantly reduced frictional costs and led to more reasonable interest rates. For instance, in the Bitcoin ecosystem, the P2P lending protocol Liquidium saw annual interest rates as high as 65% for a 16-day loan of BTC against NodeMonke collateral; in contrast, the annual interest rate for lending ETH on AAVE was only 2.54%.

• Instant Loans: Borrowers and lenders could initiate transactions instantly based on current market rates, enabling an "anytime, anywhere" borrowing experience.

What about Lending on the Bitcoin Network?

Lending in the Bitcoin Network In the Bitcoin network, due to the stateless nature of the UTXO model, there are no accounts or balances on-chain, making it impossible to implement programmable state data similar to Ethereum smart contracts. Clearly, the P2Pool lending model, easily implemented on Ethereum, cannot be directly transferred to the Bitcoin network. So, how can an equivalent Peer-to-Pool lending model be realized on Bitcoin? The solution hinges on who assumes the role of the liquidity pool.

Returning to the fundamental functions of a liquidity pool:

• Custody of Collateral and Loan Funds

• Interest Rate Calculations Combining Collateral Ratios and Asset Values

• Passive Position Liquidation

In the Bitcoin network, collateral (such as inscribed assets) and BTC, as native UTXO assets, can be effectively managed by Taproot Script. Interest rate calculations are typically performed off-chain, and users can verify the legitimacy of these calculations through the PSBT signing scheme. Additionally, trustless liquidation is achievable by relying on DLCs. The combination of on-chain and off-chain logic necessary for these operations often presents a high barrier for many users. How can protocols encapsulate and abstract these complex processes to offer easy-to-use lending services?

We'll discuss the concept of Lightning Service Providers (LSPs), a technology widely applied in the Bitcoin Lightning Network payments sector. Given the high threshold for using the Lightning Network and the complexity of connecting to it, which exceeds many end users' tolerance, there is a demand for Lightning Network-related services, fostering the LSP market. LSPs offer services, including opening user payment channels, ensuring sufficient incoming liquidity, routing payments, and maintaining stable network connections. This is similar to how most people prefer to connect to the Internet through Internet Service Providers (ISPs), who handle complex technical issues and charge for the convenience of Internet services.

As a Bitcoin Finance protocol serving as a financial service provider on the Bitcoin network, it too needs to abstract and encapsulate complex on-chain and off-chain calculations, Taproot Script signings and other business logistics to provide users with a "one-click" operational experience that surpasses the convenience of traditional financial markets, truly realizing Protocol as a Service (PaaS).

How does it work in Shell Finance?

Shell Finance, a lending protocol on the Bitcoin layer-one network, introduces vaults as the unit for each loan. This allows the protocol to connect borrower and lender markets, creating a unique Peer-to-Protocol lending structure.

Through this design, the protocol builds independent lending relationships with each borrowing position in the loan-side market, meeting diverse borrowing needs; simultaneously, it maintains the price balance between $BTC and $BTCx through the protocol and liquidity pool, absorbing liquidity from the lender market. The efficient characteristics of a fund pool are simulated on the UTXO model basis, enhancing the matching efficiency and capital utilization of the dual-sided market.

Through Shell Finance, users can experience the same transaction experience as with Peer-to-Pool lending protocols:

• Instant Lending Liquidity

• Diverse Collateral Options

• Low Loan Costs

Importantly, the protocol internally packages the BTC/BTCx trading pool module, price oracle DLC liquidation module, liquidation auction module, vault module, and more. It coordinates the calling and collaboration among these modules based on user needs, providing a simple, easy-to-use lending service.

Outlook for the Future of Bitcoin Finance

Outlook for the Future of Bitcoin Finance Looking back from 2024 at the outstanding DeFi protocols on the Ethereum network, each one cleverly utilizes paradigm shifts to offer more efficient financial services to users. Uniswap, by building spot liquidity pools and leveraging constant function market-making curves, has provided a new paradigm for DEXs; AAVE and Compound introduced the concept of borrowing liquidity pools, taking the decentralized lending market to new heights through the Peer-to-Pool model. Indeed, liquidity pools themselves are one of the most important financial primitives in the crypto world, and they apply to BiFi as well.

Though limited by the UTXO structure and data capacity, Bitcoin script programming is also explored based on the liquidity pool concept. OP_VAULT, proposed as a BIP specifically for constructing "vault contracts," aims to provide a safer, more advanced form of fund custody. The implementation scheme of OP_VAULT allows a new transaction to input parameters to a pre-committed opcode, thus updating the entire script's leaf; this moves beyond "verifying incoming data under certain conditions" to "generating new, meaningful data from incoming data." This data update provides a foundation for more intelligent asset management schemes and brings us closer to a true native liquidity pool.

Looking further into the future of the Bitcoin ecosystem, various second-layer solutions based on the Bitcoin network are also flourishing. With the emergence of Bitcoin second-layer networks equipped with Turing-complete virtual environments like AVM and BVM, BiFi is poised to expand into more complex and advanced financial experiments, and the massive financial reserves in the Bitcoin network will provide continuous momentum for the development of the BiFi ecosystem.