The following article discusses Wrapped Bitcoin (WBTC): What Wrapped Bitcoin is, why it’s used, how it works, its advantages, disadvantages, and security, Wrapped Bitcoin vs Bitcoin as well as other wrapped bitcoin alternatives.
Wrapped Bitcoin (WBTC)
A noteworthy invention called Wrapped Bitcoin (WBTC) aims to close the gap between the programmability of other blockchain systems, especially Ethereum, and the value of Bitcoin. It makes it possible for Bitcoin to operate inside the Ethereum network, opening up access to decentralized finance (DeFi) apps and services.
Definition
- An ERC-20 token that has the precise value of the asset it represents is called a wrapped Bitcoin. It implies that the value of WBTC can be set at a 1:1 ratio to Bitcoin or maintained at a constant value via a smart contract.
- A custodian maintains this 1:1 pegging by keeping an equivalent quantity of Bitcoin in reserve.
- Its value changes in tandem with the market price of Bitcoin.
Wrapped Bitcoin Purpose
Overcoming Blockchain Isolation
Different blockchains have different features and protocols, making communication difficult. Although this separation promotes security, it fragments liquidity, reducing Bitcoin’s ecosystem value. WBTC simplifies Ethereum and Bitcoin exchange communication.
Limited Smart Contract Functionality of Bitcoin
Bitcoin is inadequate for smart contracts or complicated decentralized systems because it prioritizes security over programmability. Ethereum provides automated financial services using smart contracts. WBTC lets Ethereum smart contracts use Bitcoin’s value.
Access to DeFi for Bitcoin Holders
Bitcoin holders can access DeFi through the Ethereum DeFi ecosystem, which provides services including yield farming, trading, and lending. Bitcoin owners were unable to take part prior to WBTC unless they converted their BTC. This is resolved by WBTC, which makes it possible to use Bitcoin’s value in Ethereum-based applications.
Liquidity Unlocked
The substantial unrealized liquidity of Bitcoin is represented by its substantial market capitalization. Both Bitcoin owners and the larger ecosystem gain from WBTC’s integration of this wealth into Ethereum’s DeFi network.
Faster and More Effective Transactions
WBTC makes use of Ethereum’s network, which often provides faster transaction confirmations (Ethereum’s block durations average about 12 seconds as opposed to Bitcoin’s 10-minute average) and, under some circumstances, more predictable or economical fees.
How Wrapped Bitcoin Works (Wrapping and Unwrapping Process)
Custodian procedure
After you deposit your Bitcoin with a reliable custodian, like BitGo, the cryptocurrency is locked in reserve. On the Ethereum network, you get WBTC in return.
Minting WBTC
WBTC tokens are minted by the custodian and are correlated 1:1 with the deposited Bitcoin. Institutions or traders wishing to convert sizable quantities of Bitcoin into WBTC for use in DeFi usually choose this method.
- WBTC may be burned or minting requests may be made by merchants.
- Sending Bitcoin to a reliable custodian is known as wrapping (BTC → WBTC). The custodian mints WBTC on Ethereum and transfers it to the user’s Ethereum wallet after safeguarding the Bitcoin. A KYC form and AML check are frequently required for new accounts.
- To unwrap (WBTC → BTC), users burn WBTC tokens, causing the custodian to restore the Bitcoin to their wallet.
- Verification and Transparency: Every WBTC in circulation is backed by publicly verifiable Bitcoin addresses, or proof of reserves, for system transparency. Independent checks verify reserves on both blockchains, which record minting and burning transactions.
- Users can purchase WBTC directly from merchants, although for convenience, the majority choose to convert BTC to WBTC using decentralized exchanges (DEXs).
Benefits of WBTC
- DeFi Accessibility: On websites like Compound or Aave, WBTC enables users to spend Bitcoin in a variety of DeFi activities.
- Lending and Borrowing: To earn interest or obtain assets, use WBTC as collateral on websites such as Aave or Compound.
- By providing WBTC liquidity for rewards, yield farming has the potential to outperform passive Bitcoin holding returns.
- Liquidity Provision: Contribute WBTC to liquidity pools on exchanges such as Uniswap to earn trading fees.
- Synthetic Assets: Mint assets that are secured by WBTC and linked to conventional markets.
- Staking: To receive network block rewards, lock up Bitcoin assets in a smart contract for a predetermined amount of time.
- Margin Trading: Use decentralized exchanges to trade Bitcoins on margin, or lend out WBTC for margin trading in order to receive fees.
- Improved Liquidity: By releasing Bitcoin’s market value, growing DeFi liquidity pools, and lowering transaction slippage, WBTC improves capital efficiency throughout Ethereum. Additionally, Bitcoin-backed assets provide reliable collateral choices for DeFi systems.
- Broader Utility: By allowing users to participate in sophisticated smart contract applications without having to sell Bitcoin, WBTC expands user possibilities beyond DeFi. By storing WBTC in shared wallets with other Ethereum assets, it facilitates composability (using WBTC across many protocols at once) and streamlines administration. Additionally, WBTC is usable in NFT marketplaces and blockchain games.
- Investment Options: Depending on their approach, investors can select from a variety of “wrapping models” offered by WBTC, including centralised, trustless, and synthetic assets.
Disadvantages of WBTC
- Custodial Risks: WBTC has a central point of failure since it depends on custodians (like BitGo) to store the underlying Bitcoin. Trusting these custodians to freeze assets and preserve money is crucial.
- Even after audits, Ethereum smart contracts, which WBTC uses, are prone to vulnerabilities and programming faults. Ethereum network problems like congestion and expensive petrol prices also have an impact on it.
- Price and Market Risks: WBTC keeps tabs on the price and volatility of Bitcoin. In volatile markets, large conversions may strain liquidity and trade above or below Bitcoin.
- WBTC management requires knowledge of both Ethereum and Bitcoin blockchains, which might be tough for novices. Slow WBTC-to-Bitcoin conversions (particularly for large transactions) and high Ethereum gas prices are other difficulties.
WBTC security
- WBTC tokens on Ethereum remain encrypted and secure due to blockchain technology.
- Smart contracts can stabilize Bitcoin’s asset values.
- A DAO with 17 stakeholders secures the Wrapped Bitcoin protocol.
Other Wrapped Bitcoin Alternatives
- Although WBTC is the most popular way to represent Bitcoin on Ethereum, there are additional options that employ other strategies to connect Bitcoin to other blockchains:
- Utilizing the decentralized network of nodes (RenVM) of the Ren Protocol, renBTC lessens dependency on a single custodian but is vulnerable to smart contract flaws.
- As a component of the Stacks protocol, sBTC (Stacks BTC) seeks to integrate smart contract functionality into Bitcoin using a two-way peg system that is trustless and protected by the Bitcoin network. The Stacks protocol is the only thing it covers.
- Other options are pBTC, HBTC, and tBTC.
What Is Wrapped Bitcoin vs Bitcoin?
- Wrapped Bitcoin (WBTC) or original Bitcoin depends on your blockchain ecosystem goals. Each Bitcoin version offers benefits depending on your goal. The comparison that follows will help you choose the best course of action in various situations.
- Use WBTC for trading on Ethereum-based DEXs (such as Uniswap, SushiSwap, and Curve Finance), taking part in DeFi (loan, borrowing, and yield farming), and for Ethereum developers who require Bitcoin’s liquidity. WBTC gives traders and DeFi consumers more useful options.
- Remain loyal to Bitcoin for: Peer-to-peer transactions on the native network of Bitcoin, maximizing security and decentralization, and long-term keeping as a store of value. Bitcoin is still the best option for long-term wealth preservation and security.
Difference between wrapped bitcoin and bitcoin
| Feature | Bitcoin (BTC) | Wrapped Bitcoin (WBTC) |
|---|---|---|
| Blockchain | Bitcoin blockchain | Ethereum blockchain (ERC-20 token) |
| Token Standard | Native cryptocurrency | ERC-20 token |
| Purpose | Peer-to-peer digital currency | Brings Bitcoin liquidity to Ethereum DeFi |
| Use Case | Store of value, transactions | Used in Ethereum DeFi apps (lending, yield farming, etc.) |
| Backing | Original asset | 1:1 backed by BTC held in reserve |
| Custodian | Not required (decentralized) | Central custodian holds BTC for minting WBTC |
| Smart Contract Support | No | Yes (runs on Ethereum, supports smart contracts) |
| Interoperability | Limited to Bitcoin ecosystem | Interacts with Ethereum-based DApps |
| Speed & Fees | Slower with higher fees (Bitcoin network) | Faster with lower fees (Ethereum, depending on gas fees) |
| Ticker Symbol | BTC | WBTC |
In conclusion, WBTC signifies a transition towards a network of interconnected blockchains that benefit from one other. Ethereum’s decentralized financing is now available to Bitcoin holders, increasing cryptocurrency interoperability.