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The Potential Dilemma of Bitcoin? Wrapped Bitcoin, ETFs Impacting Network Security

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The Potential Dilemma of Bitcoin? Wrapped Bitcoin, ETFs Impacting Network Security

Bitcoin has always supported miner income through block rewards and on-chain transaction fees to maintain network security. However, with the halving of block rewards and more bitcoins being custody by centralized institutions, it seems unlikely that on-chain transaction fees can completely replace block rewards in the future.

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The Potential Dilemma of Bitcoin

@DU09BTC's tweet analyzed the continuous dilution of Bitcoin mainnet fees, sparking widespread discussions in the crypto community.

1. Large Amounts of Wrapped Bitcoin Introduced

Currently, there are numerous wrapped Bitcoin products such as wBTC, cbBTC, tBTC, etc., where each time Bitcoin is converted into wrapped Bitcoin, it means these native Bitcoins will remain idle on the chain, no longer generating transaction fees.

These wrapped Bitcoins are transferred to other blockchains like Ethereum, diluting the value and liquidity of native Bitcoins on the network. With the growth of DeFi, more and more Bitcoin values are exported and become inactive on the original chain.

@DU09BTC pointed out:

With the development of DeFi, more and more BTC will be idle on the native chain because the value has been exported by wrapped Bitcoins. BitGo has wBTC, Coinbase has cbBTC, Kraken has kBTC, Threshold has tBTC. Do you think it stops here? What about in 10 years? There will be more!

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Illustration of Wrapped Bitcoin Custody

2. Concerns of ETFs and Third-Party Custody

With the approval of multiple Bitcoin ETFs, asset management institutions like BlackRock, Coinbase, etc., hold a significant amount of Bitcoin assets. However, these are not native Bitcoins but provided through indirect ownership via token holdings.

This means that even though ETF trading is active, the actual Bitcoin trading volume does not reflect on the native network. Such "value output" poses a potential threat to the security of the Bitcoin network.

Total Inflow of Bitcoin ETFs

3. Third-Party Custody Affecting Network Security

When Bitcoin is held in third-party custody, ownership is transferred to indirect holders. If these third parties fail to fulfill their commitments for specific reasons, asset holders will face risks, leading to reduced transactions on the Bitcoin network, directly impacting miner revenue, weakening overall security, and contradicting the original intent of Bitcoin.

The security of the Bitcoin mainnet primarily relies on the significant computational power provided by miners, who depend on block rewards and transaction fees for income. As more and more Bitcoins are held by third parties and external blockchains, it will compress Bitcoin miners' transaction fee income, ultimately causing profit-driven miners to leave and affect network security.

He asked:

If all the value of Bitcoin mainnet is exported, who will pay for Bitcoin network security? Ethereum? NASDAQ? They won't!

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Increasing Holdings of Centralized Institutions

How to Deal with It?

@DU09BTC mentioned that the above issues will not immediately manifest, in the future the Bitcoin block rewards will still be substantial for the next twenty years, but the demand for Bitcoin by third-party institutions will continue to increase. He suggested:

  1. Avoid holding Bitcoin through third parties: Hold Bitcoin on the chain yourself rather than through third parties.

  2. Applications like Ordinals contribute to miner income and are part of Bitcoin's future.

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Previously, early Bitcoin chief developer Gavin Andresen, who had close contact and collaboration with Satoshi Nakamoto, also envisioned a similar future. In 2021, he imagined that by 2061, the majority of Bitcoin transactions would not occur on the mainnet but would be locked in multi-signature outputs computed by multiple parties and run on another chain through wrapping.

By 2100, block rewards are nearing zero, and high-value transactions on the Bitcoin mainnet are mostly conducted among super whales in centralized exchanges, central banks, decentralized multi-signature addresses, with around 20 million Bitcoins circulating on other chains. These Bitcoins hold value due to their limited supply and Bitcoin being the world's first scarce digital asset.

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