16.7.2024
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Although Bitcoin’s DeFi ecosystem is growing at an increasing rate, a wrapped version of bitcoin has been giving the Bitcoin community access to DeFi applications on other chains for years.
Read on to learn what wrapped Bitcoin is, how it works, and the role wrapped crypto assets play in the DeFi markets.
Wrapped crypto assets are coins and tokens tied to the value of original crypto assets residing on a different blockchain. Their value is exactly (or nearly) the same as that of the underlying crypto asset, meaning they are backed on a ratio of 1:1.
Most Layer 1 blockchains are non-interoperable, meaning they cannot communicate with each other, and their assets cannot operate outside their native environments.
For instance, BTC cannot operate on Ethereum, and ETH cannot work on Bitcoin directly. As a result, wrapped assets help users “move” assets across non-interoperable chains.
Wrapped Bitcoin (WBTC) is an ERC-20 token on the Ethereum blockchain pegged 1:1 to BTC. It is backed by real BTC reserves and can be converted to the original cryptocurrency.
WBTC unlocks Bitcoin’s high liquidity on Ethereum, helping the blockchain’s DeFi ecosystem thrive. A consortium comprising Ren (previously Republic Protocol), Kyber Network, and BitGo developed the WBTC protocol in January 2019.
In addition to Ethereum, WBTC is supported by other blockchains like Base, Kava, and Tron.
Let’s look at how WBTC operates.
Native BTC is not actually moved to Ethereum, to become WBTC. Rather, BTC is held in a vault, and an equivalent amount of WBTC is minted that is backed by the locked BTC. Therefore, the wrapping process begins with minting.
You are required to send a minting request plus payment to a merchant. The payment includes the amount of WBTC you want and the transaction fee. You must also complete KYC and AML checks before WBTC can be minted.
Once the compliance checks are successfully completed, the merchant initiates a transaction to allow the custodian to generate a corresponding amount of WBTC. The merchant also sends the BTC to the custodian, who stores it in a reverse address. Next, the custodian sends WBTC to the merchant, who then sends it to you.
WBTC is created using smart contracts. For the token to operate effectively, the issuers ensure the BTC in custody always matches the WBTC in circulation.
To redeem BTC, you submit WBTC to a merchant, who will initiate a burn transaction and send the asset to the custodian.
Next, the custodian will burn WBTC (destroying a quantity of the crypto asset) and release an equal amount of BTC to the merchant from the reverse address. You will then receive BTC from the merchant.
Merchants and custodians handle the minting and burning process of WBTC tokens. These two entities, along with other institutions such as crypto exchanges, form a decentralized autonomous organization (DAO) responsible for making decisions about WBTC smart-contract changes and adding and removing merchants and custodians.
As of this writing, the DAO has 18 members, including Kyber, Aave, Compound, Set Protocol, Ooki, Ren, BitGo, AirSwap, GOPAX, Blockfolio, and Maker.
BitGo is the only WBTC custodian. It is responsible for securing BTC reserves and conducting a proof of reserve on-chain transaction that allows anyone to verify that the BTC reserves backing WBTC exist. The other founders, Ren and Kyber, both operate as WBTC merchants.
Wrapped Bitcoin (WBTC) is the market-leading token of a wrapped asset, with a market capitalization of over $9 billion. It is used in various ways in DeFi protocols. For example, borrowers use WBTC as collateral on lending protocols.
However, there are also other wrapped assets used in the DeFi markets. Examples include WETH and RENBTC.
WETH is an ERC-20 token backed by ether (ETH) 1:1. It was first created by a group of projects led by 0x Labs in 2017 to make ether ERC-20 compatible. ERC-20 compatibility allows the native asset to be directly traded with other ERC-20 tokens on decentralized exchanges. ERC-20 or Ethereum Request for Comment 20, is a standard for smart-contract tokens on Ethereum. ETH itself is the native cryptocurrency of Ethereum, not an ERC-20 token.
RENBTC is an ERC-20 token that bitcoin backs 1:1. It maintains its peg by always ensuring there’s enough BTC in reserve. These reserves are stored on a decentralized network consisting of nodes, unlike WBTC reserves, which are stored with a trusted custodian. RENBTC is used on various Ethereum dapps.
Ren, the company that helped build WBTC, is the creator of renBTC. It launched the token in 2020.
Wrapped crypto assets come with benefits and drawbacks. Here are the most important ones you should know about.
Now, let’s look at the most prominent use cases of wrapped crypto assets in DeFi.
Borrowers can use wrapped assets as collateral to get loans on decentralized lending protocols. This collateral is usually locked in a smart contract for a given period until the borrower repays the borrowed funds. Various platforms accept a wide range of wrapped assets as collateral, giving users the freedom to choose their preferred assets.
DeFi users can deposit their wrapped crypto assets in lending pools on DeFi lending protocols. These funds are then loaned to borrowers, who pay an interest rate determined by a lending pool’s supply and demand. Lenders can also maximize their earnings by searching for the best lending interest rates on a protocol’s other liquidity pools or other DeFi platforms. This process is called yield farming.
Traders can utilize their wrapped assets as security to margin trade other crypto assets. Trading on margin means leveraging digital assets you already own to purchase additional assets with more money than you have in your wallet.
Some wrapped digital assets can be “staked” on decentralized protocols to earn rewards. This form of staking is not staking in the Proof-of-Stake (PoS) sense but entails depositing your wrapped asset in a liquidity pool for a given period to earn rewards. After depositing a wrapped asset, a protocol may issue a liquidity provider (LP) token, which you can use to farm yields.
Wrapped Bitcoin and other wrapped crypto assets provide cross-chain liquidity and open up access to DeFi ecosystems on other blockchains. While this has been valuable for Bitcoin investors looking to explore yield-earning opportunities in DeFi markets on other chains, most DeFi activity is poised to return to Bitcoin.
Running on off-chain protocols like BitcoinOS, Bitcoin investors will soon be able to deploy the digital currency to explore investment opportunities in a DeFi market operating on and secured by Bitcoin.
Buy SOV today to participate in Sovryn’s Bitocracy and have your say in the new era of Bitcoin.
WBTC is a wrapped asset on the Ethereum blockchain. It is backed by BTC on a 1:1 basis, meaning its value is equivalent to that of the underlying asset. However, due to high volatility, the price of WBTC could fall below bitcoin’s value. WBTC’s bitcoin reserves are held in custody by the crypto asset trust and security company BitGo.
There are many wrapped assets in the crypto market, but the most well-known are WBTC, WETH, WeETH (a liquid staking token), renNBTC, WMATIC, and WBNB. Wrapped Bitcoin (WBTC) is the largest wrapped asset by market cap, followed by WeETH, and WBNB. These tokens and many others can be used in decentralized finance to borrow and earn interest on lending and liquidity provision.
A wrapped coin is a digital asset created by pegging its value to an original cryptocurrency. The underlying asset is held in reserve, allowing holders to redeem the original asset. For wrapped coins to be truly wrapped, their circulating supply must always match the amount of funds in reserve. Tokens representing wrapped coins are essential because they enable the transfer of value across blockchains while allowing users to access products that may not be available on the original asset’s chain.
Wrapped Bitcoin is bitcoin on another blockchain in a different form but maintaining the same value. It is beneficial because it offers a few benefits that bitcoin, in its original form, does not. For example, you can interact with Ethereum DeFi dapps and access faster transaction speeds using WBTC. While WBTC has some advantages, it’s not as secure as BTC itself since it is minted outside the Bitcoin network.
You can convert wrapped bitcoin (WBTC) to bitcoin (BTC) through a merchant like Kyber Network, Maker, Loopring, AirSwap, CoinList, and Ren. The merchant initiates a burn transaction and sends your WBTC to BitGo, the custodian. BitGo then burns the WBTC and releases an equal amount of BTC, which is sent to the merchant and then to you.
Using a decentralized lending protocol, you can deposit Wrapped Bitcoin as collateral to take out a crypto loan. The collateral is locked in a smart contract and is inaccessible until the loan is fully repaid. Alternatively, you can earn transaction fees by depositing the token in a decentralized exchange’s liquidity pool or earn interest by depositing it in a lending pool.
