Cross-chain interoperability is the ability for blockchain networks to communicate and share information or assets seamlessly between each other. It is vital as it allows users to move their assets and data across different blockchain networks, overcoming the limitations of a single blockchain.
Wrapped Bitcoin enhances liquidity and interoperability between two major blockchains–Bitcoin and Ethereum. With WBTC, users can deploy BTC on EVM-powered blockchains. It provides a bridge for Bitcoin holders to access Ethereum's extensive decentralized application ecosystem and DeFi platforms and use their BTC in them.
Wrapped Bitcoin enhances liquidity and interoperability between two major blockchains–Bitcoin and Ethereum.
Introducing Bitcoin's liquidity to Ethereum's market also enriches Ethereum DeFi by bringing BTC’s deep liquidity to various DeFi apps, allowing for more diverse financial products and services.
So what are wrapped tokens, what are their benefits (and limitations), and how do you start using or working with them today?
What is a Wrapped Token?
Let’s start with defining wrapped tokens in general. Wrapped tokens are assets issued on a blockchain that represent an equivalent value of another asset from a different blockchain. These can be fungible tokens, like Bitcoin, or non-fungible tokens, NFTs, such as the wrapped ordinals that trade on OpenSea. Wrapped tokens act as a bridge between different blockchain ecosystems and convert an asset into a standard token format that’s compatible with the destination blockchain. You might also see wrapped tokens referred to as synthetic tokens.
Wrapped tokens are assets issued on a blockchain that represent an equivalent value of another asset from a different blockchain.
Wrapped tokens rely on two core ideas: “pegs” and “custodians.”
A peg refers to linking the value of a given token to the market value of another asset, be it a token, a currency or something else. In the context of a wrapped token, the peg is usually 1:1 with the asset being wrapped. For example, each wrapped Bitcoin (WBTC) is worth 1 Bitcoin (BTC), a 1:1 peg. The peg ensures that the value of the wrapped token remains stable relative to the asset it represents, so that a trader can use a wrapped asset or the original asset interchangeably, without any loss in value. Pegging is a difficult problem, and there are many design approaches to implement them with different tradeoffs, including centralized custodians or decentralized smart contracts.
Custodians are entities responsible for holding and safeguarding the underlying assets that back wrapped tokens. In the case of WBTC, the primary custodian is BitGo, a digital asset trust company. BitGo holds the actual Bitcoins that back every WBTC in circulation. Wrapped Bitcoin had a market capitalization of over $5.5B (as of 10/24) and accounts for 94% of all wrapped BTC on Ethereum.
While “wrapped” tokens can refer to many different assets, WBTC is one of the most widely used and recognized “wrapped” tokens.
What Is Wrapped Bitcoin?
Wrapped Bitcoin (WBTC) is a tokenized version of Bitcoin on the Ethereum blockchain. Each WBTC is pegged 1:1 with Bitcoin. For every WBTC token in circulation, there is one Bitcoin held in reserve by BitGo and a consortium of custodians. This ensures that WBTC can always be redeemed for an equivalent amount of Bitcoin.
Wrapped Bitcoin (WBTC) is a tokenized version of Bitcoin on the Ethereum blockchain.
The current market cap of WBTC is $5.5B (as of 10/24), with 163,000 WBTC in circulating supply.
More specifically, WBTC is an ERC-20 token. ERC-20 is a token standard used for fungible tokens on the Ethereum blockchain. As an ERC-20 token, WBTC can interact with any interface or app on an EVM-compatible chain as well (such as Ethereum, Avalanche, BNB, Ethereum layer 2, and more).
Unlike decentralized bridges, retail users cannot mint or burn WBTC directly. Minting and Burning is handled by a consortium of merchants and custodians. In order to acquire WBTC, retail users purchase WBTC from pre-approved merchants after passing KYC and AML requirements. Here's how the process works:
- Minting: A user sends Bitcoin to a merchant. The merchant then sends a request to the custodian to lock up this Bitcoin and mint an equivalent amount of WBTC on the Ethereum network. Once the custodian confirms the receipt of Bitcoin, they authorize the minting of WBTC to the user's Ethereum address.
- Burning: The process in reverse. A user sends WBTC to a merchant, expressing the desire to redeem it for Bitcoin. The merchant burns the WBTC and sends a request to the custodian to release the equivalent amount of Bitcoin to the user's Bitcoin address.
Why Wrap Bitcoin?
Today, there is $500B of Bitcoin, and that is a lot of latent capital: users who hold Bitcoin can't do much with it today. They can really only HODL and wait for the price to go up or make simple payments on the Lightning network.
But a lot of users want to put their BTC to work, whether as collateral to mint stablecoins, to loan, to earn yield, or any number of other reasons. There is clearly demand for bringing Bitcoin to DeFi, given the adoption and popularity of WBTC.
This also helps the entire DeFi ecosystem. More options for Bitcoin DeFi means more sophisticated financial instruments, institutional players and deeper liquidity.
A lot of users want to put their BTC to work.
BTC is an ideal candidate for wrapping because of its limited programmability. You can’t currently use BTC in the majority of DeFi apps, so you have to wrap the asset if you want to put it to work. Though this is starting to shift now that Bitcoin layers are offering more BTC-native DeFi options.
The Problems With WBTC
Bitcoin is decentralized and trustless. The issue is that WBTC is the opposite. You have to trust a central service, the custodian, and trust that the peg is stable and that the deposited BTC is safe. This goes against the very ethos of decentralization and the foundational principles upon which Bitcoin was built.
With all the trust in a centralized service, you get the same problems of TradFi when that trust is misplaced:
- If the custodian collapses, all deposit BTC could be used to pay off debts and investors, as happened with FTX and Celsius, instead of going back to users.
- If the custodian is malicious, they can “rug” their users, stealing the deposited BTC.
- If the custodian is negligent or careless, they can mismanage the funds and lose them.
Bitcoin is decentralized and trustless. The issue is that WBTC is the opposite.
In order to increase trust, custodians generally offer security provisions such as transparent protocols, regular audits, and the reputation of the involved parties. For WBTC, the public can verify the amount of WBTC in circulation on the Ethereum blockchain, and regular audits of the custodian's Bitcoin holdings aim to ensure transparency.
This "Proof of Reserve'' helps ensure transparency with the 1:1 peg between WBTC and Bitcoin. If the peg is broken or doubted, it can lead to a loss of faith in the wrapped token's value and its subsequent devaluation.
But a fundamental aspect of custodians is that they have custody of your Bitcoin. You aren’t in control of your Bitcoin anymore. It is a clear case of “not your keys, not your Bitcoin.”
You also can’t buy WBTC directly with Bitcoin unless you go through KYC and give your personal information to the custodian either (so not only are you trusting them with your BTC but sensitive personal information as well). Not only is this counter to the permissionless nature of Bitcoin, but if you live in a region that is on the OFAC list, you simply can’t buy it.
Trust isn’t the only problem with WBTC when it comes to custodians. It also has the issue of fees. Since WBTC operates on the Ethereum network, any transaction involving WBTC, be it minting, burning, or simple transfers, incurs Ethereum gas fees. These gas fees can be highly volatile, often spiking during times of network congestion. Users also have to pay additional “wrapping” and “unwrapping” fees directly to the custodian.
As a result, a user might face unexpectedly high costs when interacting with WBTC, especially during peak periods. This not only adds an extra layer of cost but also unpredictability.
What Wrapped Bitcoin Offers Developers
WBTC is a synthetic Bitcoin token that is programmable and can interact with most EVM-compatible Web3 apps. WBTC is the most popular wrapped Bitcoin token for a reason. It’s readily available on most DeFi platforms and because of the centralized custodial model, it’s relatively easy to acquire and sell. For devs, this means that supporting WBTC is as easy as supporting any ERC-20 token.
Other Approaches to Wrapping Bitcoin
While by far the most popular Bitcoin peg, WBTC is not the only option. Developers who want to tap into Bitcoin’s liquidity, can explore a range of options, with different designs and tradeoffs when it comes to centralization, fees and protocols. A few projects worth following are:
- BTC.b: A wrapped Bitcoin on the Avalanche Network that doesn’t require a custodian.
- tBTC: A wrapped Bitcoin that uses the Threshold network for decentralized custody.
- HBTC: Huobi’s version of wrapped Bitcoin that is centralized on that platform.
- BBTC: A wrapped Bitcoin backed by BTC reserves custodied by Binance.
- xBTC: A custodial Bitcoin peg on the Stacks blockchain
There’s also a new Bitcoin asset coming in 2024, called sBTC.
sBTC: a Decentralized BTC Peg for Bitcoin DeFi
1% of Bitcoin’s total supply is currently locked in wrapped Bitcoin assets, the vast majority in WBTC. While the first wave of DeFi applications centered in EVM ecosystems, what if the next generation of DeFi applications are native to Bitcoin?
Unlike WBTC, sBTC is decentralized and has no central custodian.
That’s the goal of sBTC. sBTC will bring Bitcoin to Stacks, a Bitcoin layer for smart contracts. Stacks enables devs to build Bitcoin DeFi and make Bitcoin fully programmable. Unlike WBTC, sBTC is decentralized and has no central custodian, thus no trust issues and no custodial fees, keeping costs low.
This upcoming asset will allow for the lending and borrowing of BTC, trading, and the creation of new assets and products on Stacks.
WBTC has served Bitcoin users well, allowing them their first foray into the DeFi world. But sBTC brings those capabilities natively to Bitcoin, and will allow a whole new ecosystem to be built directly on the Bitcoin blockchain. Even better, it will do it more cheaply and more decentralized than WBTC, in line with the core principles of Bitcoin, as any pegged Bitcoin asset should be.
Learn more about sBTC here.