Square's (SQ -0.58%) interest in cryptocurrency just took a big step up. CEO Jack Dorsey recently announced plans for a new business segment focused on developing a decentralized finance platform using Bitcoin (BTC 1.07%).
Decentralized finance, an industry that uses blockchain technology to replace centralized institutions like banks and exchanges, has grown significantly over the last couple of years. There's over $50 billion in cryptocurrency value locked into the DeFi ecosystem. Dorsey and company think the industry is still in its early stages and that it presents a big growth opportunity for Square.
Image source: Getty Images.
What exactly is Square building?
Dorsey made the announcement of the new business segment, referred to as TBD, via a tweet, but the announcement was short on details.
Square is creating a new business (joining Seller, Cash App, & Tidal) focused on building an open developer platform with the sole goal of making it easy to create non-custodial, permissionless, and decentralized financial services. Our primary focus is #Bitcoin. Its name is TBD.
— jack (@jack) July 15, 2021
The Bitcoin blockchain doesn't support smart contracts like Ethereum's (ETH 0.24%) blockchain does. Smart contracts are little bits of code stored on the blockchain that will automatically execute when their conditions are met. They're the building blocks for a DeFi app. It's the reason most developers use Ethereum instead of Bitcoin for this purpose.
In order to implement smart contracts on the Bitcoin blockchain, Square will have to build a second layer that can lay on top of the blockchain and execute smart contracts. The good news for Square is the Bitcoin community as a whole is also interested in growing the utility of the blockchain, and it's planning an upgrade that ought to make implementing a "layer 2" easier.
Still, the decision to build a DeFi platform focused on Bitcoin from scratch is a bit curious when there are better options for DeFi presently available. But Dorsey has been very outspoken about his belief that Bitcoin will become the currency of the internet, and Square invested $220 million in Bitcoin in late 2020 and early 2021. So, Dorsey and the company are heavily invested in the growth of Bitcoin.
What can Square gain from DeFi?
Owning the platform people use to develop decentralized applications can have direct benefits for Square. It could sell developer tools or issue its own token for use on the platform.
Importantly, Square has the advantage of more than 36 million Cash App users and hundreds of thousands of merchants to whom it can promote DeFi apps. It's seen strong adoption of Bitcoin on Cash App, and adding the ability to get a loan with Bitcoin as collateral or earn interest on Bitcoin deposits could be a big draw for users and developers alike.
Moreover, Square is in the business of moving money around and doing so as quickly as possible. Broad DeFi adoption could allow Square to offer faster and less expensive ways to do that. That said, using the Bitcoin blockchain is currently one of the slower and more expensive ways to transact in cryptocurrency.
If Square's platform can draw developers to create services that Square itself can take advantage of with its Seller and Cash App platforms, it can effectively pull double duty for Square. In that case, if TBD starts turning a profit, it's just icing on the cake.
Decentralized finance may still be in its early stages, and Square can help make financial services on blockchain more mainstream. The $50 billion currently in DeFi is a drop in the bucket compared to the trillions on deposit in U.S. banks, let alone globally. That's quite a total addressable market that Square's Defi efforts could tap into.
