On 9 August 2024, Bitgo, the company administering WBTC, announced a joint venture with BiT Global. The more than 153,000 Bitcoins in custody are secured by three keys, of which one will remain with BitGo Inc., one will go to BiT Global, and one will go to a newly formed entity, BitGo Singapore, Ltd.[1]
The new custody arrangement was introduced after widespread outcry over a Justin Sun-affiliated company’s de facto control over Bitcoin in custody.
This split will diversify jurisdictions to include Hong Kong and Singapore, compared with the current US-only solution. The joint venture includes a partnership with Justin Sun and the Tron ecosystem. The change in control will take place on 8 October 2024.
Compound V3 USDC Mainnet Market
The most significant advantages of V3 vs V2 markets was moving away from the pooled-risk model, which allowed users to borrow any asset but constantly rehypothecated collateral. This model was vulnerable to a single bad asset or oracle update draining all assets from the protocol. [2]
This means that we only need to consider the WBTC deposited into the USDC market as collateral.
USDC market stats from Compounds webpage. [3]
We can see the market has a 1.34x collateralization. Furthermore the website states that total assets borrowed are, as of 2024-08-28, $333m vs $702m supplied.
Collateral can be $COMP, $ETH, $LINK, $UNI, $WBTC and $wstETH. The screenshot below shows the current composition of deposited collateral:
$WBTC is making up 61% of the collateral in the USDC v3 market. [3]
$WBTC is by far the most supplied collateral on this market and has been assigned a CF of 80% and an LF of 85%.
$WBTC depeg risks for the Mainnet v3 USDC Market
WBTC is an extended ERC20 token representing Bitcoin on Ethereum, where 1 BTC equals 1 WBTC token. The entities involved are at least one custodian and multiple merchants. Currently, there is only one custodian, BitGo, and two more custodians are coming in as part of the joint venture with BitGlobal. [9]
Minting WBTC
If a merchant deposits BTC and it is locked at the custodian’s Bitcoin address, the corresponding amount of $WBTC tokens is minted (released) to the merchant.
Burning WBTC
When a merchant wants to convert $WBTC back into BTC, they place a burn request with the custodian. If the amount can be verified, the custodian sends the merchant the requested amount of BTC to their Bitcoin address.
We could not find legal agreements between merchants and BitGo. Documents refer to a vote on WBTC DAO that accepts and adds merchants to the system. Since merchants do not have control over minting and burning, there are no risks associated with that.
Instead, the sole authority and the singular choke point for minting and burning WBTC lies with the custodian, soon the custodians.
Many market participants were worried about WBTC’s future because they feared the collateral would either be drained by a malicious actor inside the new ownership or that one of the regulations would freeze or lay claim to the Bitcoin in custody.
For market participants, this would mean that the price of $WBTC would be diverted from the price of $BTC.
What would that mean for Reserve, especially for eUSD, which supplies USDC to compound?
Any vault whose value drops below the Liquidation Factor (LF) will have its collateral auctioned off, minus a penalty. $WBTC has a 5% liquidation penalty, an LF of 85%, and a collateral factor (CF) of 80%.
BlockAnalytica has modeled the results of various depeg scenarios on their excellent website [4]:
BlockAnalytica dashboard of CaR for $WBTC in the USDC v3 market [4]
As we can see, there are two major milestones that affect WBTC vaults on this market: A ~30% price drop, after which around 31% of the collateral is at risk, and a ~50% price drop when ~77% of the collateral is at risk. Anything below a 20% depeg would mean little capital is at risk.
This analysis is, of course, not representative of wider market conditions. In the event of malicious drains of collateral or regulatory action, any $WBTC holder would likely scramble for the exit, leading to widespread market contagion. In such events, as has been the case during the $TERRA/$LUNA collapse, auctions can become extremely costly in terms of gas and tend to be very inefficient.
It is beyond the scope of this research to guesstimate the effects of such a market turmoil. It would likely mean a significant amount of bad debt for Compound and other lending protocols, like Aave, where WBTC is 15% of all the capital deposited [1]. The v3 Mainnet USDC market has $9.76m of reserves at the time of this writing.
In Compound, the community decides how bad debt is handled. First, loss capital is the amount of reserves in the collateral type, followed by the market. Further losses can hypothetically be from reserves of other Comets, v2 markets, or assets sitting in the Timelock or v2 comptroller. Bad debt can not spread throughout monoliths, however.
Any excess bad debt assigned to the USDC market would mean a loss of capital for those who supplied USDC. Given that $WBTC is 61% vs. $333m borrowed, this could mean up to $193.4m of bad debt or a 58% loss of supplied capital.
This is the absolute worst case. However, if all WBTC collateral disappeared in an instant or markets entered a full frenzied stampede due to uncertainty and doubt, USDC markets would end up bearing the full brunt.
Practical considerations and next steps
The good news is that BitGo’s reserves are public and under intense scrutiny. This Dune dashboard [5] can be viewed by anyone and monitors the addresses holding the $BTC and supply of WBTC. Anything unusual can be checked and noticed.
So far, markets have appeared to be unfazed. Source Dune Analytics [5]
Furthermore, Aave, Compound, and Spark Lend risk providers are the best in the business and monitoring the situation. We recommend reading the respective forums and dashboards, especially follow-ups to these threads:
Another great resource is Compound’s market dashboard. [3]
We recommend monitoring the situation and will check the relevant news feeds ourselves. This will be especially relevant around 2024-10-08 when the ownership changes and in the weeks after that.
In pure business terms, Sun and BitGlobal would commit economic suicide or at least bring severe harm to themselves should they conduct $WBTC operations in a haphazard or unseemly manner.
Crypto has seen its fair share of unsubstantiated claims in the past, like the FUD around USDT, which has proven to be completely unfounded.
Nevertheless vigilance is better than sorrow, so we recommend keeping alert and will do our part to report any abrupt changes of custody.