In private property law, a covenant works as a contract to restrict how an asset is used, such as prohibiting construction expansion or altering the exterior color of a structure. The term covenant is the best approach to characterize limitations on transactional behavior, given that Bitcoin is a type of private property. Despite the land being yours, there could be limitations on what you can do with it.

In this article, let’s learn about Bitcoin covenants and how they work, along with some pros and cons.

About Bitcoin covenants

Bitcoin covenants are proposed additions to the Bitcoin code that would allow people to retain some control over BTC that is no longer theirs. To put it in another way, you might impose restrictions on Bitcoins that you have transferred to another person.

Whether on purpose or by accident, if you send any quantity of Bitcoin to a wallet, your ownership expires there. There is no way to get it back or to impose restrictions on how or for what Bitcoin should be used.

Thanks to the proposed Bitcoin covenants, you could transfer Bitcoin to someone with some defined restrictions in the form of code. You can impose restrictions on the use of Bitcoin, such as requiring that it be used only after a specified period or after being sent back to your wallet.

Additionally, you may allow or restrict particular wallets. You can even utilize a covenant to act as an escrow to hold onto a specific quantity of BTC for a while before it becomes accessible for use.

A significant upgrade like this can spark a lot of discussion (later on this). In the following section, let’s see some advantages and disadvantages of Bitcoin covenants.

Benefits of Bitcoin Covenants

The Bitcoin network has grappled with inherent challenges, notably the “Bitcoin Trilemma,” which suggests that a decentralized network can only excel in two of three aspects: decentralization, security, and scalability.

Covenants offer promising solutions to enhance security and scalability.

• Enhanced Security: Covenants empower users with greater control over asset transfers, reducing vulnerabilities to theft. They facilitate the creation of secure safety vaults, bolstering end-user protection.

• Pre-Signed Transactions: Bitcoin covenants enable the implementation of pre-signed transactions. This thwarts hackers as they require the wallet’s private key to gain complete control over assets.

• Mitigation of Double-Spending: Covenants play a pivotal role in preventing double-spending attacks, contributing to the network’s security.

• Support for Bitcoin-NG: Covenants align with the principles of Bitcoin-NG, a Byzantine fault-tolerant blockchain protocol designed to enhance scalability. Bitcoin-NG advocates anticipate its seamless integration as a layer atop the existing Bitcoin network, fostering scalability while preserving security.

Downsides of Bitcoin Covenants

While Bitcoin covenants propose notable improvements, potential pitfalls and community reservations linger. Here are the key downsides:

• Community Skepticism: Prominent figures in the Bitcoin community, including Adam Back, Jimmy Song, and Andreas Antonopoulos, have raised critical concerns about BIP119, the proposal for covenants. The proposal faces resistance within the community.

• Recursive Covenants: One apprehension is the possibility of recursive covenants, where one transaction’s restrictions lead to subsequent constraints, potentially resulting in an endless chain of covenants that could congest the network.

• Censorship and Centralization Risk: Covenants could introduce censorship, centralized control, and asset confiscation risks. They might compel exchange platforms to transact exclusively with specified wallets, potentially infringing user freedom.

• Privacy and Fungibility: The introduction of covenants may alter the fungibility of Bitcoin. Currently, all Bitcoins are identical, but covenants could differentiate individual BTC units, affecting the core fungibility principle of the crypto and potentially impacting user privacy.

While Bitcoin covenants offer enhanced security and utility, their adoption necessitates carefully considering and mitigating these concerns within the Bitcoin community.

How do Bitcoin covenants work?

To understand the workings of Bitcoin covenants, it’s essential to comprehend the mechanisms safeguarding a typical Bitcoin transaction.

A typical Bitcoin transaction relies on a protective script known as a “locking script.” This script comprises prerequisites that must be met for a transaction to be processed.

These conditions encompass various elements, including the requirement of a signature proving ownership of the corresponding private key and timelocks. Timelocks are akin to covenants and specify that coins can’t be spent until a specified number of blocks have elapsed.

In contrast to a standard Bitcoin script, which requires particular conditions for unlocking specific features (such as signing a transaction with a private key), covenants extend this process by introducing additional prerequisites.

A notable precondition introduced by covenants revolves around limiting a token’s functions. Bitcoin covenants empower developers to integrate and define fresh prerequisites for Bitcoin transactions, effectively enhancing transaction security and utility.

Conclusion: The ongoing debate

Bitcoin covenants are not yet a reality because any Bitcoin Improvement Proposal (BIP) must be implemented through a democratic process. There are lobby groups on both sides who are thrilled to support controversial proposals like this one.

The supporters of covenants believe that by implementing more security, they will be able to prohibit all fraud and theft in the Bitcoin ecosystem and improve Bitcoin’s scalability. With the loss of its fungibility, some are against it and believe it will undermine Bitcoin’s major pitch as the future people’s currency.

Since there is no timetable to implement a Bitcoin improvement proposal (BIP), covenants will undoubtedly be the subject of more discussion and debate in the upcoming months and years, as well as the discovery of more drawbacks or use cases.

Disclaimer: Cryptocurrency is not a legal tender and is currently unregulated. Kindly ensure that you undertake sufficient risk assessment when trading cryptocurrencies as they are often subject to high price volatility. The information provided in this section doesn't represent any investment advice or WazirX's official position. WazirX reserves the right in its sole discretion to amend or change this blog post at any time and for any reasons without prior notice.