BitVM has recently come under scrutiny after the Taproot Wizards, Tyler and Rijndael, posted their criticism of the liquidity requirements imposed on the operator of a BitVM based two-way peg. The recent discussions have shed light on an issue that many people outside of the BitVM development community were not aware of.
The unique property of a BitVM peg, also known as bridges by altcoin developers, is that the operator must front their own liquidity to process user withdrawal requests. Unlike bridges built on other networks where funds held in the bridge contract are used to process withdrawals, in a BitVM peg, these funds are not accessible. The operator must use their own funds to fulfill withdrawal requests and then claim compensation from the BitVM contract.
The liquidity crunch issue arises from the combination of upfront liquidity requirements and the fraud-proof scheme that allows verifiers to revoke an operator’s access to funds if they fail to fulfill withdrawals. This poses a risk for operators who may run into liquidity problems and be unable to compensate themselves for the funds they have fronted.
Several potential solutions have been proposed to address the liquidity crunch issue, including throttling withdrawals, having multiple operators, implementing multiple linear operators, and establishing a backstop plan for the ultimate destination of funds in case of operator failure.
Despite the challenges posed by the liquidity crunch issue, the use of BitVM to secure a two-way peg is not considered fundamentally broken. Various implementation strategies can mitigate the risks and ensure the security of users’ funds. The rapid pace of development in this space highlights the importance of calm and informed discussions to address trade-offs and risks effectively.
