What Are Bitcoin Covenants? A Guide to a Controversial Proposal

The proposal to implement Bitcoin covenants has spurred a fiery debate in the Bitcoin community, dividing people on the subject. On the one hand, many believe that covenants could make Bitcoin safer and more scalable. Conversely, others see it as an attack on the network’s decentralized, anonymous, and censorship-free nature.

While experts unravel the implications of covenants for Bitcoin, we look closer at the proposal and how it could work. This guide to Bitcoin covenants should help clear the air if you are new to the topic.

What Are Bitcoin Covenants?

This somewhat bizarre term comes from the private property law, where a covenant is a contract restricting a commodity’s use. For example, a landlord could insert covenants in the rent contract, preventing the tenant from painting the walls in specific colors, cutting trees in the yard, etc.

In cryptocurrency, a Bitcoin covenant is a mechanism limiting the selling options that a fresh BTC owner would have over his bitcoins. For instance, it could restrict where the user can transfer those assets and how he would spend them.

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Legally, Bitcoin is private property. However, even if you own BTC, certain covenants could limit how you use them. In traditional finance, banks impose covenants on particular merchants they suspect of participating in illegal activities. To this end, a Bitcoin covenant could prevent ill-intentioned users from using BTC for fraudulent operations.

Bitcoin is constantly developing and improving thanks to Bitcoin Improvement Proposals (BIPs), a standard method of promoting modifications to the Bitcoin protocol.

The concept of Bitcoin covenants first appeared in the somewhat controversial BIP119 as a soft fork. Their implementation could give BTC owners substantial benefits. For example, a covenant would prevent theft when a holder’s account is hacked.

BIP119 modifies Bitcoin’s code, enabling it to employ a new operation code (opcode), OP_CHECKTEMPLATEVERIFY (CTV-type covenant). However, it only includes a limited list of risky use cases in which the covenant would intervene. This CTV could have potential benefits for the Bitcoin network, such as increasing its scalability.

Nevertheless, implementing Bitcoin covenants is exceptionally tricky. The cryptocurrency’s resistance to censorship, external control, and 100% fungibility could prevent its fulfillment. Let’s dive deeper to see how that would pan out.

How Bitcoin Covenants Work

A Bitcoin covenant differs slightly from other restrictions the Bitcoin script language imposes. In fact, BTC holders already have to meet specific conditions and overcome limitations before completing a Bitcoin transfer. For example, a user must provide a signature confirming that the private key matches the public key of their wallet. Otherwise, they couldn’t transfer funds. Another limitation is the timelock, which could specify that coins cannot be spent until after a certain number of blocks. These conditions are part of the locking script protecting the Bitcoin network.

Covenants take these restrictions to the next level by specifying what users can do with their coins or where they can spend them. They also impose specific conditions on unspent transactions (UTXO), defining the coins’ expenditure purposes.

A BTC holder could impose a covenant on its wallet by limiting the whitelisted addresses to where the bitcoins can be spent. This way, if a hacker breaks the account, they can only send funds to those whitelisted wallets.

Benefits of Bitcoin Covenants

The Bitcoin network has struggled with various shortcomings since its early days. One is the “Bitcoin Trilemma,” the concept that a decentralized network can only provide two out of three benefits – decentralization, security, and scalability – at any time.

Covenants could help improve two of these factors, security, and scalability.

Firstly, covenants could help increase security by giving users more control over where they can transfer their assets. They could prevent theft and help implement safety vaults for enhanced end-user protection.

A Bitcoin covenant could also help holders implement pre-signed transactions. This means that hackers cannot gain complete control over their assets even if they steal and secure the wallet’s private key.

Lastly, covenants could help prevent double-spending attacks and improve Bitcoin-NG. The latter proposes a Byzantine fault-tolerant blockchain protocol that would increase the network’s scalability. Its supporters believe in Bitcoin-NG’s steady implementation as a layer over the current Bitcoin network.

Downsides of Bitcoin Covenants

While Bitcoin covenants seem like a good, maybe even necessary, improvement on paper, they did not win the community’s full support. On the contrary, the BIP119 proposal is withstanding staunch criticism from Bitcoin experts, such as Adam Back, Jimmy Song, and Andreas Antonopoulos.

The latter believes that this implementation would lead to recursive covenants. This concept refers to a programmer restricting one transaction after another, potentially leading to limitless consecutive covenants clogging the network.

Another potential downside to Bitcoin covenants is the risk of censorship, centralized control, and confiscation. Enhanced security is often why authorities choose to strengthen their control over people. In this case, a covenant could force exchange platforms to accept deposits or withdrawals only from specific wallets.

Currently, authorities can ask exchanges to send crypto assets only to addresses with taproots or government-controlled multi-sig wallets. However, a covenant could make it easier for them to obtain user data and KYC.

Bitcoin is a fungible asset. This means that each coin is identical in function and quality. Implementing covenants could change the properties of specific BTC units. This means that the cryptocurrency would not be fungible anymore, thus destroying one of the coin’s fundamental functioning conditions.

The Bottom Line

The fiery debate on Bitcoin covenants is likely to continue for many years to come. On the one hand, this concept could increase the network’s stability and help boost scalability. Furthermore, it would enhance the user’s safety and control over their assets.

Nevertheless, Bitcoin covenants can potentially negatively affect the coin and the network. Their opponents believe that implementing covenants goes against Bitcoin’s fundamentals. Countless restrictions could limit the coin’s decentralized, anonymous, and censorship-resistant nature.

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Picking sides in this debate is difficult. In the end, only the users and node operators will be able to reach a consensus on whether to implement Bitcoin covenants or not.