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The New wBTC Custody Model and How It Compares with dlcBTC

  • BitGo recently revised the custody model for wBTC, initially proposing a multi-jurisdictional setup that raised concerns over centralization and regulatory risks. Following community backlash, BitGo introduced a third key holder to improve decentralization, but questions about transparency and regulatory compliance remain.
  • The recent changes to wBTC's custody model highlight the ongoing challenges of using wrapped Bitcoin in DeFi. The situation underscores the critical need for secure, transparent, and decentralized custody solutions in the crypto space to maintain trust and stability.
  • dlcBTC offers a more secure and transparent alternative to wBTC by focusing on self-custody, on-chain transparency, and minimal regulatory risks. With its decentralized approach, dlcBTC addresses the vulnerabilities of traditional custodial models, providing a safer option for using Bitcoin in DeFi.

Since 2019, BitGo has been the primary custodian and token issuer of Wrapped Bitcoin (wBTC), a token that has played a crucial role in enabling Bitcoin to be utilized in DeFi ecosystems. Recently, BitGo announced changes to its wBTC custody model, sparking concerns among industry players due to the potential risks introduced. 

Although BitGo quickly revised its proposal, the debate over wBTC's centralized custody model continues, raising questions about its security, regulatory compliance, and transparency. This article explores the developments surrounding wBTC's custody model and how it compares with dlcBTC, a more decentralized alternative.

wBTC was a groundbreaking innovation that brought Bitcoin liquidity to DeFi, growing into a top-15 token with over $10 billion in TVL. However, its reliance on BitGo as the sole custodian has always been a point of vulnerability. Despite BitGo's strong reputation, concerns over the lack of on-chain transparency and potential regulatory risks persist.

BitGo's recent announcement to transition wBTC's custody to a "multi-jurisdictional and multi-institutional" setup raised alarms in the crypto community. 

The proposal effectively gave BiT Global, an entity associated with the TronDAO ecosystem, control over two of the three keys, raising concerns about centralization, regulatory uncertainty, and trust issues. The proposal led to significant backlash, including MakerDAO halting new borrowing against wBTC and Coinbase announcing a competing product, cbBTC.

Image credit: Coinbase 

In response to the outcry, BitGo revised its proposal on August 14, 2024, as follows:

  • 3 jurisdictions: United States, Hong Kong, and Singapore.
  • 3 institutions: BitGo Inc., BiT Global, and BitGo Singapore Ltd.
  • 2-of-3 cold-storage multi-signature setup: Each institution holds one key.

While this revision addressed the immediate centralization concern, questions about BiT Global's role, regulatory compliance, auditability, and emergency procedures remain.

BitGo's updated proposal has far-reaching implications for the DeFi ecosystem:

  1. Decentralization Concerns: The continued reliance on centralized entities for custody in wBTC might prompt the development of more decentralized BTC wrapping solutions.
  2. Increased Scrutiny: DeFi projects may demand more rigorous vetting of custody arrangements for all wrapped assets, potentially leading to a diversification of BTC-based collateral options.
  3. Trust and Transparency: The situation underscores the importance of transparency and trust in custody models, which can significantly impact the stability and growth of the DeFi ecosystem.

dlcBTC offers a decentralized alternative to wBTC, addressing many concerns associated with centralized custody. Here's how dlcBTC compares:

  • wBTC: Under the new custody model, merchants must transfer their Bitcoin to BitGo-controlled wallets, where three institutions manage the keys. This approach, while distributed, still relies on external entities for asset security, introducing potential risks of mismanagement or regulatory action.
  • dlcBTC: In contrast, dlcBTC adopts a self-custodial approach. Merchants lock their Bitcoin in segregated custody, ensuring no single point of failure. This model enhances security and control, eliminating risks associated with centralized custodial management.
  • wBTC: The wBTC minting and burning processes remain off-chain, creating challenges in achieving full transparency. The revised custody model has yet to clarify how the community will audit these processes effectively.
  • dlcBTC: All dlcBTC transactions occur on-chain, secured by Bitcoin's full hash rate. dlcBTC also integrates Chainlink's Proof-of-Reserve for added verification, ensuring that the circulating supply cannot exceed the collateral. This approach offers a higher level of transparency and audibility compared to wBTC.
  • wBTC: The new custody model introduces regulatory complexities, especially concerning BiT Global's involvement. Regulatory actions against any of the key-holding institutions could jeopardize wBTC's operations.
  • dlcBTC: By allowing merchants to control their BTC collateral in self-custody, dlcBTC minimizes regulatory risks. This model ensures that the collateral remains under the direct control of its owners, reducing the likelihood of external interference.
  • 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 by enabling merchants to lock Bitcoin in multisig wallets. This self-wrapping process ensures that only the original depositor can access the funds, even in the event of a hack or regulatory seizure.
  • wBTC: The centralized management of keys in wBTC's custody model introduces potential vulnerabilities to hacking or manipulation by governments or other entities, which could lead to significant losses.
  • dlcBTC: dlcBTC employs a theft-proof mechanism. The DLC multisig wallet is designed to only pay out to the depositor's address. This setup ensures that even in the event of a breach, the funds cannot be diverted, offering unparalleled security.
  • wBTC: The process of wrapping and unwrapping wBTC involves 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 utilizes Discreet Log Contracts (DLCs) to automate the wrapping and unwrapping process fully. This automation significantly reduces transaction times, making dlcBTC 3-10 times faster than wBTC. It typically completes in just 3-6 Bitcoin block confirmations, which is less than an hour.
  • wBTC: The need to manage Bitcoin reserves across multiple custodians and jurisdictions introduces additional costs, such as vault fees and insurance. These costs are passed on to users, making wBTC transactions more expensive, especially for larger transactions.
  • dlcBTC: dlcBTC leverages smart contracts to manage Bitcoin reserves without traditional custodial services. This eliminates custodial overhead costs, allowing dlcBTC to offer fees 25-50% lower than wBTC, providing a more cost-effective solution for users.
  • wBTC: Although the revised wBTC custody model attempts to decentralize by involving multiple institutions, it still relies on centralized entities to manage and secure the Bitcoin reserves. This creates potential vulnerabilities, such as regulatory risks and single points of failure.
  • dlcBTC: dlcBTC is built on DLCs, which allow users to self-wrap their Bitcoin into dlcBTC. This system ensures that Bitcoin remains under the user's control at all times, significantly enhancing security and decentralization. DLCs eliminate the need for a central custodian, reducing the risk of hacks, fraud, or government seizure and ensuring that only the original depositor can access the locked Bitcoin.

dlcBTC presents a compelling alternative to wBTC, offering enhanced security, transparency, and user sovereignty. By allowing funds to be held in self-custody by each merchant and eliminating reliance on a centralized custody mechanism, dlcBTC addresses many of the risks inherent in wBTC's model. As the DeFi landscape continues to evolve, the choice of custody model will play a crucial role in shaping the future of Bitcoin in decentralized finance.

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