New wBTC Custody Model and Its Comparison with dlcBTC

Key Points

• BitGo recently modified the custody model for wBTC, initially proposing a cross-jurisdictional setup, which raised concerns about centralization and regulatory risks. After strong opposition from the community, BitGo introduced a third key holder to improve decentralization, but issues of transparency and regulatory compliance remain.

• The latest changes to the wBTC custody model highlight the ongoing challenges of using wrapped Bitcoin in DeFi. This situation underscores the urgent need for secure, transparent, and decentralized custody solutions in the crypto space to maintain trust and stability.

• dlcBTC focuses on self-custody, on-chain transparency, and minimal regulatory risk, providing a more secure and transparent alternative to wBTC. dlcBTC adopts a decentralized approach, addressing the vulnerabilities of traditional custody models and offering a safer option for using Bitcoin in DeFi.

Since 2019, BitGo has been the primary custodian and token issuer of Wrapped Bitcoin (wBTC), which has played a crucial role in driving Bitcoin's adoption within the DeFi ecosystem. Recently, BitGo announced changes to its wBTC custody model, raising concerns among industry insiders due to potential risks.

Although BitGo quickly modified its proposal, the debate over the centralized custody model of wBTC continues, raising questions about its security, regulatory compliance, and transparency. This article explores the evolution of the wBTC custody model and compares it with the more decentralized alternative, dlcBTC.

What Happened?

wBTC is a groundbreaking innovation that brought Bitcoin liquidity to DeFi and has grown to be among the top 15 tokens, with a total locked value exceeding $10 billion. However, its reliance on BitGo as the sole custodian has been a weakness. Despite BitGo's good reputation, concerns about insufficient on-chain transparency and potential regulatory risks persist.

BitGo recently announced a shift in wBTC custody to a "multi-jurisdictional and multi-institution" setup, which raised alarms in the crypto community.

Entities related to the TronDAO ecosystem control two of the three keys, raising concerns about centralization, regulatory uncertainty, and trust issues. The proposal faced strong opposition, including MakerDAO halting new loans against wBTC, and Coinbase announced the launch of a competing product, cbBTC.

Image Source: Coinbase

In response to the strong backlash, BitGo modified its proposal on August 14, 2024, as follows:

• 3 jurisdictions: the United States, Hong Kong, and Singapore.

• 3 institutions: BitGo Inc., BiT Global, and BitGo Singapore Ltd.

• 2-of-3 cold wallet multi-signature setup: each institution holds one key.

While this revision addresses the immediate centralization concerns, questions regarding BiT Global's role, regulatory compliance, auditability, and emergency procedures remain.

Impact of BitGo's Proposal on DeFi

BitGo's updated proposal has profound implications for the DeFi ecosystem:

1. Decentralization Issues: Continued reliance on centralized entities for wBTC custody may drive the development of more decentralized BTC wrapping solutions.

2. Increased Scrutiny: DeFi projects may require stricter scrutiny of custody arrangements for all wrapped assets, potentially leading to a diversification of BTC collateral options.

3. Trust and Transparency: This situation highlights the importance of transparency and trust in custody models, which can significantly impact the stability and growth of the DeFi ecosystem.

How Does dlcBTC Compare to the New wBTC Custody Model?

dlcBTC provides a decentralized alternative to wBTC, addressing many issues associated with centralized custody. Here’s a comparison between dlcBTC and wBTC:

Collateral Management

• wBTC: Under the new custody model, merchants must transfer their Bitcoin to wallets controlled by BitGo, where three institutions manage the keys. While this approach is distributed, it still relies on external entities to secure the assets, introducing potential risks from mismanagement or regulatory actions.

• dlcBTC: In contrast, dlcBTC employs a self-custody model. Merchants lock their Bitcoin in isolated custody, ensuring there is no single point of failure. This model enhances security and control, eliminating risks associated with centralized custody management.

Auditing and Transparency

• wBTC: The minting and burning processes of wBTC remain off-chain, posing challenges for achieving complete transparency. The revised custody model has not clarified how the community will effectively audit these processes.

• dlcBTC: All dlcBTC transactions occur on-chain, protected by the full hash power of Bitcoin. dlcBTC also integrates Chainlink's proof of reserve for additional verification, ensuring that the circulating supply does not exceed the collateral. This approach offers a higher level of transparency and auditability compared to wBTC.

Regulatory Uncertainty

• wBTC: The new custody model introduces regulatory complexities, particularly with BiT Global's involvement. Regulatory actions against any key-holding entity could jeopardize the operation of wBTC.

• dlcBTC: By allowing merchants to self-custody their BTC collateral, dlcBTC minimizes regulatory risks. This model ensures that collateral remains under the direct control of its owners, reducing the likelihood of external interference.

User Sovereignty

• wBTC: The wBTC model requires users to relinquish control of their Bitcoin to external custodians, which contradicts the principle of user sovereignty.

• dlcBTC: dlcBTC prioritizes user sovereignty, allowing merchants to lock Bitcoin in multi-signature wallets. This self-wrapping process ensures that only the original depositors can access the funds, even in the event of a hack or regulatory seizure.

Theft Prevention Mechanisms

• wBTC: The centralized management of keys in the wBTC custody model poses potential risks of being hacked or manipulated by governments or other entities, leading to significant losses.

• dlcBTC: dlcBTC employs theft-proof mechanisms. The design of the DLC multi-signature wallet only allows payments to the depositor's address. This setup ensures that even in the event of a violation, funds cannot be transferred, providing unparalleled security.

Transaction Speed

• wBTC: The wrapping and unwrapping processes of wBTC involve manual steps and coordination between multiple institutions, making it partially automated. This can lead to delays, with transaction times ranging from several hours to over a day, depending on the complexity of the operation.

• dlcBTC: dlcBTC fully automates the wrapping and unwrapping processes using discrete log contracts (DLCs). This automation significantly reduces transaction times, making dlcBTC 3-10 times faster than wBTC. It typically completes in just 3-6 Bitcoin block confirmations, taking less than an hour.

Fees

• wBTC: Managing Bitcoin reserves across multiple custodians and jurisdictions incurs additional costs, such as vault fees and insurance premiums. These costs are passed on to users, making wBTC transactions more expensive, especially for larger trades.

• dlcBTC: dlcBTC utilizes smart contracts to manage Bitcoin reserves without the need for traditional custody services. This eliminates custody management fees, allowing dlcBTC to offer costs that are 25-50% lower than wBTC, providing users with a more cost-effective solution.

Achieving Decentralization and Security through DLC

• wBTC: While the revised wBTC custody model attempts to achieve decentralization by involving multiple institutions, it still relies on centralized entities to manage and protect Bitcoin reserves. This creates potential vulnerabilities, such as regulatory risks and single points of failure.

• dlcBTC: dlcBTC is built on DLCs, allowing users to wrap Bitcoin into dlcBTC themselves. This system ensures that Bitcoin remains under the user's control at all times, greatly enhancing security and decentralization. DLC eliminates the need for a central custodian, reducing the risks of hacking, fraud, or government seizure, and ensuring that only the original depositors can access the locked Bitcoin.

Conclusion

dlcBTC offers an appealing alternative to wBTC, providing enhanced security, transparency, and user sovereignty. By allowing each merchant to self-custody their funds and eliminating reliance on centralized custody mechanisms, dlcBTC addresses many of the inherent risks in the wBTC model. As the DeFi landscape continues to evolve, the choice of custody models will play a crucial role in shaping the future of Bitcoin in decentralized finance.