A Comparative Analysis: Blockstream’s Liquid Bitcoin vs. Ethereum’s Wrapped Bitcoin

19 views 4:08 am 0 Comments June 20, 2023

In the face of rising transaction fees brought on by increased Bitcoin activity, many enthusiasts are looking for alternatives to mitigate these costs. Bitcoin Layer 2 options like the Lightning Network offer affordable transaction fees, but may not be suitable for Bitcoin holders wanting to transfer large quantities, given that many Lightning wallets require a third-party custodian for funds. The prospect of losing self-custody and the technical knowledge needed to maintain a significant balance on the Lightning Network can be quite daunting. As a result, some have sought out different paths.

Bitcoin users who employ a dollar-cost averaging (DCA) strategy often face the challenge of moving small quantities of bitcoin from exchanges to the blockchain. This action often results in a multitude of smaller unspent transaction outputs (UTXOs), which can complicate coin management and lead to larger fees when consolidating UTXO inputs for larger transactions. To counter this issue, alternatives with lower fees have come to the forefront.

Two such alternatives that have gained prominence for their potential to increase liquidity and functionality while theoretically reducing transaction fees are Blockstream’s Liquid Bitcoin (L-BTC) and the Ethereum-based ERC-20 token, Wrapped Bitcoin (WBTC). Let’s delve into their unique features, advantages, and disadvantages:

Blockstream’s Liquid Bitcoin (L-BTC):

  • L-BTC operates on the Liquid sidechain, an independent blockchain layered over the Bitcoin network.
  • A federated consensus model is used in Liquid, where a group of trusted entities authenticate transactions on the Liquid network.
  • L-BTC supports transactions across blockchains with other assets issued on the Liquid sidechain while offering enhanced privacy and confidentiality.

Key Advantages and Disadvantages of L-BTC:

  • Strengths of L-BTC: Quicker transaction confirmations due to reduced block times, enhanced privacy measures, compatibility with other assets on the Liquid sidechain, and the capacity to leverage Bitcoin’s liquidity in cross-chain transactions. Users in the network can operate their own node to validate proof-of-reserves and peg their Bitcoin into Liquid, thus eliminating the need for a federated third-party member. Acquiring L-BTC does not require KYC / AML procedures.
  • Weaknesses of L-BTC: Dependency on a federated consensus model, limited “decentralized” applications compared to Ethereum, and the necessity to trust in the functionaries. Users also need a federated third-party member to peg out from Liquid to the main chain.

Ethereum’s Wrapped Bitcoin (WBTC):

  • A joint initiative by Kyber, BitGo, and the now non-operational Republic Protocol (REN), WBTC is an ERC-20 token on the Ethereum blockchain. Ethereum’s smart contract functionality is utilized to securitize Bitcoin and issue WBTC tokens.
  • The governance of WBTC involves a decentralized autonomous organization (DAO), liquidity providers (merchants), a single custodian, BitGo, who manages the Bitcoin reserves, and token holders who participate in voting.
  • WBTC integrates seamlessly with the extensive Ethereum ecosystem, promoting easy interoperability with Ethereum-based decentralized applications (dApps) and smart contracts.

Key Advantages and Disadvantages of WBTC:

  • Strengths of WBTC: Integration with the extensive Ethereum ecosystem, a wide array of “decentralized” applications, decentralized governance involving multiple parties, and the ability to leverage Bitcoin’s liquidity within the Ethereum network.
  • Weaknesses of WBTC: Slower transaction confirmations and higher fees during Ethereum network congestion, dependence on a single entity for holding Bitcoin reserves, and the need to trust the custodian. In comparison to L-BTC, WBTC presents more uncertain counterparty risks due to less defined governance. Users cannot operate their own node, and peg ins and peg outs are solely dependent on WBTC merchants. Lastly, WBTC merchants are obligated to perform KYC / AML procedures to authenticate the user’s identity.

The key to understanding these platforms is to consider their reliance on trusted intermediaries and custodians for operations. Any failures in custody, governance, or regulatory compliance could endanger user funds or destabilize these systems. While there have been no major reported failures, it is important to recognize that these risks exist and prudence should be exercised when using either L-BTC or WBTC.

The tokenization of Bitcoin, as seen in L-BTC and WBTC, might be seen as a departure from Bitcoin’s original decentralized vision. Some Bitcoin users might argue that this undermines Bitcoin’s core principles and introduces additional risks and complexities. On the other hand, proponents may argue that tokenized Bitcoin enhances liquidity, scalability, and functionality, benefitting the ecosystem at large.

Both L-BTC and WBTC are alternatives that allow Bitcoin hodlers to access the benefits of other blockchain networks, such as faster transaction confirmations and integration with dApps. However, L-BTC offers lower fees, quicker confirmations, and improved scalability than WBTC. By leveraging the Liquid Network, L-BTC provides a more efficient and practical solution for Bitcoin hodlers, bypassing the limitations of WBTC on the Ethereum network. L-BTC, hence, emerges as a more compelling choice for Bitcoin hodlers seeking alternative low-fee options while preserving a direct connection to the Bitcoin network.