sBTC will be a game changer for Bitcoin applications. There are still some open questions with regards to its implementation. It would be great to surface these open questions for a community discussion and discuss the merits of different solutions.
For the uninitiated, sBTC is a decentralized two-way peg to use BTC in fully expressive smart contracts on the Stacks L2 layer. It’s pretty cool. If you haven’t read the whitepaper, I would recommend doing that first
Every sBTC will be 1-to-1 collateralised by BTC. The BTC on Bitcoin L1 is kept on a script controlled by an open group of threshold signers. These signers are the ‘stackers’ who lock STX capital in Stacks consensus and earn a BTC reward for performing the work of signing BTC peg out transactions. (STX is the native token of the Stacks L2, used for miner incentives and signer incentives). In addition to the 1-to-1 backing of sBTC with BTC, the current whitepaper proposes an additional >200% collateralisation ratio of STX to BTC.
A fixed collateralisation ratio of STX to BTC introduces a cap on the amount of sBTC that can be minted that can introduce bootstrapping challenges in the early stage of the network.
An example of a bootstrapping issue introduced by a cap on sBTC supply:
The primary use case of BTC in smart contracts is collateral. Users lock BTC to take out a loan against their BTC, allowing users to get liquidity without selling their precious BTC. I expect collateral to be the killer usecase for sBTC.
If a user would take out a USD loan against sBTC and BTC experiences a price drop, the user now needs to top up sBTC collateral. However, when BTC drops it’s likely that STX drops faster. As a result, there’s a non-trivial probability that the sBTC cap will be reached and the user would be unable to peg in fresh BTC to sBTC to top up their collateral → user gets liquidated.
It could be theoretically possible to use a soft cap where it gets more expensive to peg in BTC when the cap is reached (or financially rewarded to peg out), which helps solve the above mentioned potential liquidation issue.
Institutional users are most likely to have problems with a capped sBTC supply, since they would need to peg in/out in size to maintain their positions. For these institutional users, a CeFi loan against their BTC would offer a much better experience than using a capped version of sBTC (if sBTC is close to the cap), especially since large institutions can get a white glove service with CeFi companies (proof of no rehypothecation of collateral, etc).
In an ideal world, a theoretical best solution can be to allow for uncapped sBTC supply. In this case, sBTC would remain backed 1-to-1 with BTC at all times, yet there would be no cap on sBTC in circulation.
If users don’t trust the STX stakers, users can just peg out their sBTC when sBTC supply grows to a level that they’re uncomfortable with (vs stacked STX value). At the same time, for STX stackers to steal BTC from the peg wallet, they would still need to collude. If the signing threshold for processing peg outs is (say) 70%, then >70% of STX stakers would have to collude to steal the BTC. If large institutional players like custodians, exchanges, staking companies etc are part of the signer set then collusion only becomes possible in practice by getting these large custody providers, exchanges, and other large holders of STX to collude with each other. All of these players have reputational risk (and real threat of going to jail!) in addition to just the economic loss. There can be public dashboards to monitor the level of STX locked to sBTC ratio and users can transparently get this information through wallets and make their own decisions i.e., free markets at work.
For the community to make a decision on whether capped or uncapped sBTC supply is the way to go, it would make sense to see which signers will emerge for the sBTC consensus upgrade. If large professional entities like Coinbase Custody, Bitgo, Anchorage etc are signers (and hold more than 30% of the STX supply) then users know that these custodian/exchanges will need to collude with each other to break the system which is a highly improbable event in practice.
For now, it would be great to discuss this question of peg-collateralisation openly. It’s important for the community to be aware of this topic and surface all arguments for/against. Please share your thoughts below