BitVM was criticized earlier this year for the large amount of liquidity required to allow a rollup or other system operator to process withdrawals from the two-way peg mechanisms built using BitVM’s design. GalaxyInvestor in Citrea, a leading cryptocurrency exchange, has carried out an economic analysis to determine the conditions that are required for a BitVM two-way peg to be a profitable operation.
For Pegging into the BitVM system, for those unfamiliar, requires operators to take custody user funds in a n-of-1 multisig. This creates pre-signed transaction sets that allow the operator facilitating the withdrawals to claim the funds back after a challenging period. The Users are then issued backed tokens on the second layer or rollup system.
Pegouts It is a little more complicated. The User must spend their money on a second layer system and then craft an Partially Signed Bitcoin Transaction (PSBT) pays them back on the mainchain minus a fee for the operator processing withdrawals. They You can keep creating new PSBTs, paying the operator higher prices until they accept. At this point the operator will take their own liquidity and pay out the user’s withdrawal.
The After the operator has processed withdrawals totaling the deposited UTXO amount, they can initiate a withdrawal from the BitVM System to make them whole. This Includes a challenge-response time period to protect against fraudulent activity. Galaxy Models are a 14 day time window. During Anyone who can prove that the operator has not been honoring the withdrawals made by all users during that time period can initiate the challenge. If The operator can’t prove that they processed all withdrawals correctly, so the connector input, (a special transaction entry required to use the pre-signed transaction) used to claim back their funds, will be destroyed, preventing them from recovering their funds.
Now that we’ve gotten through a mechanism refresher, let's look at what Galaxy Modeled: The economic viability of using such a peg.
There When determining if this system can be run profitably, a number variables must be taken into consideration. Transaction Fees, liquidity available and most importantly, the opportunity cost associated with devoting capital for processing withdrawals from BitVM peg. This The last one is crucial in order to be able to source the liquidity needed to manage the peg. If If liquidity providers can earn more money using their money in other ways, then they’re losing money by operating a BitVM.
All The system will not make sense if it is not profitable. I.e. To generate a profit. The Two references for competing interest rate Galaxy Look at what AaveDeFi is a protocol for operating on Ethereum, and OTC Markets Bitcoin.
Aave At the time of their report, lenders earned approximately 1% interest on WBTC.Wrapped Bitcoin Peg into Ethereum) lent out. OTC lending had rates up to 7.6% higher than Aave. This The expected return on investment between DeFi users versus institutional investors is vastly different. Users To attract capital from other systems, BitVM must generate revenues that are higher than these interest rates.
By Galaxy’s projections, as long as LPs are targeting a 10% Annual Percentage Yield (APY), should cost users -0.38% on a pegout transaction. The The only wildcard variable is the transaction fee that the operator must pay in high-fee environments. The The operator can claim the liquidity immediately after initiating pegout. However, the user funds must wait until the end of the two-week challenge to be reclaimed.
If If fees spiked in the meantime, it would reduce the operators’ profit margins once they claimed their funds from the BitVM peg. HoweverTheoretically operators could simply wait for the fees to subside and then initiate the challenge period. They would then be able to claim their money back.
Overall The viability of BitVM is dependent on the ability to generate a sufficient yield on the liquidity used to process withdrawals in order to attract the required capital. To To compete with OTC, these yields need to be higher to attract more institutional capital.
The Full-time Galaxy You can read the report here.
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