Hi friends,
Welcome to The ₿it Economy! I’m Rob, and each week I write a blurb about something I learned that’s broadly Bitcoin related. If you have thoughts, I'd love to hear from you. With the launch of tBTC this past week, I’d like to brief you on the pros and cons of tokenized Bitcoin. Today’s rip is on tokenized Bitcoin and My goal is to shed a tidbit of info that I believe will get you thinking about the digital world around you. If you know anyone who would be interested, please do forward this along, send them to the archive, or have them subscribe here. 👇
-Rob
A Word on Wrapped Bitcoin
Networks Need Value
Bitcoin is the largest, most robust, and decentralized computing network in the world. These traits have seen the digital asset grow to have the largest market capitalization by a long shot — accounting for over 60% of the entire ecosystem. There is no question that having access to that kind of value could be incredibly useful for DeFi and various other digital asset projects.
However, as the ecosystem grows it is imperative to know the risks one is taking when interacting with the various bridge protocols out there. And just because an influencer tells you should do something does not mean you should do it. Remember to always do your own research before interacting with these protocols. As a primer, this post intends to shed light on what tokenized Bitcoin is, the risks associated with it, and how it fits into the bigger picture.
Tokenize What?
Tokenized bitcoin is a component of the greater DeFi ecosystem in that anyone can contribute code and use (most) of these open source protocols no matter their social status or country of origin. This is mostly different from the regular banking system, where these two factors often determine and possibly limit one's chances to be served. Recently several approaches have been made to tokenize Bitcoin and move it to other blockchains with different properties. The individual projects vary in decentralization and trustlessness depending on how the 1:1 peg to the original Bitcoin blockchain is achieved and how decentralized the host blockchain is. In a way, it's comparable to a paper note that's redeemable for gold. The paper note would be the tokenized BTC and the gold would be BTC.
Your Options
DeFi is (sort of) permissionless, in that anyone can contribute code and use (most) of these open source protocols no matter their social status or country of origin. The reason why there is an interest in tokenizing Bitcoin is to enable functionality that is not natively supported by the Bitcoin blockchain so that it is compatible with these protocols. Below are the most popular projects in development:
Risk
Counterparty Risk
While tokenized BTC may facilitate using bitcoin in DeFi, it is subject to counterparty risk. For example, the BTC used to collateralize WBTC (and its more decentralized siblings) is maintained by agents that might be susceptible to a hack. Whether it be a central point of failure with BitGo or a smart contract mishap with Keep's tBTC, there are many attack vectors that could lead to a hack and to massive losses for users. It is almost impossible to code error free, particularly if one has to take into account future developments of the protocol.
In trusting these third parties, one's bitcoin is not fully secured. Those who hold tokenized bitcoin do not actually hold the underlying asset, nor do they transact on the Bitcoin network. Rather, they hold tokens that are backed 1:1 by the centralized (or decentralized) entity who administers the tokenized asset on blockchains like Ethereum or Polkadot.
Liquidity Risk
Liquidity is crucial for efficient pricing in the financial industry. Currently, liquidity in digital asset protocols is largely outpaced by central alternatives with many low fee liquidity providers that stabilize traditional finance. In times of crisis, the network becomes congested so much that arbitrageurs and liquidity providers maintain prices across venues, causing massive dislocation on individual exchanges — thus triggers uncertainty and the markets drop. This dip in price can affect protocols like Synthetix (sBTC) where users must partake in overcollateralized loans. In other words, to loan an amount that is less than what one has for in the event of a default, the lender will be able to liquidate and get their funds back.
Regulation Risk
Decentralized projects (often) operate without a license in most jurisdictions, regardless of where the end-user is based. Like their digital counterparts, the taxation and handling of tokenized assets is not clearly outlined in most jurisdictions. And assets that fall under the DeFi umbrella will certainly experience stronger scrutiny given that the user base and locked in assets are subject to further growth. It is not too far off to think that financial regulation might require some kind of responsible counterparty which makes truly decentralized governance and decision making process not yet imaginable.
In the Bitcoin ecosystem, it is often debated whether another executive order 6102 could happen with Bitcoin. If given the choice of actually owning the private keys or trusting a third party with them, one would assume we would all obviously choose to own the actual Bitcoin. It is much easier to hide and more difficult to confiscate. Remember not your keys, not your Bitcoin.
The Big Picture
It is no secret that tokenized BTC can usher in a new dynamic to the greater DeFi ecosystem. However, as there are tradeoffs with anything, users who decide to take the plunge and transact with it are doing so at the cost of security. As Jameson Lopp said earlier in the year, "There's owning BTC and there's owning promises of BTC. Some promises are stronger than others". Though I'm a proponent for cross-chain composability (see here), the current iterations still don't do it for me. In times of volatility, DeFi can be very fragile and the system's leverage can be unwound rather quickly. Wrapping sound money in unsound infrastructure is a recipe for disaster. Ultimately, synthetic Bitcoin like wBTC and renBTC have price but not the fundamentals. Can this change in the future? Yes, I think tBTC is a great start but if there is no control of your private keys then you are giving up your right to the hard, self-sovereign aspect of Bitcoin. I understand that not everyone wants the responsibility in holding their own money, but for those who do there is Bitcoin.
News 📰
The top announcements in Bitcoin. All in one place.
Three Iranian Power Plants Plan to Sell Electricity to Crypto Miners
Unchained Capital Announces Advanced Multisig Business Accounts
Lightning Node Firewall Circuitbreaker Announced
Coinbase Announces Rosetta-Bitcoin API Implementation
Venezuela Government Requiring All Bitcoin Miners to Join National Mining Pool
Square Crypto Launches Web Portal
New Whirlpool Fee Calculator Launched
Market Watch 💸
One-stop-shop Bitcoin market & network snapshot.
What I'm Reading 📕
Scowered the internet so you didn’t have to.
Bitcoin Optech Newsletter #116
Citadel's Sharpe is Uniswap's Opportunity
How to Pay for Bitcoin Development
What I'm Listening To 🔊
Give your eyes a break and pop in the earbuds.
The Hidden Truths of DeFi & Tokenized Bitcoin
Billions of Bitcoin on Ethereum
Why a Currency Devaluation is Likely with Lyn Alden
'Accommodative' Monetary Policy & Risks to Central Bank Independence
Alex Bosworth Talks Routing Nodes
Dispelling FUD: Questions about DeFi Favorites
Designing a Culture of Reinvention
Can Bitcoin in Custody Be Insured?
Gas Wars: Understanding Ethereum's Mempool & Miner Extractable Value
Why Every Company Will Be a Fintech Company
What I'm Watching 📺
Take a break from Netflix and check these out.
Raoul Pal and Vijay Boyapati on Swan Signal
Housekeeping 🏡
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Final Quote 🎩
Thanks for reading. Send me tips, stories I’ve missed, or comment below. And if you liked this piece, you can sign up here for more issues of the Bit Economy, a newsletter on something bitcoin related.
Until then, have a great week! See you next Sunday.