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Restoring Faith in BTC in 2024: Let’s Start with Packaging
Below is a guest post by Aki Balogh, CEO and co-founder of DLC.Link
Bitcoin (BTC) entered 2023 with immense promise. While subject to natural ups and downs, its momentum suggested a maturing asset class ready for mainstream adoption. A year later, that promise has grown even stronger, particularly around the evolution of BTC ETFs. However, while the industry has seen a surge in cryptocurrency adoption, institutional investors remain hesitant and policymakers remain skeptical.
Building Trust
The industry is grappling with a fundamental question: How do we restore trust in BTC and cryptocurrencies? Originally designed to decentralize ownership and control, they have often centralized and pooled assets, often with disastrous results.
One critical area that requires a trust overhaul is wrapped Bitcoin. Designed to integrate BTC with other blockchains, wrapped Bitcoin (wBTC) offers undeniable utility in the liquidity of Bitcoin holdings, so it can be used for lending, staking, and investing. Simply put, wrapped BTC holders can leverage the features and benefits of DeFi without having to sell their BTC for ETH or other tokens. However, one glaring flaw, centralized custody, undermines the very purpose of wrapped BTC tokens.
Unlike traditional BTC, wrapped BTC allows people to use their BTC within different blockchain ecosystems (e.g. Ethereum or Solana), allowing the BTC owner to unlock their liquidity for use in financial transactions.
Opening up these benefits to new audiences fosters a greater sense of financial inclusion and attracts new people to the space. Overall, the success of Wrapped BTC may allow institutions to view the sector more positively.
The enigma of custody
However, wBTC has a glaring flaw in that it relies on a centralized custodian. Until recently, there was no way to wrap BTC for use in DeFi without introducing a centralized custodian. This custodian acts as a “trusted” third party responsible for safeguarding user funds, while also allowing compatibility between Bitcoin and any DeFi ecosystem it will be transferred to.
For example, to mint wrapped Bitcoins, BitGo (a US-based custodian) receives 1 BTC, stores it in its private vault, and issues a corresponding wrapped BTC to the owner, so they can move their BTC between chains and ecosystems.
Not surprisingly, there are a number of counterparty risks that can arise in cryptocurrencies when an entire ecosystem depends on a third party. If that custodian unlocks the BTC to someone else, maliciously or incorrectly, the underlying BTC is lost and the wrapped token becomes useless to the rightful owner.
As the value of BTC continues its predicted growth in 2024 (with some analysts suggesting it could peak in $150,000 by the end of 2025) users are becoming increasingly wary of this custodial risk. Imagine a scenario where your life savings, represented in wrapped BTC, disappear due to custodial failures, bad transactions, counterparty risk, seizure by governments/regulators, or embezzlement.
Not to mention that under current law, FDIC deposit insurance coverage does not apply to non-bank custodians, which includes most cryptocurrency companies that offer custodial services.
The Illusion of Innovation
There are many BTC wrapper options on the market, highlighting the demand that exists among BTC holders looking to bring their cryptocurrency to DeFi. The reality is that the vast majority of these options repurpose the same custody models and their inherent risks. In parallel, we have the rise of Bitcoin ‘Layer 2’ (L2) solutions that add another layer of complexity. These solutions entice users with high returns, often without adequately disclosing the underlying risks.
Here’s the truth: These L2s are not true second layers built on top of the Bitcoin blockchain itself, but rather sidechains, separate blockchains connected to Bitcoin. Connecting BTC to these sidechains exposes users to potential exploits and vulnerabilities that simply don’t exist on the secure Bitcoin network. Furthermore, the promised returns offered by these L2s are often unsustainable. They rely on complex incentive mechanisms that cannot be sustained in the long term.
The Path to Trust
In this environment of eroding trust, there is a solution that can ensure that users retain full control of their assets. Using discrete ledger contracts (DLCs) within Bitcoin, cryptocurrency traders can establish a theft-proof bridge to wrap Bitcoin. DLCs, native to Bitcoin, were invented by MIT academic and Lightning Network co-creator Tadge Dryja.
Unlike their custodial counterparts, DLC wrapped Bitcoin allows users to maintain complete self-custody of their BTC during the wrapping process with the support of a federated merchant network (similar to USDC’s design). This ensures the integrity of the wrapped tokens.
This federated model spreads risk across a broad pool of participants, significantly reducing reliance on a single entity, bringing decentralization back to Bitcoin. Just as the US dollar is backed by a diverse set of assets held by the Federal Reserve, wrapped BTC incorporating DLC is backed by a collective of merchants, eliminating the single point of failure inherent in custodial models.
The future is safe
We have seen Bitcoin withstand so many challenges so far and yet it continues to thrive, a testament to its strength. In my view, the future of Bitcoin is undoubtedly secure, especially with the introduction of self-wrapped BTC and the incorporation of DLC. These solutions, aligned with Bitcoin’s core value of self-custody, address a fundamental concern: centralized control over wrapped assets.
While wrapped Bitcoin has seen adoption, its current centralized model focuses risk and security on user control and a commitment to decentralization: Enter DLC. Imagine users holding the reins, wrapping and unwrapping their Bitcoin via secure, permissionless protocols. This promotes trust by empowering individuals, aligning perfectly with Bitcoin’s decentralized ethos.
Security, not the pursuit of yield or blind faith in untested solutions, should be the cornerstone of all financial technology. I believe that packaging solutions that empower users, not custodians, are the key to unlocking public trust. Widespread adoption depends on user trust.
By prioritizing security, user control, and responsible innovation, we can unlock Bitcoin’s true potential and completely revolutionize the financial landscape. Let 2024 be the year we move forward and rebuild trust in BTC, one secure shell at a time.