A Beginner’s Guide to Bitcoin Covenants

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If you are an avid crypto learner, then you already know everything there is to know about Bitcoin. How digital transactions take place, how it has changed blockchain technology and the digital world of finance, and everything in between. But there are some restricted aspects of Bitcoin that are not that common, and you can only bump into these should you care to explore more about them; one such aspect is the Bitcoin Covenant.

What are Covenants?

Think of a covenant as a patent that gives exclusive rights to the ownership of a certain object to the person who has initially filed the patent. In that instance, the covenant is exactly the same as a patent, but if we go to its exclusive definition, then a covenant is used within the private property law for the sake of restricting the very use of the object that it identifies or connects with.

This approach might seem a bit restrictive at first, but it is a necessary evil because no one could be given access to the source code of Bitcoin, for they can change it, edit it or modify it according to their own will.

Introduction to Bitcoin Covenants

Now you might be thinking that how does the assortment of a covenant comply with Bitcoin, which is a decentralized cryptocurrency and has no ties with any organization, person, or government? Since Bitcoin is a collection of computer code and various binary algorithms, some kind of restrictions were necessary to be imposed on its functioning and access so that no user could modify or change the source code and turn it into something completely different than what it presently is.

Bitcoin is private property, and the term covenant actually uplifts the momentum as well as the depiction of what Bitcoin is trying to do here. You do have access to your crypto tokens, such as Bitcoin tokens, and you do own them but in a restrictive capacity. What you can do with it is limited because of this covenant approach that was imposed on Bitcoin since its development.

A Bitcoin covenant can provide you with clear-cut instructions on how you can spend the token, places that this token can be spent on and things that you can buy with it, and how this can be transferred from one place to another. Sounds a bit restrictive, doesn’t it? Sure it does, but that is a Bitcoin covenant for you.

If you’re having a hard time trying to understand what is the purpose of this Bitcoin covenant and why it was imposed on you, then all you need to do is to look into a real-world example, and that will make you understand why. The Bitcoin covenant restrictions are the same as the restrictions some banks might impose on the accounts of their users based on their engagement with illicit activities on the Internet such as buying stuff that is illegal or engaging in money laundering or some other vile activity.

It has been established before by crypto analysts and people who deeply understand the value and significance of decentralization that Bitcoin covenants can actually help in upgrading the overall infrastructure of Bitcoin. But it doesn’t take away the fact that these are extremely difficult to implement and could raise controversy over the functionality of the cryptocurrency as well as the censorship-resistant property that the user is holding. For this matter alone, the inclusion of these restrictions was not seriously considered for a very long time.

Improving Bitcoin Through Covenants

Since Bitcoin is a decentralized entity which means that everything that you do with it is anonymous, it can’t be traced, and anything that is remotely associated with your identity would be redacted in any transaction that you make on the blockchain Ledger. Therefore many people have used it for all kinds of illicit purposes, they have used it to purchase illegal items off of the black market, and they have used it for money laundering and other illicit activities as well.

This begs the requirement of placing a covenant on Bitcoin for specific users who occasionally engage in these kinds of activities. With this element in implementation, Bitcoin can be improved as an asset where these covenants would propose different changes to the overall consensus protocol of Bitcoin.

Covenants can be included within the Bitcoin improvement proposal, which is a generalized proposal being reviewed and orchestrated by multiple miners on the blockchain as they continue to add suggestions to improve the functionality of Bitcoin, and when consensus is reached on one of these suggestions, that particular element is made part of Bitcoin’s protocol. Bitcoin improvement controls help the cryptocurrency to be able to modify and resolve advanced issues pertaining to its usability, security as well as scalability.

What Do These Covenants Do?

Think of these covenants as smart contracts which are viable for Ether and other such platforms, but Bitcoin makes use of covenants. These covenants, when embedded into a particular Bitcoin script, would prevent even an authorized user from spending these tokens on some other specific script. They explain modifications that are being commenced through them with the help of smart contracts on how to proceed with a situation when certain conditions are met; when these conditions have been approved, the code within the covenant would be executed on its own, much like a smart contract.

Use Cases of Governance

When Bitcoin covenants are made part of a specific user’s wallet, it means that they can’t spend their Bitcoin tokens without the approval of the code that is taking over the usability of the tokens in the first place. These might have their own disadvantages, but when it comes to use cases, there are plenty.

First of all, with the help of these Bitcoin contracts, the funds of the users could be stopped from being robbed or hacked in a cyber-criminal activity which can ultimately help scale the Bitcoin network and make it less permeable to allow these kinds of hacks because these have already been screened through the Bitcoin covenants and have been added into the Bitcoin code. Think of it as an antivirus, always looking for leaks or possible points of intersects where a breach could take place.

With the help of these covenants, multiple other applications could be extracted from bitcoin, such as scaling up the Bitcoin transaction capacity, which means that the throughput would increase while, at the same time, more and more transactions could be validated and authenticated in real-time. Other than that, congestion control and trust minimized loans could be applicable or given out by applying Bitcoin covenant on the tokens that are being given away to a person as a loan.

It means that when that person is trying to spend those tokens on something that was not agreed upon during the loan application, the covenants would act as a restriction and would not allow that specific person to spend their tokens on something that was not part of the contract. This kind of safeguards the lender and alarms them ahead of the way so they can rescue their funds from the receiver of the loan and end the contract right then and there rather than taking a heavy loss.

Use of Covenants in the CTV Code

Toying with the concept of covenants, Jeremy Rubin came up with a  Bitcoin Investment Proposal, which posed a change within the code of bitcoin. In the light of this change, Bitcoin was to be using a new operation code which was introduced as a CTV covenant. This CTV has been immensely helpful as it has implemented congestion control transactions within the Bitcoin network.

Whenever there is a rise in the overall transaction traffic, the fee factor continues to rise at the same rate, which means that if there is a huge tide of unconfirmed transactions, then the new ones would have to pay a lofty fee to even get the attention of the miners to validate their transactions.

With the help of the CTV code, large payment processors having tons of transactions pending approval within the Bitcoin infrastructure can include all of their payments within a single transaction for the sake of confirming these transaction packs through a single miner. It helps in saving block space and results in a cheaper execution of the transaction while at the same time not slowing down the process at all.

Working Mechanism of Bitcoin Covenants

To be able to understand the working of covenants, it is important that you take into account a normal bitcoin transaction. Whenever you have to transact Bitcoin from one wallet to another, you initiate a request to do so over the Bitcoin blockchain. There, your request is received, and upon verification by a miner, the respective funds are moved from your wallet address to the receiver’s wallet address.

And when the transaction is completed, a block is formed on the blockchain containing all the essential information for the transaction that just transpired, thus completing the transaction in its entirety. In this normal Bitcoin transaction, in the case of covenant Bitcoin transactions, your Bitcoin is protected with the help of a locking script, and the conditions for that script must be met if you want to use the tokens for whatever purposes.

Some of the examples include denial of service unless a signature of approval is seen from a conclusively regulatory body or from the authentic user carrying the private key, which should match the public key for the funds to be released. There might also be time locks that are exactly similar to covenants, and these indicate that tokens just can’t be spent until after a certain number of blocks have been created on the blockchain.

Normal vs. Covenant Bitcoin Transaction

In a normal Bitcoin transaction, only a few conditions need to be met for the sake of unlocking the funds and making them available for whatever purposes the user intends to use them. They might have to authenticate their private key with the public key or sign a regulatory form to make sure that it is the owner who is attempting to use the said tokens. In a covenant condition, you go a step further by getting restrictions on the token itself and things that you can do with it or where that particular token can be spent in general.

In another explanation to better ascertain the functioning of a covenant, you could say that a Bitcoin covenant is a mechanism that enforces certain conditions on how the control of the coins will be delegated from one person to another. Until unless those conditions are met, the coins can’t be used, can’t be spent, and have no worth at all.

A Bitcoin covenant contains a set of conditions proposed on an unspent transaction output that will define how coins could be spent, such as in what narrative, to buy what and where and the very place or market these coins can find value in. Suppose there is a crypto wallet out there containing Bitcoin tokens, and a Bitcoin covenant is placed on the wallet, which means that there are specific instructions handed over to the wallet, and the funds present can’t be taken away or withdrawn at any capacity until unless the conditions specified by the Bitcoin covenant are met.

Now what can be done here is that a few of the other wallet addresses which would be used in a receiving capacity could be added to the white list for that particular wallet on which a Bitcoin covenant has been placed. This way, the wallet would be able to transfer tokens to those addresses that are present within the white list, thus making things a bit easier for the end user.

Advantages of Bitcoin Covenants

You have been practicing leaning into tons of benefits when it comes to the idea of Bitcoin covenant throughout the extent of this article. The first and foremost benefit is that it doesn’t allow unprecedented expenditure of crypto tokens without the approval of the owner first. To improve the overall security profile of Bitcoin as a cryptocurrency but also as in blockchain technology and decentralized entity, developers are always banging their heads against walls to come up with new technologies that favor this very concept, and covenants can help to enhance this effect moving forward.

These can help in advancing the scalability of the overall Bitcoin platform in general, which means that there will be lesser processing times and faster processing and validation of transactions overall; if you choose to place a covenant on your Bitcoin tokens, you would have to meddle with the element of always authenticating every purchase that you make with your tokens, but on the bright side of things, you would be able to backtrack any hack or criminal activity that is conducted on it. And it would become harder for people to steal your tokens from you, and that is the most significant use case of the Bitcoin covenant.

Prevents Crypto Hacking Activities

Even if a hacker or a cyber criminal organization has gained access to your crypto funds and has the private keys on them, they would still not be able to have full control over your funds, thanks to a Bitcoin covenant placed on your wallet.

With the help of this mechanism, a time lock could be enforced on your funds as key deletion kicks into action, which means that a private key is no longer required to access the funds, but they would be available after a certain block has been minted on the blockchain giving you ample time to take the control back from whatever organization or hacker has exploited your tokens.

Prevents Double Spending Attacks

A restricting mechanism could be implemented by the covenants, which would prevent double spending attacks that are a nuisance within the Bitcoin territory. It will continue to update data in real-time both on the digital Ledger of the blockchain and on the primary network of Bitcoin as well making double spend attacks almost impossible. How can a token be spent twice or thrice when a record of it already being spent exists on the blockchain thanks to restrictions applied on the wallets of multiple Bitcoin users making the whole network more secure, increasing throughput, and improving latency along with the scalability of the Bitcoin network.

Drawbacks of Bitcoin Covenants

Although the benefits of this technology are huge, there are some drawbacks as well, such as tampering with the fungibility aspects of the network and the risks of censorship and confiscation. This means that governments would be able to take a look at every transaction that is being commenced under the reign of a covenant which kind of obliterates the purpose of having a decentralized network and lending anonymity to the end user. But despite the drawbacks, the functional aspects alone are enough to implement this system to its full capacity.


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