Concerns about BTC-pegged Ethereum tokens on the rise

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Written on May 25, 2020

Reading time 3 minutes

BTC-pegged ERC-20 tokens became very popular recently, especially with institutional investors.
However, Ethereum's Vitalik Buterin worries that they could inspire similar, but badly-designed projects.
There are risks tied to the way they operate, which could lead to centralization.

Bitcoin-pegged tokens on Ethereum network became quite a popular topic recently, but also a controversial one, as they caused a major split in the crypto community. Projects like these became quite popular with institutional investors, and one could argue that they drive adoption.

However, some members of the crypto community itself have significant concerns, especially when it comes to their consensus mechanisms.

One example is Wrapped Bitcoin (wBTC), which has been around since 2018. The project uses BitGo as a Proof-of-Reserve custodian. In essence, this is an ERC-20 token, which uses Bitcoin to maintain its value. Meanwhile, it provides simpler and faster cross-exchange transfers, which is one of its biggest use cases.

Details about wBTC

Originally, wBTC was adopted by different DEX projects, including the likes of Compound, as well as Dharma. It can also be exchanged through atomic swaps on Ren and Khyber Network.

As mentioned, its custodian is BitGo, which holds all BTC coins that are used for backing wBTC tokens. That way, a token gets the best from BTC and ETH networks.

Meanwhile, BitGo keeps the BTC storage quite transparent, as its security officer, Benedict Chan, noted at one point. Anyone can access a webpage that shows a list of all custodied BTC addresses, and compare the stored amount with the amount of circulating wBTC tokens.

All of this made wBTC tokens extremely popular, and only recently, reports even showed that the number of BTC locked in favour of wBTC exceeded the amount of BTC locked away in Lightning Network. Meanwhile, the interest from DeFi projects, such as MakerDAO, further added to the project’s popularity.

Earlier in May, the company issued 1,000 wBTC tokens, which allowed the token to exceed the amount of BTC on the Lightning Network.

Vitalik Buterin’s concern with BTC-pegged ERC-20 tokens

Despite the tokens’ popularity, there are still those who are concerned about them, such as Ethereum’s Vitalik Buterin.

Buterin expressed his concerns on Twitter, commenting on a tweet that noted that the amount of BTC on Ethereum grew to be 2.5x larger than on Blockstream.

I'm worried about the trust models of some of these tokens. It would be sad if there ends up being $5b of BTC on ethereum and the keys are held by a single institution.

— vitalik.eth (@VitalikButerin) May 21, 2020

Buterin did not specifically say that he is bothered by wBTC, nor BitGo, but he clearly feels discomfort when it comes to projects like these. He believes that their popularity could inspire similar projects that would be badly designed.

It happened with ICOs, after all, as well as with other projects that became very popular very quickly. While wBTC’s trust models are, in fact, verifiable, this could be a road towards centralization. There is also the issue of tokens relying on third-party custodians, which further increases the risk.