January 15, 2024
Comparative Analysis of Wrapped Bitcoin Projects: Unravelling Unique Features of dlcBTC
Exploring wrapped Bitcoin solutions.
Traditionally, blockchains exist in isolated states and cannot communicate with each other. For instance, Bitcoin holders cannot spend their coins directly on the Ethereum network, nor can Ethereum users utilize its smart contracts on the Bitcoin blockchain. Basically, there's no one-size-fits-all blockchain solution, and each distinct design combination presents differences in security, privacy, efficiency, flexibility, platform complexity, developer ease-of-use, and even political values. The heterogeneity of user needs shows the coexistence of many blockchains.
The inability of blockchains to communicate limits decentralized finance (DeFi) applications from fully exploiting the assets held in various protocols. Having BTC on the Ethereum blockchain, for instance, and using it in smart contracts was quite a thought-provoking idea, and it has been made possible by the introduction of wrapped tokens. Wrapped tokens were designed to overcome the lack of communication between blockchains to enable the seamless cross-chain transfer of value and assets.
This article explains the concept behind wrapping Bitcoin. Furthermore, it compares various wrapped Bitcoin projects, highlighting their roles, uses, and drawbacks. It also recommends a fully trustless and secure version of wrapped Bitcoin as the ideal solution, exemplifying the Bitcoin ethos of decentralization and security.
Why Wrap Bitcoin?
There are numerous reasons for wrapping BTC. First, even with investors' interest in Ethereum and Layer 2 scaling ecosystems, BTC still retains the biggest liquidity portion. Therefore, most of the trading pairs in centralized exchanges (CEXs) are denoted in BTC, while most trading pairs in decentralized exchanges (DEXs) are designated in ETH, USDT, SOL, BNB, etc., accumulating a much lower trading volume than BTC alone. This explains the lack of liquidity prevalent in DEXs compared to CEXs.
Secondly, the Bitcoin network is known for low scalability and high transaction fees during congestion periods. As such, it is not ideal for daily volumes of transactions, especially microtransactions. Finally, native assets of various ecosystems, such as Ethereum, Binance Smart Chain, Arbitrum, Solana, etc., have diverse token standards. This makes it impossible to manage them with one smart contract. Besides, even within the same ecosystem, tokens may belong to different standards, such as ERC-20, ERC-223, TC-10, BEP2, and more.
What are the Different Techniques for Wrapping BTC?
Minting copies of BTC on another chain, like Ethereum, is relatively easy. However, the challenging part is making those copies as acceptable as the underlying asset. First, the value of the wrapped token must mirror that of BTC, and the peg must be maintained. Second, the safety of the locked BTC (collateral) and the freedom to redeem the token at any time must be guaranteed. Finally, the wrapped BTC must be convenient to use, and its utility extends beyond holding BTC in its native blockchain. Currently, there are three common methods of wrapping BTC:
Centralized
The centralized wrapping technique relies on one or more trusted entities to maintain the value of wrapped BTC. Third parties are responsible for providing proof-of-asset (PoA) as proof that the locked BTC is safely stored and not misused in any other way. Moreover, the auditability of the locked BTC must be kept over time with unlimited access, and the entities handling the protocol must ensure the wrapped BTC is redeemable anytime.
Hybrid
The hybrid wrapping technique leverages custodians and smart contracts to mint tokens. A centralized entity performs some special tasks that smart contracts cannot do, such as Know Your Customer (KYC) processes and ensuring that the smart contracts are correctly implemented.
Synthetic
Synthetic BTC wrapping doesn't require locking BTC in a trusted vault or smart contracts. A user locks some assets of an equivalent value (or more) of the represented BTC. For example, a user can lock 5000 USDT worth of SNX and ETH to mint sBTC of equal value. When users want to burn sBTC, they don't get the represented token back (BTC) but the provided assets instead.
Centralized, hybrid, and synthetic are the common techniques of wrapping BTC. However, lately, DLC.Link has introduced a self-wrapping technique to enable the use of native BTC in DeFi platforms without wrapping or bridging. The technique leverages Discreet Log Contracts (DLCs), which are secured by the full hashrate of the Bitcoin network, ensuring Bitcoin-level security. Moreover, the DLCs ensure only depositors access the locked BTC, eliminating third-party custody risks.
The Different Types of Wrapped BTC
Wrapped Bitcoin (wBTC)
Wrapped Bitcoin (wBTC) is a tokenized representation of BTC on the Ethereum blockchain. It allows users to bring Bitcoin's value and liquidity to the Ethereum ecosystem, enabling BTC to be utilized in DeFi applications, smart contracts, and other Ethereum-based platforms. The process involves users (wBTC merchants, not retailers) depositing their BTC into a custodial account, and in return, they receive an equivalent amount of wBTC on the Ethereum blockchain. This ensures a 1:1 peg between wBTC and BTC, maintaining value parity.
While wBTC facilitates interoperability between Bitcoin and Ethereum ecosystems, it introduces certain risks. The process's custodial nature means users rely on a third party to hold and manage their BTC during the wrapping process. This presents counterparty risk, as the custodian becomes a single point of failure susceptible to hacking, fraud, or fund mismanagement. Additionally, a level of trust is required in the custodian's ability to maintain the 1:1 peg between wBTC and BTC accurately.
Ren Bitcoin (renBTC)
renBTC is an ERC-20 token minted by Ren Protocol - a decentralized network that enables interoperability between blockchains. The RenVM protocol allows users to convert their BTC into renBTC on the Ethereum blockchain, similar to wBTC. The process involves users locking up their BTC in RenVM smart contracts, and in return, they receive an equivalent amount of renBTC on the Ethereum blockchain. This token can be used in various DeFi applications and smart contracts within the Ethereum ecosystem.
One advantage of renBTC is its decentralized nature. The RenVM protocol leverages a network of nodes, known as Darknodes, to collectively manage the custody and minting of renBTC, reducing reliance on a single custodian and enhancing security. However, risks still exist. Users face potential smart contract vulnerabilities and centralization of management. For example, the collapse of Alameda adversely affected the Ren protocol since its treasury was managed by Alameda. Besides, the minting process happens on the RenVM protocol, meaning users don't enjoy the Bitcoin-level security.
Stacks Bitcoin (sBTC)
sBTC is a non-custodial, programmable 1:1 BTC-backed token that facilitates the decentralized movement of BTC in and out of Bitcoin layers. Essentially, it enables builders to unlock BTC as a fully programmable asset, making way for BTC-backed DeFi, NFTs, and more. With the launch of sBTC, the Stacks protocol will be the first Bitcoin layer to facilitate the movement of BTC in and out of the Bitcoin network while securing transactions by 100% of Bitcoin hashrate.
sBTC provides Bitcoin write functionality since the sBTC peg technique can write Bitcoin transactions to the Bitcoin blockchain in a fully decentralized way. The team behind this project believes their product will unlock billions of dollars of latent BTC capital to build a BTC ecosystem that surpasses all other ecosystems. The major drawback of sBTC is that it only opens BTC for use in Stacks – it doesn't solve the issue of bridging BTC for use in other chains.
Threshold Bitcoin (tBTC)
tBTC is a decentralized and trust-minimized wrapped form of BTC on the Ethereum blockchain. Threshold protects users by separating operations into minters and guardians. Guardians are stakers of Threshold’s token, T, who manage bitcoin wallets used to issue tBTC on Ethereum. On the other hand, minters are a group of Ethereum ‘blue chip’ decentralized autonomous organizations (DAOs), including Curve DAO, Aave, Alchemix, Yeran.Finance, and Euler.
While tBTC aims to address the custodial risks associated with centralized solutions like wBTC, it has challenges. As mentioned, tBTC is not trustless – it’s trust minimized. Threshold believes by creating a big pool of minters, it makes it difficult (but theoretically not impossible) to misuse minting powers. As such, the minters are always monitoring mints that lack matching BTC in the Threshold wallets.
Huobi Bitcoin (hBTC)
Huobi Bitcoin (hBTC) is a standard ERC-20 token issued by Huobi Global on the Ethereum blockchain. The token is designed to enable the use of BTC in DApps and smart contracts within the Ethereum ecosystem. Obtaining hBTC typically involves users depositing their BTC into a custodial account provided by Huobi. In return, they receive an equivalent amount of hBTC on the Ethereum network.
hBTC allows users to interact with the broader DeFi ecosystem and benefit from the features and opportunities available within the network. Its major drawbacks include custodial risks associated with relying on a central entity, regulatory uncertainties, and the need to trust the custodian's security measures.
DLC.Link Bitcoin (dlcBTC)
dlcBTC is a non-custodial representation of BTC on the Ethereum network, allowing BTC holders to participate in DeFi while retaining complete ownership of their assets. It leverages DLCs to lock BTC in a special multisig Unspent Transaction Output (UTXO), with one key managed by the depositor and the other distributed across a decentralized network.
Unlike most versions of wrapped Bitcoin, dlcBTC eliminates the need for intermediaries by self-wrapping BTC in a lockbox, exemplifying the principle of user sovereignty. The token is secured by the full hashrate of the Bitcoin blockchain and doesn't require depositors to lock or send their BTC to external custodial addresses. Though dlcBTC shares a lot of similarities with sBTC, it's more competitive with wBTC and tBTC on Ethereum. Furthemore:
- The DLC lockbox only pays out to the depositor, meaning that even if the system is hacked, the deposit will only be sent to the rightful owner.
- dlcBTC lets depositors use native BTC on the Ethereum blockchain.
Conclusion
The evolution of wrapped Bitcoin projects has significantly expanded the possibilities for leveraging BTC in various blockchain ecosystems. While centralized, hybrid, and synthetic wrapping methods address interoperability challenges, risks associated with custodial management and smart contract vulnerabilities persist. The comparative analysis of popular wrapped Bitcoin variants, such as wBTC, renBTC, sBTC, tBTC, hBTC, and dlcBTC, reveals the trade-offs between security, decentralization, and user control.
dlcBTC emerges as a standout solution, providing a non-custodial and secure representation of BTC on the Ethereum network. Leveraging DLCs, dlcBTC ensures user sovereignty, eliminating third-party custody risks and enabling the use of native BTC in DeFi platforms without traditional wrapping or bridging. As the blockchain landscape continues to evolve, dlcBTC exemplifies the principles of decentralization and security, offering a promising path forward for BTC holders seeking seamless participation in the booming DeFi ecosystem.
