Clever new building block to boost growth in tBTC System

Blogpost written by Nahuus and Eastban.

Intro

In 2020, Keep Network brought us tBTC, first and only truly decentralized bridge between Bitcoin and Ethereum. The bridge enables Bitcoin holders to make use of all the new features of the Ethereum network whilst still keeping ownership of their original BTC asset and its most appreciated attributes.

The most important point here is decentralized. Why ?

Because in Bitcoin your money is yours. You control it absolutely through the application of digital signatures, and no one can censor it, no one can seize it, no one can freeze it. No one can tell you what to do or what not to do with your money.

It is therefore strange and concerning to see that so many Bitcoin was brought to Ethereum through centralized systems, through middlemen, through intermediaries, through custodians, based on… trust.

Because when you must trust someone in the middle, then you have counter-party risk: issuers can be hacked, seized or lose access to their BTC wallet.

tBTC — Decentralized Alternative

And fair enough, what alternatives were out there? As said, tBTC was launched in September 2020, and brought us this alternative. And the protocol has proven to work wonderfully ever since. This is also noted by the fact that demand far exceeds capacity. And that’s the number one challenge of tBTC v1… scalability. Due to the collateral requirements, the TVL has remained significantly lower than other centralized alternatives out there like WBTC and renBTC.

The Keep Team has been developing tBTC v2 since, and is now on short term releasing an essential new piece ‘coverage pools’. Coverage pools will both enhance tBTV v1 and be an essential part of the tBTC v2 protocol.

The new money-lego

The newly developed ‘money lego’ coverage pools is basically an insurance fund. Towards a tBTC user they form an insurance, to make sure in all events a user is made whole. Towards investors, coverage pools offer an interesting opportunity to earn rewards.

In tBTC v1, providing funds to the coverage pools will earn you rewards in the Keep Network native token ‘KEEP’. In tBTC v2, the 2nd revision of tBTC on which the team is working full steam, both KEEP rewards as well as network fees will be earned.

After adding funds to the pools you will receive ‘covTokens’, that represent your share of the coverage pool. Similar to an LP token when providing Liquidity on Uniswap. Besides representing ownership, it is planned to add these covTokens to other protocols as collateral to increase earnings on your funds.

Don’t miss more details in the original blog post.

What will coverage pools bring to tBTC System?

In short, they enable scalability. In v1 they allow lowering the collateralization thresholds, allowing increased tBTC volume per ETH collateral. Furthermore they’re reducing the potential costs and work of being a node operator / signer.

In v2 they allow a decoupling of being an active network participant by operating a node, or being a more passive participant by providing funds and earning rewards without active management.

Coverage Pools in tBTC v1

Coverage pools will act as a ‘buyer of last resort’ in the tBTC v1 liquidation auction. In principle this means there’s a guaranteed buyer for each auction, regardless of the c-ratio. This allows lowering the courtesy and liquidation thresholds from the current 115% and 110% to levels close to 100%.

This in turn reduces the loss for signers in an auction event, as there is less ETH $ put up for auction, hence the loss in auction and notifier fees go down significantly. There can even be cases where the signers are earning through an auction, in cases where the BTC they receive back is more valuable than their bond that was solved.

Above means less cost for signers in liquidation auctions, which means a liquidation is less of a big deal, less need & drive for it to be prevented. It’s this fact that allows to lower the start c-ratio from the current 200% to significantly lower values, and with this scaling the TVL of tBTV v1.

In summary: Coverage pools in tBTC v1 allow scaling TVL by lowering c-ratios while also reducing signer cost and work. More details on the economics will be shared by the team soon.

Coverage Pools in tBTC v2

tBTC v2 has several differences compared to tBTC v1. For example a signer group will be made up of 100 randomly selected nodes, instead of the 3 nodes it consists of today. Furthermore there will not be a wallet per deposit, but a wallet per interval, for example weekly or per pre-defined BTC quantity.

This signer group will be randomly selected out of a pool with >1000 nodes, and chances that a majority of malicious nodes (>51 out of a 100) is selected are very low. However, there is a chance, and for this the coverage pools were developed. Coverage pools are the insurance against fraud in tBTC v2. In case of a fraudulent event, the funds in the coverage pools will be used to make the tBTC users whole.

Due to the significantly reduced chance for fraud that is enabled by the design of tBTC v2, the collateral (coverage pools) can be significantly reduced. This is the enabler for scaling the tBTC TVL.

In summary: In tBTC v2 users are protected by the coverage pools, and people that provide funds to the coverage pools will be rewarded in network fees and network incentive rewards. Coverage pools allow the tBTC v2 TVL to significantly exceed the tBTC v1 TVL, since required collateral levels are drastically reduced.

Details: “Coverage Pools in tBTC v1”

In tBTC v1, each BTC deposit is backed by ETH collateral of 200% at start. This ETH is provided by a group 3 node operators, so called ‘signers’. This means that these signers, on top of the ability of being an active network participant, need to have a certain level of capital available. This will remain the case in v1, but will change in v2. However, coverage pools in v1 do allow to lower the collateral ratios.

Due to ETH-BTC ratio changes over time, the c-ratio of each deposit will change over time as well. In order to protect the user, the person who deposited BTC and minted TBTC, there are minimum thresholds for the c-ratio. In case a c-ratio of a deposit goes below these thresholds, a liquidation process is initiated. This liquidation process secures that this specific deposit is redeemed, and that there’s again a deposit with sufficient c-ratio backing the users BTC deposit.

In the liquidation process, signers in principal lose value. Part of it goes to the liquidation notifier (50% of remaining ETH bond), and part is directly lost in the auction itself. Therefore the signers want to prevent entering the liquidation phase. They do this by themselves redeeming the deposits they are backing, before these reach c-ratio threshold levels. This requires active monitoring, significant work but also results in cost and the need for back-up capital. Signers need to acquire the tBTC to redeem the deposit, and for this they pay fees and need to have the required funds.

The higher the c-ratio thresholds and c-ratio start levels are set, the higher the potential value loss in a liquidation event is. The c-ratio start level is currently set at 200%, with the goal of minimizing the amount of deposits ever reaching the liquidation thresholds The liquidation & courtesy call thresholds are set at 110% and 115%. The reason they are set at these levels is to prevent that a c-ratio will ever go below 100% during a liquidation auction, since this would shift the value loss risk from the signers to the user — BTC depositor. This is because an auction where the ETH that is put up for auction is worth less than the TBTC that is needed to buy it, is not economically interesting and will not be bought.

This is essentially what the coverage pool will change. The coverage pool will always buy the ETH bond in a liquidation auction. Any auction that is not yet bought once the 24 hours of the auction have passed, will be bought by the coverage pool regardless of the c-ratio. This can in fact mean that the signers receive a bonus, they receive more BTC in value than the ETH they lost.

This essentially also means that there is no risk for a user even if the c-ratio of his deposit goes below 100%. Because of this the liquidation and thresholds can be significantly lowered, to for example 101%, and with this significantly lowering the signer cost in case of a liquidation.

As the above example shows, lowering liquidation thresholds will significantly lower signer cost in case of auctions. Result of this is that signers do not have the same need to prevent liquidations anymore. This in turn allows the start c-ratio to be lowered from the current 200% → more BTC can be backed per ETH → scaling.

Soon we expect to have Coverage Pools added on Keep Network’s dApp and start earning fees and rewards with this new money-lego !

Want to know more ?

Join Discord.

Want to see the code ?

Coverage pools are being developed out in the open under an MIT license. Feel free to review the code, submit PRs, and add feature requests.

Entrepreneur. BI & Blockchain enthusiast.