If you are familiar with decentralized finance (DeFi), you may have come across the term “wrapped tokens” or “Wrapped Bitcoin). Wrapped Bitcoin (WBTC) brings bitcoin (BTC) to the Ethereum blockchain. But why are they needed? Blockchains such as Bitcoin and Ethereum cannot interact with each other since they are built using different systems. This hinders the creation of an interoperable ecosystem where data and information can be exchanged seamlessly.
Wrapped tokens find significant application in DeFi, where the efficient, smooth, and quick transfer of funds is imperative. Newer blockchains are trying to overcome the interoperability issue, but earlier blockchains, such as Bitcoin and Ethereum, need a solution. This is where wrapped tokens such as Wrapped Bitcoin (WBTC) come into the picture. This article will take a closer look at WBTC and understand how it works.
What Are Wrapped Crypto Tokens?
Wrapped crypto tokens are cryptocurrencies that have their value pegged to other crypto assets or even traditional assets such as gold, stocks, shares, and even real estate. The original token is “wrapped,” and a new token is minted, which allows users to conduct transactions on other platforms. The beauty of wrapped tokens is that it enables non-native assets to be used on a blockchain, building bridges between siloed networks and improving interoperability.
Wrapped tokens can represent various assets ranging from commodities, stock, fiat currency, crypto assets, and even real estate. However, because these tokens are wrapped and pegged to other assets, they are managed by a custodian entity that wraps and unwraps the token. Wrapped Bitcoin was among the first wrapped tokens to be used on the Ethereum blockchain, allowing investors to earn a fixed income.
What Is Wrapped Bitcoin?
Wrapped Bitcoin was launched in 2019 by BitGo, Kyber Network, and Ren and was intended to turn BTC into an ERC20 and bring it over to the Ethereum network. WBTC acts as a bridge between Bitcoin and Ethereum, allowing bitcoin holders to access DeFi applications while allowing Ethereum-based applications access to greater liquidity.
Once WBTC is deposited in an Ethereum address, it can be used for various purposes on the network, such as savings, lending, and investment services.
How Does Wrapped Bitcoin Work?
Let’s understand how WBTC tokens work. However, before that, we must understand the creation and management of the WBTC protocol. Three players play a critical role in the management of the WBTC protocol.
- The WBTC DAO – The WBTC DAO, or Decentralized Autonomous Organization, comprises 17 members. These members are responsible for holding a multi-sig smart contract and also for adding or removing WBTC custodians and merchants.
- Merchants – Merchants send a certain amount of BTC to the custodian, triggering the minting process. They then request an equivalent amount in wrapped tokens, in this case, WBTC.
- Custodians – Custodians act as vaults, providing security and reliability to WBTC. They also ensure that all WBTC tokens are verified and fully backed through on-chain proof of reserves.
Users wishing to mint WBTC must deposit BTC and submit a request, following which the merchant transfers BTC to a custodian address. The BTC is locked, following which the custodian address mints the equivalent amount in WBTC (1:1 pegged to the value of BTC) on the Ethereum blockchain.
When users wish to convert the WBTC back to BTC, the WBTC is burned, and the locked BTC from the custodian address is released back to the user. All the minting and burning of the tokens is recorded on the blockchain, ensuring transparency and verifiability. As the DeFi ecosystem grew, so did the demand for an asset such as WBTC. With the demand for using BTC in the DeFi ecosystem growing, the asset had to be converted into an ERC-20-compatible token to exist in the ecosystem.
How To Use Wrapped Bitcoin
Wrapped Bitcoin offers several advantages to users, allowing them to access dApps, decentralized exchanges (DEXs), and smart contract-driven platforms. Let’s look at how WBTC makes things simpler for BTC users wishing to use their assets in the Ethereum ecosystem.
WBTC is an excellent avenue for bringing greater liquidity to the Ethereum ecosystem. The sheer number of applications running in the Ethereum ecosystem means that funds are spread across a host of applications and protocols. This leads to a lack of liquidity, preventing these applications from functioning optimally. WBTC eases liquidity concerns by bringing in liquidity from BTC holders that wish to participate in the Ethereum ecosystem.
WBTC is a very popular token in DeFi. Majority of the DeFi apps, like MakerDAO, Curve Finance, Aave, etc., allow you to provide liquidity in WBTC and earn rewards.
Because WBTC is an ERC-20 token, it offers significant functionality, especially when compared to BTC. WBTC allows users to use smart contracts. Additionally, WBTC holders can deposit their assets into DeFi protocols and take out a loan. Should they choose to, they can use the funds to purchase even more WBTC.
Bitcoin has several functionalities, but if you hold only BTC, you will be locked out of the decentralized application ecosystem currently thriving on Ethereum. WBTC is a clever way to enjoy the best of both worlds. Maintain your exposure to BTC while participating in all things DeFi on Ethereum
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