mBTC - A Decentralized Solution for Cross-chain BTC

The system may appear simple but is quite clever. First, when a user's $BTC is deposited by a merchant to the custodian, wBTC is issued to the user via smart contracts on the Ethereum network. This approach avoids double spending issues and ensures the scarcity of $BTC, thereby establishing the value of wBTC. Secondly, merchants are responsible for KYC processes, wBTC issuance, and collecting fees from customers. They can also attract more customers through the use of wBTC. BitGo, as the custodian, benefits from handling KYC and compliance requirements while gaining access to merchant channels, making it a win-win situation. However, the most significant issue lies in the fact that BitGo, as the wBTC issuer and the sole custodian of $BTC, also has the power to approve or reject merchant applications, which poses undeniable centralization risks.

Merlin Protocol's mBTC Solution

To address the centralization risks faced by wBTC, Merlin Protocol introduced mBTC and proposed a decentralized cross-chain BTC solution, aiming to resolve the centralization issues encountered by wBTC through decentralized cross-chain channel service providers.

Specifically, mBTC is similar to wBTC in the sense that it is issued on other networks as a proof of the user's ownership of $BTC on the Bitcoin network. However, the mBTC system combines the roles of merchants and custodians. These service providers, referred to as "cross-chain channel service providers" within the mBTC system, are responsible for issuing and redeeming mBTC while also safeguarding the $BTC collateralized by users on the Bitcoin network. Moreover, the entry barriers for cross-chain channel service providers differ from those of wBTC merchants. Becoming a cross-chain channel service provider for mBTC does not require permission, thus avoiding the centralized risk of single-entry permits.

When a user wants to purchase new mBTC, they can apply to any cross-chain channel service provider and collateralize their $BTC on the Bitcoin network. Once the service provider receives the user's $BTC, an equivalent amount of mBTC is issued and sent to the user's specified Ethereum address. Similarly, for redemption, users only need to perform the reverse operation. This design not only reduces the communication costs between merchants and custodians in the wBTC system but also resolves a series of centralization issues caused by a single custodian.

However, some may question whether this simply disperses the trust risk from a single custodian to multiple cross-chain channel service providers, with users ultimately bearing the risk of custodian default. When designing mBTC, this issue was taken into consideration, and a mechanism similar to a lending protocol's over-collateralization was proposed. Specifically, cross-chain channel service providers need to collateralize a portion of their assets on the Ethereum network as margin through mBTC smart contracts. Currently, supported collateral types include $ETH, $USDT, and $USDC. Based on the margin amount, the service provider receives an mBTC issuance limit worth two-thirds of the margin value. Additionally, as the mBTC limit is utilized, the service provider must maintain the margin value at 105% or higher of the issued mBTC value, taking into account changes in the margin and $ BTC prices. Failure to do so will result in the liquidation of the service provider's collateral assets on Ethereum to compensate for mBTC users' losses. To obtain real-time prices for the margin and $BTC, the mBTC system incorporates an oracle. To facilitate this, Merlin Protocol has joined the Chainlink BUILD program.

mBTC workflow. Source: Merlin Protocol

In order to incentivize more cross-chain channel service providers to join the mBTC system, when users redeem mBTC, the service providers can receive a 1.5% fee. By introducing economic incentives, the mBTC system is interconnected, achieving decentralized cross-chain BTC functionality. Additionally, mBTC redefines the production relations of cross-chain BTC business. It is not just a simple cross-chain tool but a decentralized system. It requires no maintenance from any individual, and each participant can spontaneously contribute to the operation of the mBTC system.

It is worth mentioning that with the development of Ethereum Layer-2, the demand for cross-chain BTC functionality on Layer-2 is also increasing. In the future, mBTC plans to gradually introduce cross-chain features from the Bitcoin network to Ethereum Layer-2s.

Closing Thoughts

After the release of wBTC in 2019, it coincided with the boom of various applications such as DeFi. The circulation of wBTC has continued to increase and currently accounts for 94% of cross-chain BTC on the Ethereum network. Although competitors like hBTC and imBTC emerged after wBTC, these solutions fundamentally have not escaped the operational mode of centralized custody and have failed to challenge the dominance of wBTC. Whether mBTC's decentralized solution can break through remains to be seen.