What is sBTC? A Guide to Non-Custodial Native Bitcoin DeFi

Original title: "What is sBTC? A Guide to Non-custodial Native Bitcoin DeFi"

Original author: Su Xu, Xverse

Have you heard of the "Bitcoin Write Problem"? Without being too technical, it all comes down to Bitcoin's limited programmability. This is why we don't see the same type of DeFi applications on Bitcoin as on other chains. However, for a decentralized economy to work, users need to be able to swap, borrow, and earn yield on the assets they hold.

This limited programmability has led to the emergence of blockchains such as Ethereum, which offer more web3 functionality and custodial "wrapped Bitcoin" tokens that reflect the value of Bitcoin. However, compromises on security and reliance on centralized entities have led to countless hacks, bankruptcies, and billions of dollars in losses.

A solution is needed to go beyond the base layer to leverage Bitcoin. In this article, we explain why Web3 needs Bitcoin and introduce sBTC: a non-custodial Bitcoin peg that will become the backbone of decentralized finance.

Why Bitcoin for Web3?

The Bitcoin blockchain has never experienced a vulnerability or hack in 15 years of use and maintains a network value of over $1.2 trillion, four times that of Ethereum. Web3 requires the decentralization, security, and durability that only Bitcoin can provide.

Decentralization

Governance of Bitcoin rests in the hands of its holders, miners, node operators, and other network participants, with its rules encoded in its protocol. This decentralization was demonstrated when the Bitcoin community resisted changes to the protocol.

In contrast, Ethereum has a more centralized governance structure with a charismatic co-founder and influential entities who can make changes to the Ethereum blockchain and monetary policy. This includes rolling back already settled transactions. This flexibility allows for experimentation, but it also undermines the security and durability of blockchains, which are essential for building trust in public economic systems.

Security

Ethereum has transitioned from a Proof-of-Work (PoW) consensus mechanism to a Proof-of-Stake (PoS) mechanism to improve scalability. However, PoS has several fundamental problems that compromise security.

For example, whoever holds the tokens is also the one who validates the chain. This leads to a concentration of decision-making power and financial rewards in the hands of the wealthiest currency holders and relies on a measure of wealth that is determined internally rather than externally by the system. Since the largest holders will make decisions in their own favor, this could lead to further centralization - a situation whose long-term effects are unclear.

In contrast, Bitcoin’s proof-of-work mechanism, which relies on external resources to verify blocks and rewards users for honest verification, provides a secure, tamper-proof, and decentralized settlement layer that is valuable for a range of applications.

Durability

Bitcoin has a long history and is not easily changed, making it stable and reliable. Ethereum’s experimental spirit and frequent rule changes make it less reliable. The interconnectedness of Ethereum’s settlement and smart contract functions poses a challenge to ensuring the security of the system. In contrast, Bitcoin’s minimal and pure settlement layer is treated as sacrosanct, helping to ensure the stability of the system.

Bitcoin was designed to be the base layer for high-value settlement. Now it’s time to introduce more powerful and expressive smart contracts required by DeFi applications by adding layers.  

Stacks Bitcoin Layers

“Layers” can provide scalable web3 solutions.

We have seen the Ethereum layer bring about the entire decentralized application ecosystem and attract more capital and market value. Introducing layers for Bitcoin will also bring innovation and continued growth.

Currently, the number one project for Bitcoin Web3 is the Stacks Bitcoin layer launched in January 2021. Stacks extends the functionality of Bitcoin, leveraging the security of Bitcoin as an anchored base layer without making any changes to Bitcoin itself to provide smart contract functionality to support the development of decentralized finance (DeFi) and other Bitcoin-powered Web3 applications.

Proof of Transfer (PoX)

Using a unique consensus mechanism called Proof of Transfer (PoX), Stacks can read the Bitcoin chain state and anchor its own blocks to Bitcoin's Proof of Work (PoW). When Bitcoin forks, the Stacks layer forks as well, and has a built-in BTC price oracle: Stacks miners spend BTC to mine STX, and this spend rate is an excellent on-chain proxy for the BTC to STX price.

The advanced smart contracts needed to leverage Bitcoin’s security, capital, and network functionality are now possible without making any changes to Bitcoin itself.

Clear Language

Stacks uses the Clarity smart contract language, which is decidable and human-readable. Clarity gives developers a secure way to build complex smart contracts on Bitcoin, unlike Ethereum’s Turing-complete language, which cannot be formally verified and can lead to more undiscovered vulnerabilities.

Speed

Once the Nakamoto upgrade is complete, Stacks will receive a speed upgrade (up to 5 second block confirmation times) to help scale Bitcoin. One potential unlock is lightning-fast payments on the Stacks layer that benefit from Bitcoin finality. Additional layers built on top of it, called “subnets,” can further increase speed and scalability, enabling lightning-fast payments with Bitcoin finality.

sBTC: Bitcoin’s Web3 Holy Grail

Despite significant progress with Stacks, it is still not possible to transfer BTC in and out of smart contracts in a completely trustless manner. This has been Bitcoin’s “holy grail” problem for nearly a decade.

sBTC is a non-custodial form of pegged Bitcoin with 100% Bitcoin finality. sBTC will soon be available on the Stacks Bitcoin layer, enabling smart contracts on Bitcoin. Get ready for DeFi, NFTs, and DAOs that run entirely on Bitcoin, using Stacks as a stealth smart contract layer.

How does sBTC work?

sBTC works by using a synthetic asset model on Stacks. To obtain sBTC, users must redeem their BTC for sBTC through a smart contract on the Stacks network, without relying on a centralized entity.

This is achieved by using the PoX consensus mechanism that is connected to Bitcoin and facilitates sBTC’s novel trustless peg design. Additionally, since sBTC is a 1:1 Bitcoin-backed asset, sBTC holders can represent their BTC holdings as sBTC on the Stacks network.

This synthetic representation allows users to participate in DeFi activities, such as lending or trading, while still retaining ownership and earnings of their underlying Bitcoin. Additionally, users do not pay any fees when converting between BTC and sBTC, other than Bitcoin transaction fees.

If you need full programmability, sBTC is the closest thing to native BTC. It has all the benefits of Wrapped Bitcoin (wBTC) without any of the drawbacks of wBTC. You no longer need to trust a custodian to back the wrapped token and real Bitcoin 1:1 like you do with wBTC.

Here is a quick breakdown of the design of the peg mechanism, which is rooted in security, decentralization, and usability:

Peg-In

First, a user converts native BTC to sBTC on Stacks 1:1 by sending BTC to a native Bitcoin wallet. This wallet is controlled by a decentralized open membership group called “stackers” who lock STX tokens in Stacks’ PoX consensus mechanism. Through BTC rewards, stackers are financially incentivized to process pegs/outs through the capital they lock in Stacks and the rewards they earn.

These rewards provide them with a strong economic incentive to participate in pegs/outs without introducing additional peg fees. sBTC is then minted on the Stacks layer while still being secured by Bitcoin (because Stacks follows Bitcoin’s finality).

Source: sBTC White Paper

Transfer out of peg

To peg and redeem native BTC, users need to send a request to the staker, which is processed in the same way as BTC transactions.

Then, more than 70% of the stakers must collectively sign to destroy the sBTC and programmatically send the corresponding native BTC back to the user's BTC address. This process may take up to 24 hours.

Source: sBTC White Paper

sBTC is in the spirit of Bitcoin

The spirit of Bitcoin has always been to advocate self-custody.

"Bitcoin is a purely peer-to-peer electronic cash that allows online payments to be sent directly from one party to another without going through a financial institution." - Satoshi Nakamoto, 2008.

The sBTC white paper was written by the sBTC Working Group, which is open to the public and includes contributions from computer scientists at Princeton University, developers at the Stacks layer, and anonymous contributors.

In 2022, the failure of centralized entities such as FTX, Genesis, and Voyager caused users to lose more than $2 trillion. These failures demonstrate the importance of reaffirming the spirit of Bitcoin: creating a truly decentralized and transparent system.

sBTC builds on these foundational principles, solving the “Bitcoin write problem” and ushering in a new era of Bitcoin applications that can rapidly accelerate the Bitcoin economy.

sBTC is designed to be both decentralized and secure, especially when BTC is moved to another layer that supports smart contracts and decentralized applications (dApps).

The digital asset enables Bitcoin holders to maintain ownership of their BTC holdings and benefit from the security of Bitcoin, while also having access to the growing Bitcoin DeFi ecosystem.

Will stackers misbehave?

sBTC is trust-minimized and incentive-compatible: these properties are the same as the security of Bitcoin itself. The stacker group will be rewarded with BTC for processing sBTC transactions.

In addition, the threshold wallet is based on a 70% threshold. This means that more than 70% of stackers would have to collude in an economically irrational way to attempt an attack. If at least 30% of stackers are honest, then no malicious peg can occur.

In addition, there is a recovery mode where BTC rewards are used to satisfy peg requests. Therefore, native BTC is not "stuck". In addition, the process is fully transparent, so anyone can see on-chain how much BTC is in a wallet, and how much sBTC has been minted.

To ensure that the system remains incentive-compatible, the maximum "active" ratio of circulating sBTC is 50% of the total STX locked. If the maximum ratio is reached, no peg service will be provided until the ratio is restored. This means that even if the price of STX drops significantly relative to BTC, incentive compatibility will be preserved.

What is the Stacks Nakamoto Upgrade?

The Stacks Nakamoto upgrade is a hard fork of the Stacks Bitcoin layer that aims to unlock the full potential of Bitcoin by improving block creation speed, Maximum Extractable Value (MEV) vulnerability, and transaction finality on Stacks.  

- Faster block times: The Nakamoto upgrade decouples Stacks block production from Bitcoin block arrival times, allowing Stacks blocks to now be produced every 5 seconds.

- Finality: The Stacks network anchors its chain history to the Bitcoin chain history to ensure that transactions are irreversible. Additionally, Stackers monitor miner behavior on the network and make the final decision on whether to include a block in the chain.

- MEV Protection: The upgrade ensures fair distribution of rewards and avoids Maximum Extractable Value (MEV) manipulation. MEV refers to the profit gained by reordering transactions that have not yet been confirmed.

With the update, Stacks will become a more efficient and scalable layer for DeFi and Web3 on Bitcoin.

How the Satoshi Upgrade Paved the Way for sBTC

The Satoshi Upgrade introduced features to Stacks that cleared the way for the launch of sBTC by allowing trustless transfers from Bitcoin to sBTC on Stacks through a peg/peg mechanism managed by a group of decentralized actors, the sBTC signers.

The sBTC signers are stackers who lock the BTC sent to them by users in a multi-signature wallet and then mint sBTC on Stacks and send it to users.  

The Nakamoto upgrade also increases transaction speeds on the Stacks network, reducing settlement times from minutes to seconds. This makes sBTC faster and more efficient to deploy in DeFi protocols on Stacks.

In addition, the upgrade introduces an improved PoX consensus model that links the history of Stacks to the history of Bitcoin, so that in every new Bitcoin block, the state of the Stacks network is also recorded, making it impossible to change the history of the network without changing the history of Bitcoin.

In addition, stackers can also monitor miners' behavior and decide whether to add blocks to the chain, thereby enhancing the security of the Stacks network.

By providing a fast and more versatile infrastructure, the Nakamoto upgrade provides sBTC with everything Stacks needs to power DeFi and Web3 on the popular Bitcoin layer.

What's next for sBTC?

The introduction of sBTC will emphasize that Bitcoin is more than just a store of value. sBTC is built as a decentralized and secure digital asset that will expand the functionality of BTC.

In addition to launching on Stacks, sBTC will also be available on Aptos Network and Solana to further enhance Bitcoin’s role in the growing cross-chain DeFi ecosystem.

With sBTC, builders can realize the full potential of Bitcoin as a fully programmable asset, paving the way for the creation of Bitcoin-backed DeFi, non-fungible tokens (NFTs), and more.

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