eBTC: ETH Native Synthetic BTC

# eBTC: ETH Native Synthetic BTC ## Abstract The key principle of Bitcoin is that the asset and the system securing it are trustless and censorship resistant. When bridging Bitcoin from it's native chain to an EVM chain like Ethereum, there is an extreme technical difficulty in cross chain communication which to this point has forced wrapped assets to compromise on these fundamental properties. The most popular BTC synthetic is wBTC, a custodial version of BTC, in which "merchants" will mint you wBTC tokens in exchange for your BTC. Other solutions like REN try to solve this with decentralized custodians secured using secure multiparty computing (sMPC) or tBTC which uses signer nodes collateralized with ETH. While these solutions have brought roughly $6.1b worth of BTC onto smart contract chains, that is only approximately 1.5% of all BTC in value. This paper will describe a BTC synthetic that is native to Ethereum, where you can maintain control of your tokens and collateral while having a trustless solution to utilize BTC in Decentralized Finance, as well as other opportunities this system creates. BTC and ETH both have the potential to be the largest financial instruments in the world, allowing for great potential in a completely immutable and censorship resistant protocol to finally offer a synthetic BTC on Ethereum with similar properties to native BTC. The ETH/BTC ratio is a widely tracked and high volume pairing as the two assets have been the largest in crypto for many years and currently ~70% of non-stablecoin cryptocurrency marketshare. Historically, the ETH/BTC pair goes long periods of time staying in tight ranges of <1% changes for months at a time and has had a nearly 3 year period of <3% changes. Compared to BTC/USD or ETH/USD, this is a relatively low volatility pairing and comes with the full benefits of decentralization. ## Current Landscape As of the writing of this paper, the main players are: ``` - wBTC: $5.265b Market Cap - hBTC: $826mm Market Cap - renBTC: $69.4mm Market Cap - sBTC: $14.3mm Market Cap ``` The nature of how these tokens collateralize the wrapped asset exposes them to inherent risks. These include custododial trust, censorship of transactions and/or regulation from government agencies. The protocols all attempt to do the same thing - bridge BTC to an EVM chain - which requires some form of custody. At best, this is an extension of multi signature wallets similar to REN's systems, but the default is to trust a known actor to handle storage and issuance. An alternative system is to overcollateralize the BTC synthetic with another asset, done completely on the destination chain. Synthetix does this with SNX backing sBTC, but this is a highly volatile asset and does not correlate well with BTC or USD. Because of this, it has a 400% collateral ratio, making it capitally inefficent to mint and use. The most liquid and highly correlated asset with BTC is ETH, having a 0.85 correlation coefficient over the past 1 year. This is higher than any other asset in the top 10 cryptocurrencies, and 0.31 higher than SNX. When contrasting ETH/BTC lending to ETH/USD lending, the value is even more apparent. Over 2022, average intraday volatility from Jan 1, 2022 to Sept 14, 2022 for ETH/BTC is +-3.61% with highest negative daily change being -6.66%. In this 257 day span there have been 20 days with >3% swings in price. ETH/USD pairings are much more volatile, with average intraday volatility being +-7.17% and the highest negative change being -15.88%. There are also an order of magnitude more volatile days, with 244/257 days having >3% swings in price. ## BTC in DeFi As of right now, the main use case for BTC in DeFi is collateral for lending or minting stablecoins. wBTC is the vast majority of the market and 26.53% of all wBTC is in Maker / Compound / Aave. APY for this supply is extremely low (0.13% on AAVE and 0.04% on Compound) but still attracts hundreds of millions in assets. These are some of the most reliable methods to creating a leveraged long position in DeFi but with the underlying volatility and being lumped in with other collateral options it becomes quite cost inefficient. Creation of a product like eBTC adds in a number of advantages to the current system. It creates a dedicated ETH/BTC lending market in which the users can participate in liquidations and be rewarded in ETH or BTC rather than token incentives. In doing so, it gives more usecases for both tokens in order to trade and leverage the ETH/BTC ratio in whichever direction you'd choose. It also ties the longevity of the asset to however long ETH is running. Without requiring external systems like custodians or wrapped assets, users can mint and redeem eBTC as long as Ethereum is functioning in a completely trustless and unstoppable system. It is also a way to trade regardless of market as the ETH/BTC ratio goes up and down in bull and bear markets. It's much more akin to trading something like forex than equities. ## Why is this necessary? Regulatory agencies have been cracking down on centrally issued stables and wrapped tokens, leaving a clear vulnerability for the entire DeFi space. As evidenced by the recent Tornado Cash blacklisting event and subsequent crackdowns by OFAC on a very broad range of accounts, relying on central actors exposes you to tangible regulatory risk of not being able to access your collateral for something as simple as exercising your right to privacy. The way to combat this is to build resilient systems which are censorship resistant, and then build value-add products and services on top of them. This will lead to a system which has removed the Achilles' heel of censorship and move everyone closer to the original vision of a decentralized financial system. Removing the need for trust when bringing BTC to DeFi also allows for more participants to enter into the system. Institutional sized investments can be made without needing to entrust their funds to an intermediary and professional traders can leverage the most liquid assets in the cryptocurrency market to play both bullish and bearish cases on ETH and BTC. ## Proposed System The proposed system of eBTC is to use ETH as the single asset to mint eBTC in a completely trustless and immutable set of smart contracts. Taking inspiration from the definition of [hyperstructure](https://jacob.energy/hyperstructures.html), the system should be a public good which can run forever without maintenance, interuptions or intermediaries. ETH as a single asset for minting BTC is ideal, it is highly correlated, extremely liquid and completely decentralized. This allows for a much tighter collateral ratio and a much more capitally efficient system for utilizing liquidity on chain to get access to BTC exposure. In order to have both sides of the ETH/BTC ratio covered, there also needs to be a way to use eBTC to rehypothecate the underlying collateral. A partner system should be available to post eBTC as collateral to borrow underlying ETH, while also having a liquidation module similar to the one Liquity has for LUSD. The key points of this system are: - Immutable smart contracts, no proxies or upgradables - ETH **only** as collateral - Permissionless and uncensorable - Zero human governance - Ability to borrow underlying collateral to go "long" on BTC/ETH How this is achieved can be attacked in multiple ways depending on the economic levers that would be pulled, target audience for minting / redeeming, timeline and complexity of the project. ## Potential Inspiration for Architecture There have been many attempts at fully on-chain systems to handle stable coins. We can use these as inspiration to build a similar system denominated in BTC. - [Liquity](https://docs.liquity.org/faq/general) - Liquity is a decentralized borrowing protocol that allows you to draw interest free loans against ETH used as collateral - [SAI](https://github.com/makerdao/sai) - A simple single-collateral stablecoin that is dependent on a trusted oracle address and has a kill-switch. Interesting to see if we can have this duplicated for mirrored markets (ETH as collateral to mint BTC, BTC for collateral to borrow collateralized ETH) - [SNX V3](https://github.com/Synthetixio/synthetix-v3) - Siloed version of synthetix allowing for explicitly defining collateral and output Not exact fits, but potential for inspiration: - [Ajna](https://www.ajna.finance/) - Oracle-less lending market developed by ex Maker contributors. Not launched yet, - [Rai / Reflexer](https://medium.com/reflexer-labs/stability-without-pegs-8c6a1cbc7fbd) - ETH backed stablecoin, not pegged to the USD but tracks an internal price based on market forces (not sure if this fits) Follw [this link](https://docs.google.com/document/d/1i5kd_atURF1wj66QP2gARYGsD89hatcLpimNI0fHb8Q) for more noodling on the dual collateralization model ## Growth Plan With eBTC being a primitive and ideally a hyperstructure, the things that will drive adoption are the things that can be built on top of it. Creating a truly trustless and unstoppable BTC synthetic allows Badger and other DAOs or entities to access the full suite of DeFi products available without needing to worry if the underlying value will be blocked by regulations or sanctions. Some initial thoughts of products or paths to growth could be: - Using eBTC as an instrument to go long on ETH/BTC ratio (ETH bull case) - Borrowing underlying collateral with eBTC to short the ETH/BTC ratio (BTC bull case) - Minting ETH against eBTC with no interest opens up a large array of ETH centric yield possibilities while retaining your exposure to BTC - Vault products which deposit in the liquidation modules and compound the rewards you get - Use badger influence to generate rewards on balancer / curve for pairing with eBTC to drive adoption - Pair badger with eBTC to give more censorship resistance - A FRAX type model built on top of eBTC to remove any potential regulation which would render the protocol useless