Homecryptocurrency news

A quick guide on Bitcoin covenants and their importance

A quick guide on Bitcoin covenants and their importance

5 Min(s) Read

By CNBCTV18.com  IST (Published)

Mini

Bitcoin covenants are proposed extensions to the Bitcoin code that would enable people to hold certain control over BTC that's no longer with them. In simpler words, you could add restrictions to Bitcoins that you've transferred over to someone else. Find out more about their advantages, disadvantages, and the controversial debate surrounding them here-

Outside of computers and blockchain technology, covenants are extensions applied to contracts that dictate specific inclusions, restrictions, or rules that the new owner has to abide by. For instance, if a building is being sold, an applied covenant could dictate that the colour of the building can never be changed. If the colour is changed, it could mean a penalty or lapse of the contract.
In a more important context, an applied covenant also could dictate what happens to employees of a company upon a takeover from another company. This is used to protect the interests of employees who have been loyal to the company. In the Bitcoin setting, covenants aren't a reality yet, but they were part of the controversial Bitcoin Improvement Proposal 119 (BIP 119) that was presented by developer Jeremy Rubin earlier this year.
The founder(s) of Bitcoin created BIPs to empower the BTC community to peer-review and implement improvements, upgrades and fixes that could help Bitcoin become the world's currency.
In this article, we discuss what Bitcoin covenants are, their advantages and disadvantages, and the controversial debate surrounding them.
What are Bitcoin covenants?
Bitcoin covenants are proposed extensions to the Bitcoin code that would enable people to hold certain control over BTC that's no longer with them. In simpler words, you could add restrictions to Bitcoins that you've transferred over to someone else.
Currently, if you transfer any amount of Bitcoin to some wallet, by choice or by mistake, your ownership ends there. There is no way of getting it back or dictating what the Bitcoin needs to be spent on or used for.
With the proposed Bitcoin covenants, it would be possible for you to transfer Bitcoin to someone with some attached restrictions in the form of code. You could make it so that the amount of Bitcoin can only be transferred back to your wallet or that it has to be spent only after a certain amount of time or whatever rules you can imagine.
You could allow or block certain wallets as well. You can even use a covenant to act as escrow to hold on to a certain amount of BTC for a period of time before it is available for use.
As you can imagine, a drastic upgrade such as this can be a matter of great debate. Let's find out the possible advantages and disadvantages of Bitcoin covenants.
Advantages of Bitcoin covenants
Currently, the irreversible nature of Bitcoin means that if someone manages to steal your private code and transfers funds to their wallet, there is no way to get it back or find out who the wallet belongs to (which would still be the case after covenants).
However, with Bitcoin covenants, you have another layer of protection that would restrict the use of that amount of bitcoin. Simply put, if someone steals from you, you can choose where they spend their money and even make it so that they can only send the BTC back to you and nothing else.
The throughput and scalability that's been a long case of concern can also be improved with covenants. Multiple transactions can be clubbed together to take lesser block space through a covenant, this will reduce the time taken to process transactions and the gas fees as well.
Additionally, Bitcoin covenants increase Bitcoin's utility from just value transfer to something closer to smart contracts. You can set timelines for payments, have agreements within the payment mechanism, and even plug the transfer of Bitcoin based on fluctuating market prices.
Disadvantages of Bitcoin covenants
The major disadvantage of Bitcoin covenants is the loss of fungibility. This means that not all Bitcoins will be the same after adopting covenants. Bitcoins "untouched" by covenants will have greater value, creating complications when it comes to even a simple transfer of funds.
Covenants can be recursive — which means that the added covenant could go beyond one transaction and remain linked to the amount after the initial transaction. If, for instance, you add a covenant that dictates that 10 percent of the transfer amount gets back into your wallet, regardless of whoever sent it to you, it will get the entire amount back to you in a matter of 10 transactions. This leads to a further loss of fungibility.
Lastly, the mass adoption of Bitcoin depends on it being simple enough for common people to understand and use. While some think that Bitcoin is quite complicated already, covenants will take it to another level. Regardless of the efforts put in by the industry to bring Bitcoin to the people, covenants will extend the learning curve and could hinder mass adoption.
The ongoing debate
Bitcoin covenants aren't a reality yet because it takes a democratic process to implement any Bitcoin improvement proposal. For a controversial proposal such as this one, there are lobbies on both sides rallying with similar enthusiasm.
The ones who want covenants implemented think that the increased security will stop all the thefts and malpractices in the Bitcoin ecosystem and help the scalability of Bitcoin. The ones who are against it believe that it would destroy the big upsell of Bitcoin as the people's currency of the future with the loss of its fungibility.
As there is no timeline for implementing a Bitcoin improvement proposal, we will surely see more discussion and debate in the coming months and years on covenants and more disadvantages or use cases unearthed.
Check out our in-depth Market Coverage, Business News & get real-time Stock Market Updates on CNBC-TV18. Also, Watch our channels CNBC-TV18, CNBC Awaaz and CNBC Bajar Live on-the-go!