Since the early years of cryptocurrency, users have faced a significant issue with interoperability, that is, the ability to move assets from one blockchain to another. It has also been difficult to perform functions on more than one chain simultaneously. Over time, many developments have led blockchain technology towards an interoperable future.
One such example is the use of bridges, which were developed to facilitate the transfer of crypto between smart contract-capable blockchains, as well as from Ethereum to its layer 2 solutions and back.
Another common example, and one of the earliest solutions to the lack of blockchain interoperability, is token wrapping. A wrapped token represents a cryptocurrency that would not otherwise be supported natively on a blockchain. One of the most popular of these is Wrapped Bitcoin (WBTC). WBTC tokens are minted on Ethereum (and other chains) and are backed by an equal amount of bitcoin held as collateral with a custodian.
WBTC is important because it provides bitcoin price exposure for users of decentralized finance (DeFi) and makes a BTC-linked asset available outside of its native blockchain for trading against ether and other ERC-20 tokens (when wrapped on the Ethereum blockchain), for decentralized lending/borrowing, and for use on derivatives platforms.
How was Wrapped Bitcoin developed?
The whitepaper for Wrapped Bitcoin was published in January 2019 by three companies/groups: BitGo Inc, Kyber Network, and Republic Protocol (which later became Ren). In it the founders defined the concept of “wrapped” tokens using Ethereum’s ERC-20 token standard, and they promised the first wrapped token would be WBTC.
BitGo is a California-based company that focuses on digital asset services including custodial services, and it serves as the sole custodian of the BTC that backs WBTC.
Kyber Network describes itself as a “liquidity hub” for the DeFi space, providing tools to decentralized exchanges (DEXes) and aggregating crypto liquidity pools to help users execute efficient swaps using the KNC token. Kyber supports WBTC by being its main liquidity provider, a member of its decentralized autonomous organization (DAO), and by helping list WBTC on its network.
The Republic Protocol, later re-named Ren, was perhaps best known for issuing renBTC to further its goal of increasing inter-blockchain liquidity. Republic Protocol, along with Kyber, was the first merchant to list WBTC.
Since beginning to offer WBTC in 2019, the group has also begun offering both WBTC and WETH through similar means on the Tron blockchain.
How does Wrapped Bitcoin work?
For bitcoin to be traded on Ethereum, it must exist in an Ethereum-friendly format. ERC-20 is a formal token standard that forces digital assets to comply with certain specifications on its blockchain. This makes them fully fungible (interchangeable) and able to be used seamlessly across smart contract protocols. WBTC is simply a token that represents BTC as an ERC-20 token on Ethereum.
Wrapping and unwrapping
The process of minting (creating) and burning (destroying) WBTC is performed in several steps.
- A merchant, such as a centralized exchange or crypto project, submits a request to mint WBTC. Merchants must perform know-your-customer (KYC) identification and anti-money laundering (AML) checks before distributing WBTC to customers.
- The merchant then sends the required BTC collateral to BitGo, WBTC’s sole custodian. BitGo then holds BTC in a 1:1 ratio with the WBTC it mints.
- The mint of WBTC is completed by BitGo and sent back to the merchant. Of note, only merchants can exchange WBTC for BTC held by BitGo.
- Retail users, crypto projects, and others obtain WBTC through either centralized sources (e.g. centralized exchanges) or DeFi channels (e.g. DEXes).
- Unwrapping requires merchants to send WBTC to BitGo to receive BTC in return—simply the reverse of the above process. As custodian, BitGo then burns the WBTC tokens on Ethereum.
Importantly, WBTC can be considered a crypto-backed stablecoin, since BTC funds are held 1:1 in reserve for WBTC. These funds are published on the wbtc.network website, which serves as a proof of reserves.
Because this system relies on merchants and a singular custodian, critics have pointed out that WBTC carries some centralization risk.
Other BTC-based tokens
Although WBTC was the first asset to track bitcoin and make its liquidity tradable on Ethereum, others have followed. On the “centralized” side, the Huobi exchange issues HBTC. Within DeFi, Ren protocol offered renBTC. Launched in 2020, tBTC is another BTC-pegged asset which uses smart contracts to be mint its token from overcollateralized BTC deposits.
How is the WBTC token used?
WBTC can be used like any other ERC-20 token on the Ethereum blockchain. This means it can be used in DeFi protocols or traded on centralized exchanges as a substitute for bitcoin, since its value is intended to track BTC’s price.
Retail crypto users can obtain WBTC through DEXes like Uniswap or centralized exchanges like Bitstamp. This allows them to gain exposure to Bitcoin on other blockchains without having to directly wrap or unwrap their bitcoin with WBTC’s custodians.
Importantly, because WBTC is a crypto-backed, BTC-pegged stablecoin, it does not have its own token economics (or tokenomics). The supply of WBTC varies with how much BTC is held as collateral by BitGo. In 2021, this peaked at nearly $16 billion worth of BTC.
Wrapped Bitcoin essentials
- Wrapped Bitcoin (WBTC) is a token linked to the price of bitcoin which is minted Ethereum and other blockchains to make bitcoin accessible in DeFi.
- WBTC is minted by a single custodian—BitGo—in exchange for BTC provided by merchants and held as collateral in a 1:1 ratio. Merchants then distribute WBTC to the broader crypto community.
- The fact that WBTC relies on a custodian has drawn criticisms, with some pointing to its centralization as being a risk factor for the cryptocurrency.