Blockchain

What is Wrapped Bitcoin? A Guide to WBTC

WBTC is a way for Bitcoin to run on the Ethereum blockchain.

Performing quick and affordable transactions using Bitcoin (BTC) has long been a problem of the community ever since it became more popular. This is why there have been many developments planning to address this issue. 

But what if we can make our BTC coins functional on the Ethereum (ETH) blockchain? Would there be a difference?

Wrapped BTC (WBTC) is a multi-institution project that aims to solve common BTC problems by creating its ERC-20 token counterpart. And in the process, BTC holders are now able to access Decentralized Finance (DeFi) projects from the Ethereum network. 

But how does this actually work?

Table of Contents

Background

Wrapped BTC (BTC) was launched back in January 2019 as a shared initiative between DeFi players like BitGo, Compound, Dharma, Kyber Network, MakerDAO, Ren, and the Set Protocol.

There are many concerns with the current state of the Bitcoin blockchain. And most of them are centered around transaction speed and interoperability with other chains. Transacting in BTC can be expensive both in time and resources.

We have Bitcoin’s block size limit to thank for that. As a result, the slow confirmation time influences the speed by which transactions are settled, including how transaction fees are priced. Oftentimes, either transactions take longer confirmations, or they come with very high fees.

Those who could afford to pay higher fees will be served by miners first. But this begs the question, is Bitcoin good enough for cash if it costs too much to simply spend? There have been numerous solutions like Lightning Network that could help the network scale for fast and cheap transactions.

Until now, the lightning network’s adoption rate has been rather stagnant. DeFi, on the other hand, has attracted several hundreds of thousands of users in a short span of time. And it has a peculiar solution in the form of wrapped tokens.

Normally, Bitcoin should not be able to run on DeFi platforms. And this is because most DeFi protocols run on the Ethereum network. The WBTC project seeks to solve these issues.

What is WBTC?

WBTC is an ERC-20 token that represents BTC in the Ethereum blockchain. Each WBTC is fully-backed by BTC at a 1:1 ratio. The primary purpose of WBTC is to transfer the stability and liquidity of BTC into the Ethereum network.

For every WBTC out there, there is an equivalent amount in BTC being held by a custodian. For WBTC, the custodian is BitGo. And by holding a WBTC, you are also holding its BTC equivalent by proxy.

One of the problems WBTC is trying to solve is the speed of transactions when they are made in BTCs. Because WBTC is on top of the ETH blockchain, it does not suffer from the same block confirmation problems from the BTC blockchain. 

Transactions can be confirmed and finalized faster with WBTC since Ethereum block confirmations take only about 15 seconds. This is a far cry from Bitcoin’s 10-minute block time.

Now, by just wrapping your BTC, you can make it ERC-20 compliant. By then, you get to enjoy the world of Ethereum without actually letting go of your BTC. WBTC allows users to access projects in Ethereum such as smart contracts or dApps. 

An example of dApps where WBTCs can be used are Compound and MakerDAO. These are DeFi protocols that let users borrow or lend money on the ETH network.

However, these protocols require users to lock up ERC-20 compliant tokens in order to access their services. If you only have BTC, you would not be able to access this financial service. But now, you can just wrap them and join these protocols without ever letting go of your BTC.

The DeFi ecosystem benefits from WBTC too. When they get a hold of BTC, dApps can enjoy the liquidity that cryptocurrency can bring to the network. WBTC also offers a new collateral type for dApps. 

This means that the likelihood of increasing DeFi adoption rate becomes higher just by opening the door to BTC holders.

What are Wrapped Tokens?

Wrapped tokens are digital assets built on the Ethereum blockchain backed by other assets. Like WBTC, other wrapped tokens can be backed on a 1:1 ratio of its underlying asset. A smart contract makes sure that its value is the same as its underlying asset by monitoring its price in real-time.

The difference with a wrapped token and its underlying asset is that the wrapped tokens can more easily be used by dApps or other platforms functioning on top of the Ethereum blockchain. 

There are also other wrapped tokens like imBTC and Wrapped ETH (WETH). They function the same way, and they are backed by the assets they represent.

How Does It Work?

WBTC is a collaborative project between different organizations in the Ethereum blockchain. But some of the primary actors in the Wrapped BTC ecosystem are the following:

  • Custodians – These are the organizations that hold the asset that the wrapped token represents. In the case of WBTC, BitGo holds the underlying assets that back the WBTC.
  • Merchants – They regulate the distribution of wrapped tokens. They can either issue or burn wrapped tokens.
  • Users – They hold, transact, and perform other financial transactions with the wrapped Bitcoins that circulate in the Ethereum network.

The process of wrapping tokens begins with users who want to convert their BTCs into WBTC. Merchants initiate the whole process of minting or burning WBTCs after performing due diligence and Know-Your-Client procedures.

After a merchant has decided to mint wrapped tokens, they go to custodians (i.e. BitGo) to keep custody of the actual BTC before minting WBTC. Then, custodians provide WBTC to merchants so they can distribute them to the users.

WBTC DAO

WBTC is a Decentralized Autonomous Organization (DAO) initiative. This means that the operation of the whole WBTC ecosystem is governed by the community. Through multi-sig contracts, every decision that is made for the network (can either be a simple update or modification) must be approved by its members.

Through the Proof-of-Reserve consensus mechanism, the whole community is assured that every WBTC circulating in the market is fully-backed by its underlying asset. Information on the actual amount of WBTCs and backing BTCs in the whole ecosystem is available and verifiable on the WBTC dashboard.

How to Buy, Sell, or Create WBTC

Buying WBTC is fairly easy. Users just need to get in touch with partner merchants to request for wrapped BTC in the same amount of BTC that they are willing to deposit. After some checks on the customer’s information, the WBTC will be released to them.

To sell WBTCs or exchange them back for BTC, users just have to send redemption requests to their merchant. Then, the amount of Bitcoins that will be returned to the user will be the same amount of Wrapped BTC burned. After the whole process, the Bitcoins are returned to the user.

Conclusion

The DeFi community is continuously working on projects that integrate several blockchains together. And with Wrapped BTC, the ETH community can welcome BTC holders to help develop the DeFi ecosystem together.

With the liquidity that BTC can provide, and the innovations that the DeFi space can come up with, the crypto community is only bound to grow further. 

Wrapped tokens are not just about having people dip their toes on the ETH network. It is also about taking advantage of the strengths of both networks in order to develop better use cases for crypto.

Source: https://www.asiacryptotoday.com/wrapped-bitcoin-wbtc/

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