The Beginner's Guide: What is a Wrapped Bitcoin?
Wrapped Bitcoins (wBTC) are exactly what Bitcoin holders need for making the best of the DeFi revolution. You can use your wBTC tokens for liquidity mining, yield farming, and much more, on DeFi platforms.
So how can wrapped Bitcoins be used on the Ethereum platform? Can you use wrapped Bitcoins on the Binance platform? More importantly, how do I convert my Bitcoins to wrapped Bitcoins?
Well, that's what this article is all about. There are many advantages to converting your Bitcoins into Wrapped Bitcoins or wBTC tokens. So read on to learn all you need to know about the minting and burning of wrapped bitcoins.
Contents
- What is a Wrapped Bitcoin?
- Why “Wrap” Bitcoins?
- How is Bitcoin Converted to Wrapped Bitcoin?
- What is Minting and Burning of wBTC?
- Who Controls the Workings of wBTC Protocol?
- Advantages of Wrapped Bitcoin
- Other Wrapped Bitcoin Models
- The Way Ahead for Wrapped Bitcoin
- Before You Go
What is a Wrapped Bitcoin?
The simplest definition of a wrapped Bitcoin: It is an ERC-20 token on the Ethereum blockchain.
Wait, did I say Bitcoin on Ethereum? Aren’t they two different blockchains altogether?
Yes, that is correct. Bitcoin (BTC) is the crypto asset on the Bitcoin blockchain while ERC-20 tokens are the native tokens of the Ethereum blockchain.
- A wBTC token is built using the protocol standards of an ERC-20 token. So it can be used on the Ethereum blockchain.
- At the same time, wBTC represents Bitcoin (BTC) on a 1:1 basis. In simpler terms, one wrapped bitcoin is always equal to one bitcoin.
In other words, ‘wrapping’ a BTC converts it to a wBTC (an ERC-20 token). As an ERC-20 token, this wBTC can now be used on the Ethereum blockchain.
This raises another question! Are wrapped Bitcoins only for use on Ethereum blockchain? What about the Binance Blockchain?
The good news is that you can use the Binance Bridge to wrap your crypto assets (BTC, ETH, USDT, etc) in the form of BEP-20 tokens. Just like the ERC-20 tokens on Ethereum, BEP-20 tokens are the native tokens of the Binance Smart Chain (BSC)
Just like wrapped tokens on Ethereum, you can wrap Bitcoin and many other cryptos for use on the Binance Smart Chain (BSC). The Binance Bridge allows you to wrap your crypto assets (BTC, ETH, XRP, USDT, BCH, DOT, and many more) for use on the Binance Smart Chain in the form of BEP-20 tokens.
In this article, we’ll keep the focus on Wrapped Bitcoins (ERC-20 tokens) used on Ethereum.
Why “Wrap” Bitcoins?
But why would we want to wrap something as highly-priced as bitcoin and use it on the Ethereum blockchain? The answer is quite interesting.
As you know, digital currency is synonymous with Bitcoins. In fact, bitcoin is considered the original cryptocurrency, the first of its kind. Despite the thousands of cryptocurrencies that are available today, Bitcoins continue to enjoy supremacy in the crypto world. The market cap they possess is huge. It is indeed the most valuable and commonly held cryptocurrency in the world.
But they have one major drawback. Bitcoin may have ushered in the new dawn of blockchain technology. But that was more than a decade ago. Technology has evolved beyond imagination since then. By 2020, DeFi became the hottest trend in the crypto world. Unfortunately, the Bitcoin blockchain is not capable of introducing ‘Decentralized Finance’ (DeFi) concepts in its ecosystem.
Launched in 2015, Ethereum grew quickly to become the most actively used blockchain. When Ethereum introduced ‘Decentralized Finance’ (DeFi) and its products in their ecosystem, they became popular among crypto users. But bitcoin users missed the monetary benefits promised by DeFi.
wBTC was invented to bridge the interoperability between these two big blockchains, Bitcoin and Ethereum. The process is:
- Bitcoin (BTC) gets wrapped into wBTC.
- With wBTC, bitcoin users can get into the Ethereum blockchain.
- wBTC can take part in all types of transactions and reap the benefits of DeFi and its various products.
You can convert BTC to wBTC. You can also convert back wBTC to BTC any time you wish. This flexibility prompts the users to avail this service frequently in their transactions with ease.
How is a Bitcoin Converted to a Wrapped Bitcoin?
The process of creating a wrapped bitcoin from a bitcoin is known as wrapping.
Keep in mind that a wrapped Bitcoin is an ERC-20 token running on the Ethereum blockchain and that it represents a real bitcoin in a 1:1 ratio.
In the wrapping process, the bitcoin (BTC) is first deposited as collateral in one exchange. Once the process is completed, its equivalent (ERC-20) token is minted. Thus we can say that minting brings new wBTC to the market.
The parties involved in the wrapping process are:
1. The User - who wants to convert his Bitcoin (BTC) to wrapped bitcoin (wBTC).
2. The Merchant - the one who confirms user identity and authenticity before the minting takes place. Some of the major central and decentralized exchanges that act as merchants include Uniswap, Binance, OKEx, Huobi Global, and the Kyber Network.
3. The Custodian - the one who is responsible for the safe custody of the bitcoins deposited for conversion. When a ‘User ‘deposits his bitcoins for wrapping, the ‘Custodian’ stores it under his safe custody, and then mints the corresponding wBTC.
The Custodian also burns wBTC when the users need their BTC back. Custodians are responsible for maintaining the 1:1 ratio between BTC and wBTC. For wBTC, the only custodian is BitGo.
What is Minting and Burning of wBTC?
Let us now analyze the minting and burning processes in little more detail.
What is Minting wBTC?
Assume that you are a trader and you already have BTC in your wallet. You need wBTC to enter the DeFi market. The conversion of BTC to wBTC is known as minting wBTC.
The steps involved are:
1. Initiate request: You put in a request for a wrapped bitcoin to the merchant.
2. Complete KYC: Upon receiving the request, the merchant carries out a KYC (Know Your Customer) and AML (Anti-Money Laundering) process to confirm your identity and authenticity.
3. Merchant sends BTC to Custodian: Once KYC and AML are over, the merchant then sends BTC to the custodian and requests the custodian to mint wBTC equivalent to the bitcoin deposited.
4. Custodian Mints wBTC: The custodian receives the request and BTC from the merchant, waits for six confirmations, and then mints the equivalent wBTC (ERC-20 tokens), and then releases the newly minted ERC-20 token to the merchant’s address on the Ethereum wallet.
5. P2P Swapping: Now, you and the merchant have to do trade via a centralized exchange or a peer-to-peer transaction through a decentralized exchange. This peer-to-peer transaction is otherwise called atomic swapping. In this transaction, the merchant's minted wBTC gets swapped with your BTC.
6. wBTC is deposited in your Wallet: You now get the minted wBTC tokens that are equivalent to your deposited BTC, in your wallet.
These minted wBTC tokens can then be used in any of the DeFi platforms to enjoy a wide variety of money-making options such as yield farming, gaming, liquidity mining, lending or borrowing, token staking, obtaining governance tokens, etc.
What does Burning wBTC Mean?
Burning is the reverse process of minting. When you mint crypto tokens, you have created new tokens and these get added to the tokens in circulation. When you burn a crypto token, you have destroyed it - removed it from circulation permanently.
When you convert BTC to wBTC, the new wBTC tokens were freshly created or minted while the BTC is guarded safely by the Custodian. But when you convert your wBTC back to BTC, you get back your bitcoins, but the corresponding wBTC tokens are destroyed or ‘burned’.
The steps involved are:
1. Initiate request: You give a request to the merchant for reclaiming your BTC.
2. Merchant sends WBTC to Custodian: The merchant trades back your wBTC with the custodian for BTC.
3. Custodian releases BTC to Merchant: Custodian waits for 25 block confirmations on the Ethereum network upon releasing Bitcoin back to the Merchant.
4. The wBTC tokens are burned: The wBTC are deducted or burned from the merchant's Ethereum wallet, and this is called a burned transaction. It is done strictly with the merchant’s addresses after the burn transaction is initiated.
Who Controls the Workings of wBTC Protocol?
What if this Custodian doesn't burn the wBTC they get? Can they misuse it? Who controls all this? Why is BitGo the only custodian or how did Kyber Network become a wBTC merchant?
Well, did you know that these two were among the three masterminds behind the innovative idea of wrapping bitcoins? Here's a quick look at the creation and launching of wBTC and about who all controls the working of this protocol.
The wrapped bitcoin protocol was originally developed by a consortium of three partners, namely, BitGo Inc, Kyber Network, and Ren (previously known as Republic Protocol).
They first released a whitepaper detailing the protocol and its use-cases on January 24, 2019. By January 31, 2019, eight merchants started promoting the bitcoin-to-wBTC conversions marking the launch of wBTC tokens. After the initial launch, more merchants followed the suit.
- BitGo: BitGo is a trading company that acts as a custodian of digital assets. They are responsible for conducting regular audits to ensure additional security to the system. They also initiate ‘Proof of Reserve’ transactions which helps users to verify the validity of their bitcoin reserves.
- Kyber Network: They actively participated in the creation of wBTC. Kyber Network plays the role of a merchant in the project. If you do not understand the real meaning of a custodian or merchant, no need to worry. Please have a look at the below sections where I am explaining the concepts in detail.
- Ren: Ren is also relatively a new company that was founded in 2017. The main objective of Ren is to formulate cross-chain integrations of crypto assets and DeFi Apps.
A Decentralized Autonomous Organization (DAO) controls the working of the protocol behind wBTC. At present, the DAO committee has around 30 members. Each of these members has the voting power to make changes in the smart contracts on which the wrapped bitcoin system is built.
The public can view the minting of wBTC tokens on the Ethereum blockchain and the burning of wBTC tokens on the Bitcoin blockchain.
Advantages of Wrapped Bitcoins
So is it worth the effort of going behind wrapping bitcoins? Do wrapped bitcoins have any advantages? Let’s check them out.
1. Interoperability
The main objective of WBTC is to bring Bitcoin holders to DeFi platforms so that they can be part of some of the exciting financial opportunities available on the Ethereum blockchain.
Bitcoin is digital gold as it possesses the largest market cap. It indeed is a reliable and strong store of value. But the disadvantage of bitcoin is that it does not follow the ‘Turing model’ and is not programmable. Therefore the Bitcoin blockchain is not capable of providing exciting or innovative use cases to its users.
Meanwhile, the Ethereum blockchain is built in such a way that it is capable of building decentralized applications on its ecosystem. That is the reason why we see a vast majority of DeFi applications on the Ethereum blockchain.
The wrapped bitcoins bridge the gap between the two blockchains of Bitcoin and Ethereum, making them interoperable.
2. Shared Incentives
With the advent of wrapped bitcoins, chain-maximalism perspectives are blooming in the crypto space. Before the invention of wrapped tokens, bitcoin users could not enter the DeFi market. With wrapped bitcoins, bitcoin holders can participate in DeFi trades and earn interest on their DeFi investment without diminishing the value of their bitcoin holdings.
Thus the wrapped bitcoins have paved the way for shared incentives between Bitcoin and Ethereum blockchains. The wrapped tokens have rolled back maximalist notions of the Bitcoin blockchain. With increased network effects, the hassle and perceived risk of trading tokens out of the Bitcoin network got effectively reduced.
3. Speed
A significant advantage of wBTC is speed. Wrapped bitcoin transactions are quicker than bitcoin transactions because wBTC runs on the Ethereum blockchain.
The Ethereum blockchain can add a new block every 15 seconds. But BTC resides on the Bitcoin blockchain, which adds a new block only every ten minutes.
From this fact, it is evident that the movement of wBTC between Ethereum wallets, exchanges, and services is much faster than that of bitcoins. Another advantage is the shorter transaction waiting time in transferring BTC to Ethereum because the Ethereum network has comparatively higher throughput and block confirmation time.
4. Secure and Safe Transactions
wBTC publishes all on-chain transactions. Therefore it is possible to verify transactions on both Bitcoin and Ethereum networks.
If a user is so interested, he can independently audit how much of his BTC got sent to the WBTC address and double-check whether the transactions match the amount of WBTC tokens created on the Ethereum blockchain.
Smart contracts control the swapping of bitcoin with its token counterpart. Therefore the transactions are more secure. Security and safety in transactions encourage more bitcoin users to get hold of wrapped bitcoins.
5. Investment Opportunities
Tokenizing Bitcoin opened up new investment opportunities. The main advantage of tokenization is that bitcoin holders do not have to sell their bitcoins to buy other crypto tokens to participate in DeFi trades.
6. Trackable & Transparent
The bitcoin wrapping and reconversion processes are completely transparent and trackable. It is easy to find out the amount of wBTC in circulation.
All on-chain transactions are trackable, and a user can track them if required. Trackability of transactions reduces the scope of fraudulent transactions which increases the trust and reliability of the system.
7. High Influx of Liquidity
With wrapped bitcoins, bitcoin whales could enter DeFi markets. Once whales came into the picture, the liquidity and user base of the DeFi sector have increased immensely.
With a high flow of liquidity, bitcoin users can now stake in liquidity pools, participate in yield farming, get hold of governance tokens, lend or borrow crypto assets, participate in Initial coin Offerings, and so on.
With tokenized bitcoins, decentralized exchanges can support bitcoin trading pairs. The trading pairs resulted in high liquidity flow from bitcoin holders to liquidity pools in decentralized exchanges.
Other Wrapped Bitcoin Models
So far, we had discussed a centralized wBTC model, but interestingly, there are a couple of other wrapping models available. Let us have a quick look at them.
Though there are different wBTC models in use, each of them gives us the same output. They all convert a bitcoin to its token counterpart on the Ethereum blockchain. The three most popular wrapping protocols in use today are Centralized, Trustless, and Synthetic.
1. Centralized
We have already seen this strategy. In this strategy, a user has to rely on an intermediary to safehold his bitcoin. The user deposits his bitcoin with a centralized intermediary. They lock up the bitcoins in a smart contract and issue equivalent ERC-20 tokens to the user.
The only downside to this approach is that a user is dependent on the intermediary. In this method, the intermediary is the custodian of the deposited bitcoins.
2. Trustless
This doesn’t mean you can’t trust anyone, instead, it removes the question of trust altogether. In a trustless system, those involved do not need to know or trust each other.
This blockchain strategy is more advanced and decentralized. A prime example is the service of Keep Network. They offer the users wrapped bitcoins in the form of tBTC.
Unlike the centralized strategy, smart contracts keep the safe custody of deposited bitcoins here. The users' bitcoins are locked in smart contracts and without the consent of the user, the platform cannot do any adjustments on the bitcoin. This method is a trustless and autonomous system.
3. Synthetic Assets
'Synthetic Assets' is yet another model that is gaining popularity among traders. In this scheme, a user can lock his bitcoin in a smart contract and get hold of a synthetic asset with the equivalent value.
Here the BTC is not backed by the synthetic asset directly. The Synthetix exchange backs the synthetic assets with native tokens of the platform. One of the major players in this category is Synthetix Decentralized exchange (DEX). The wrapped token of the Synthetix DEX is known as sBTC, and the platform relies mainly on liquidity pools.
Wrapped tokens on Binance Smart Chain (BSC)
This article would be incomplete without a final mention of wrapped bitcoins on platforms other than the Ethereum network.
For Binance fans, the Binance Bridge Project increases interoperability between different blockchains. It allows you to convert your crypto assets (Bitcoin, USDT, ETH, etc) into Binance Chain and Binance Smart Chain wrapped tokens. You can also swap them back to your original crypto assets.
The Way Ahead for Wrapped Bitcoin
As per the current day statistics, no doubt wrapped assets have proved their worth. Have you ever wondered what might be the future that awaits wrapped bitcoins?
Considering the overall value and affordability of wrapped BTC, it is no wonder that developers are trying their level best to expand this concept. Already there is a high ongoing demand to introduce wBTC into more diverse and complex DeFi projects.
At present, the leader of the DeFi sector is the Ethereum blockchain. But this dominance is diminishing as more players are entering the field.
Very soon, you might be able to witness wBTC on other blockchains as well. As far as Ethereum is concerned, they might evolve into a full-fledged functional network to host complex DeFi concepts.
Before You Go
The concept of wBTC is going to stay here and gain more momentum shortly. Initially, no one wanted to trade bitcoins as they were always on an all-time high.
But wrapped bitcoins opened up an opportunity for bitcoin holders to receive passive income by participating in DeFi markets that too without losing the ownership of their dear bitcoins. Because of this reason, you can expect more traders in this space very soon.
The fact that wrapped bitcoins account for at least one-fourth of DeFi's market cap proves that wrapped bitcoins are a whopping success.
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