Although Bitcoin (CRYPTO: BTC) remains the most valuable cryptocurrency in the world, it lacks much of the functionality other cryptocurrencies possess today, particularly smart contract capabilities. Without smart contracts, Bitcoin holders are unable to directly participate in the rapidly growing decentralized finance (DeFi) economy, where users engage in lending, borrowing, yield farming, and even buying non-fungible tokens (NFTs).

But Coinbase's (NASDAQ: COIN) recent innovation could change this dynamic, unlocking Bitcoin's dormant potential to reach new heights. Here's why the launch of its cbBTC is a game changer for Bitcoin and its holders.

What is cbBTC?

Bitcoin can be compared to an old-fashioned telephone -- highly reliable, but limited in functionality. In contrast, newer cryptocurrencies function more like smartphones, letting users engage with a wide range of innovative applications across the DeFi economy.

The key difference lies in smart contract functionality, which Bitcoin lacks. Smart contracts let other cryptocurrencies interact with decentralized applications (dApps), enabling a range of use cases beyond simply holding value. As a result, Bitcoin remains isolated from the broader DeFi economy and its potential innovations.

However, new technologies are bridging this gap. Wrapped Bitcoin, Stacks (a Bitcoin Layer 2 solution), and various other projects have tried to introduce smart contract functionality to Bitcoin but have done so with limited success. However, that might be changing as Coinbase has introduced a new Bitcoin-equivalent token: cbBTC.

This is a wrapped version of Bitcoin that exists on the Ethereum and Base networks, two blockchains with burgeoning DeFi economies. By creating cbBTC, Coinbase lets users leverage their Bitcoin in DeFi while keeping the original Bitcoin fully backed.

How does cbBTC work and what makes it different?

cbBTC is essentially a token that represents Bitcoin at a 1:1 ratio. The process is straightforward: Bitcoin holders send their BTC to a Coinbase-controlled Bitcoin address. Once the transaction is confirmed on the Bitcoin blockchain, an equivalent amount of cbBTC is minted on Ethereum or Base and sent to the user's wallet. When redeeming, users send cbBTC back to Coinbase, which burns the tokens and transfers the equivalent amount of BTC to the user's Bitcoin address, completing the process in reverse.

What sets cbBTC apart from other attempts at a DeFi-capable Bitcoin like WBTC or Stacks is its ease of use. Coinbase offers a simple, seamless process in which Bitcoin holders can convert their BTC into cbBTC without leaving the Coinbase platform. Unlike more complex alternatives that require multistep processes and a deep understanding of blockchain technology, Coinbase's solution is frictionless, making it accessible to mainstream users. This ease of access could be crucial in unlocking billions in dormant Bitcoin capital and could result in a significant inflow of Bitcoin into DeFi markets, potentially driving Bitcoin's value higher.

Unlocking Bitcoin's economic utility

Bitcoin is currently valued at about $1.1 trillion, but its primary use is as a store of value. Although this strategy has been effective, it leaves much of Bitcoin's broader economic utility untapped.

Imagine walking into a bank to obtain a loan with a bag of gold bars -- it's cumbersome and inefficient. The same can be said for Bitcoin in its current form. However, with the introduction of cbBTC, Bitcoin holders can now leverage their assets within DeFi easily. This enables new use cases like lending Bitcoin to earn interest, borrowing against Bitcoin holdings, and even participating in yield farming, or lending crypto to earn a return.

By enabling Bitcoin to be used as collateral or for other DeFi purposes, its value can be further unlocked, potentially leading to big gains in the crypto's price. In fact, Ethereum, widely considered the backbone of the DeFi economy, has a market cap of about $300 billion, and at one point soared to nearly $550 billion during the last bull market. A large part of this valuation is due to its smart contract functionality and utility within DeFi.

If Bitcoin can replicate some of Ethereum's success in this area, it's not hard to imagine Bitcoin's market cap increasing by hundreds of billions of dollars over time. The more Bitcoin is used in DeFi, the higher the demand for it becomes, driving up its price as the available supply plateaus.

We are only at the beginning of this revolution, but the trajectory is clear: Bitcoin's integration into the DeFi ecosystem is inevitable, and innovations like Coinbase's cbBTC are the key to unlocking Bitcoin's full potential. As Bitcoin expands its role beyond just a digital gold-like asset, its long-term value proposition is set to grow, adding billions to its market cap in the process.

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RJ Fulton has positions in Bitcoin, Coinbase Global, Ethereum, and Stacks. The Motley Fool has positions in and recommends Bitcoin, Coinbase Global, and Ethereum. The Motley Fool has a disclosure policy.

How Coinbase's Newest Innovation Could Boost Bitcoin's Long-Term Value by Billions was originally published by The Motley Fool