Have you heard of WBTC?

For those who experienced DeFi Summer, WBTC is a familiar name. As one of the earliest stablecoins created in 2018, WBTC played a leading role in integrating Bitcoin liquidity into the DeFi and Ethereum ecosystems in 2022.

However, WBTC recently faced a trust crisis. On August 9, BitGo announced a joint venture with Hong Kong-based BiT Global, planning to transfer WBTC’s BTC management address to a multi-signature wallet controlled by this joint venture. BiT Global, the Hong Kong enterprise, is backed by Justin Sun.

This move has sparked discussions in the market about the security of WBTC’s control. In response, Justin Sun stated that there are no changes to WBTC compared to before, and audits are conducted in real-time, managed in the same manner by the custodians Bit Global and BitGo.

Despite this, within the past six days since the news broke, Crypto.com and Galaxy have redeemed over $27 million in Bitcoin, indicating that market concerns remain. This article will delve into the operational mechanism of WBTC and provide an update on the development of decentralized Bitcoin stablecoins.

The Stability Mechanism Behind the WBTC Controversy

To grasp the key issues behind the recent WBTC trust crisis, it’s essential to first examine its stability mechanism.

WBTC, an ERC20 token fully collateralized 1:1 with Bitcoin and based on Ethereum, operates on a consortium model. This is somewhat akin to existing banking tier-2 systems, where there are “custodians” (previously only BitGo) and “acquirers” (certified entities) between the custodians and ordinary users.

Custodians are responsible for accepting and securely storing a certain amount of Bitcoin. Upon receiving Bitcoin, they issue an equivalent amount of WBTC tokens, which are then released to a specified Ethereum address. Conversely, the burning process is also handled in the reverse direction.

Acquirers, on the other hand, function as retail entities. They interact directly with users, performing necessary KYC/AML procedures to verify identities, and ultimately provide services for acquiring and redeeming WBTC. Thus, they serve as a bridge, greatly facilitating the circulation and trading of WBTC in the market.

In essence, custodians directly determine the credibility of WBTC’s minting, burning, and custody processes. This centralization means users must fully trust that custodians will not engage in fraudulent activities and will strictly follow regulations for WBTC minting and burning.

For instance, if a custodian receives 100 BTC but issues 120 WBTC, or misuses the 100 BTC through restaking or other means, it undermines the entire system’s balance and trust.

Especially concerning is the potential for over-issuance, which could decouple the value of WBTC from the actual value of the staked Bitcoin, leading to market chaos and investor panic, and potentially causing the collapse of the entire stablecoin mechanism.

Previously, BitGo was the sole custodian of WBTC. As an established crypto custodian, BitGo has, to some extent, withstood market and time tests, providing relatively stable assurance for WBTC’s development. Data shows that over 154,200 WBTC have been issued with a total value exceeding $9 billion, indicating the market’s trust in BitGo.

Source: WBTC Official Website

Ultimately, the reason lies in the transfer of WBTC’s reserve asset multi-signature authority from BitGo to a joint venture controlled by Justin Sun.

This also reflects the centralization concerns regarding WBTC’s own operational mechanisms. As a result, the market is calling for the exploration of decentralized solutions to reduce excessive reliance on centralized custodians, particularly by leveraging blockchain technology to minimize single points of failure and human manipulation risks, thus enhancing the security and reliability of BTC stablecoin mechanisms.

The Tumultuous Journey of Decentralized BTC

Since the last bull market cycle, various decentralized BTC stablecoin solutions have been an important innovation track. Projects like renBTC and sBTC emerged, becoming crucial conduits for Bitcoin’s entry into the DeFi ecosystem and channeling substantial BTC capital into Ethereum, also diversifying earning opportunities for BTC holders.

However, as bull and bear markets came and went, many of the former star projects have met their demise.

Firstly, renBTC, once the most prominent, represented a decentralized BTC stablecoin solution in contrast to WBTC’s centralized approach. Its entire issuance process was relatively decentralized, with users depositing native BTC into the designated RenBridge gateway as collateral, and RenVM issuing corresponding renBTC on the Ethereum network via smart contracts.

The project was notably linked with Alameda Research (indeed, Alameda had acquired the Ren team), which was once a major highlight, but after the FTX crisis, Ren was inevitably affected, facing operational funding disruption and large-scale capital flight.

Although attempts at self-rescue were made, as of this writing, the latest public update is from a September 2023 Ren Foundation announcement, and the situation seems almost moribund.

Secondly, Synthetix’s sBTC was a synthetic Bitcoin asset created through SNX staking and was once a leading decentralized Bitcoin pegged asset. However, in the first half of this year, Synthetix completely discontinued non-USD synthetic assets on Ethereum, including sETH and sBTC, which failed to gain significant traction in the DeFi ecosystem.

Currently, the most interesting ongoing project is Threshold Network’s tBTC. It’s worth noting that this is a continuation of the well-known tBTC from Keep Network—Threshold Network was formed from the merger of Keep Network and NuCypher.

tBTC replaces centralized intermediaries with a randomly selected group of operators running nodes on the network. These operators use Threshold cryptography to secure the Bitcoin deposited by users. In short, user funds are controlled by a majority consensus of the operators.

As of this writing, tBTC’s total supply exceeds 10,000 coins, with a total value of nearly $600 million, up from less than 1,500 coins six months ago, reflecting significant growth.

Source: Threshold Network

In summary, the competition among various solutions fundamentally revolves around asset security. The recent WBTC issue has highlighted the demand for decentralized stablecoins, and in the future, projects like tBTC and similar ones will need to continuously improve their decentralized designs to meet market and user needs while ensuring asset security.

New Solutions for Bitcoin L2?

In fact, whether it’s today’s WBTC, tBTC, or the former renBTC and sBTC, they all share a common feature: they are all ERC20 tokens.

The reason is quite simple and somewhat frustrating: only by bridging to the Ethereum ecosystem and leveraging its rich DeFi landscape can Bitcoin’s liquidity be effectively unlocked. From one perspective, Bitcoin, with a market cap of $1.16 trillion (as of August 15, 2024, according to CoinGecko), represents the largest “sleeping pool” of funds in the crypto world.

Thus, since the DeFi Summer of 2020, WBTC, renBTC, and others have become primary attempts to unlock Bitcoin’s liquidity: users can stake BTC to receive equivalent wrapped tokens, which are then bridged to the Ethereum ecosystem to participate in DeFi and other on-chain activities.

This reliance on Ethereum continued until the Bitcoin ecosystem’s explosive growth driven by the Ordinals craze in 2023, which brought a new solution: Bitcoin L2s offer users the possibility to engage directly with various smart contract applications on Bitcoin-based L2s, such as staking, DeFi, social, and even more complex financial derivatives markets, significantly expanding the range and value of Bitcoin assets.

Take Stacks’ sBTC (not to be confused with Synthetix’s sBTC) as an example. As a decentralized 1:1 Bitcoin-backed asset, sBTC facilitates the deployment and movement of BTC between Bitcoin and the Stacks L2, and can be used as gas in transactions without requiring additional cryptocurrencies.

Moreover, sBTC’s security is theoretically higher than traditional Ethereum-based wrapped tokens, as its security is partially ensured by Bitcoin’s hash power; reversing transactions would require attacking Bitcoin itself.

From this perspective, Stacks’ introduction of sBTC serves, to some extent, as an alternative to the traditional “wrapped tokens + Ethereum” model. It brings smart contracts into the Bitcoin ecosystem in a decentralized manner, thereby integrating Bitcoin into the DeFi world.

As Bitcoin L2s continue to evolve and innovate, new solutions like sBTC could potentially erode the market for wrapped tokens like WBTC, further enhancing Bitcoin’s liquidity and use cases.

Conclusion

Reflecting on the “wrapped tokens + Ethereum” model since 2020, it hasn’t seen significant growth, with only a modest influx of BTC funds—essentially marking the 1.0 phase of unlocking Bitcoin liquidity.

Frankly, if we consider Bitcoin purely as a trillion-dollar asset pool, there’s little need to reinvent the wheel with another Bitcoin L2. The existing “wrapped tokens + Ethereum” ecosystem and DeFi use cases are already more than adequate. In fact, much of the logic behind Bitcoin L2s today isn’t fundamentally different from integrating BTC into the EVM ecosystem via tBTC, renBTC, and similar ERC20 wrapped tokens.

However, when it comes to native security and enhancing Bitcoin’s ecosystem value, the rise of Bitcoin L2s is quite significant. They offer better security for Bitcoin assets and help retain value within Bitcoin’s own ecosystem, rather than letting it spill over into Ethereum’s domain.

The recent WBTC crisis has stirred considerable concerns. What are your thoughts on the future of Bitcoin stablecoins? Feel free to share your insights in the comments.

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