Weekly Gauge #73: Bitcoin DeFi
Wrapper or L2s
In 2018, DeFi on Ethereum was very small, with low liquidity and trading volumes. Kyber founders acknowledged Bitcoin liquidity as essential for growth and partnered with BitGo to create Wrapped Bitcoin (WBTC). They chose a centralized model for simplicity and trust, which was challenging but crucial for adoption. The community supported WBTC, leading it to become the dominant Bitcoin token on Ethereum. However, BitGo's recent custody changes plan have raised concerns about the trust and future stability of WBTC, which could impact its role in the DeFi ecosystem.
wBTC custody change
Recently, BitGo announced a significant change in the custody model for WBTC. The company plans to transition WBTC’s underlying Bitcoin to a multi-jurisdictional custody model through a joint venture with BiT Global. This move aims to diversify custodial operations across multiple jurisdictions, including Hong Kong and Singapore, enhancing both the security and global expansion potential of WBTC. While BitGo's announcement emphasizes that this upgrade will be frictionless and transparent to users, the involvement of BiT Global and its ties to Justin Sun has raised concerns. The DeFi community is particularly wary due to past issues with Sun’s projects, such as TUSD's questionable backing and the poor performance of his previous Bitcoin wrapper with Huobi, HBTC.
BitGo blogpost announcement : https://blog.bitgo.com/bitgo-to-move-wbtc-to-multi-jurisdictional-custody-to-accelerate-global-expansion-plan-2ea0623fa2c8
Maker reaction trigger
The concerns regarding WBTC's custody change were first raised on the MakerDAO forum by BA Labs, a risk management service provider for Maker. They pointed out the operational risks associated with the transition to multi-jurisdictional custody, particularly emphasizing the uncertainties introduced by BiT Global's involvement and its connection to Justin Sun. To mitigate these risks, BA Labs suggested drastic measures: reducing WBTC’s borrow cap and Loan-to-Value (LTV) ratio to zero, effectively closing new entries to the WBTC market on Maker.
https://forum.makerdao.com/t/wbtc-changes-and-risk-mitigation-10-august-2024/24844
However, these proposed measures were viewed by some as disproportionate, given the 60-day transition period before the custody changes would take effect. This delay provides ample time to assess the situation further, rather than implementing immediate and severe restrictions that could disrupt the DeFi ecosystem.
In contrast, AAVE’s reaction to the WBTC custody change has been more moderate. The AAVE governance forum discussion focused on maintaining capital efficiency and recognizing the significant size and revenue generated by the WBTC market, which contributes approximately $6 million in annualized revenue. AAVE emphasized the importance of carefully weighing the risks without rushing into decisions that could negatively impact the platform's operations.
Additionally, AAVE’s service provider, Llama Risk, conducted a thorough analysis of BiT Global, scrutinizing its custodial practices and the potential risks associated with the new custody model. Llama Risk’s research provided a detailed assessment of BiT Global’s operations, noting concerns about their practices, https://governance.aave.com/t/chaos-labs-wbtc-bitgo-custody-update/18607 “ the mere possession of a TCSP license does not provide assurance that BIT GLOBAL TRUST LIMITED has adopted best practices for digital asset custody, such as asset segregation and the utilization of cold storage solutions.”, but stopped short of recommending immediate, drastic actions like those proposed on the MakerDAO forum.
Overall, while MakerDAO’s response was swift and severe, AAVE took a more balanced approach, prioritizing capital efficiency and taking a data-driven approach to risk assessment.
AAVE governors answer to concerns:
The pending questions of which entity will serve as the major partner in BitGo's new joint venture and in which jurisdiction the WBTC collateral will be custodied will determine the future of wBTC on major lending platforms, which account for the vast majority of its utility in DeFi. The resolution of these legal uncertainties will significantly impact wBTC's continued dominance and trust within the ecosystem.
BTC collateral in DeFi
Amid the ongoing concerns surrounding wBTC's centralized management, particularly in the MakerDAO community, tBTC issued by Threshold could seize a significant opportunity, which the founders didn’t miss to highlight in Makers forum post’s comments. With Maker's wBTC debt market exceeding $150 million, any potential reduction in wBTC's dominance could open doors for tBTC, which boasts decentralized key management
3.1 wBTC vs tBTC pools
wBTC pools aren’t much incentivized by bribed incentives, nonetheless, its position into the Curve tricrypto base pools alongside with USDT, USDC and ETH makes wBTC one of the highest volume generating asset on the DEX with a higher APR to TVL ratio than other BTC wrappers;
tBTC pools are incentivized mainly through governance markets, on both Curve and Balancer ecosystems, aiming in general for around 2% APR on the deepest pools, up to 20% for the less liquid ones.
3.2 DeFi collateral
Bitcoin’s dominance in the market and its correlation with ETH make it an ideal collateral in DeFi protocols, note that this is also highlighted by the large difference in TVL between CEX or DEX trading pools, and lending markets. WBTC, with its established trust and liquidity ($9B), has become a key asset, representing 15% of AAVE’s supplied capital ($2.4B) and offering a Loan-to-Value (LTV) ratio of 74% on Maker. In contrast, tBTC offers a lower LTV on platforms like Silo (60%) but provides a more decentralized alternative for those wary of centralized custodianship.
https://x.com/SiloIntern/status/1805809841463771315
3.3 tBTC alternative
tBTC's permissionless nature offers a significant advantage over centralized alternatives like wBTC. This feature aligns with the core principles of DeFi, providing users with a more secure and trustless way to engage with Bitcoin on the Ethereum network.
tBTC has seen growing adoption within the Curve ecosystem, particularly with its integration to crvUSD collaterals. This adoption is bolstered by governance-driven incentives that reward liquidity providers and CRV/CVX token holders, offering APRs that range from 2% on the deepest pools to as high as 20% for less liquid pools. While tBTC presents an alternative to wBTC, it comes with certain limitations,notably in scalability due to the current relatively small number of nodes (around 137).
https://x.com/thesis_co/status/1822313014030143649
In conclusion, these developments could challenge the dominance of wBTC, especially if BiT Global legal uncertainties persist, opening the door for more decentralized options like tBTC to capture a larger share of the market.
The mid-term prospects for BTC in DeFi are promising, particularly with the development of BTC-native Layer 2 solutions like Stacks. The upcoming Nakamoto upgrade on Stacks, set to activate in August 2024, will significantly enhance BTC's utility by introducing sBTC, a decentralized and secure Bitcoin representation that can be leveraged in DeFi applications with faster transaction times. This could reduce the reliance on BTC wrappers like wBTC on Ethereum, potentially shifting some liquidity and activity to Bitcoin-native platforms, thus diversifying BTC's role in the DeFi ecosystem.
More detail on stacks & nakamoto upgrade: https://medium.com/@aspendigitalAMP/understanding-bitcoin-layer2s-and-stacks-nakamoto-upgrade-26c70e6eccbb#:~:text=In%20addition%2C%20the%20Nakamoto%20upgrade,to%20activate%20in%20August%202024.