Wrapped Bitcoin 101

What are Wrapped Cryptocurrencies?

Wrapped cryptocurrencies are digital assets that mirror the value of another asset on a different blockchain or token standard. These wrapped assets can then be used on a blockchain network that they would otherwise be incompatible with.

Wrapped tokens are designed to have the necessary traits and characteristics that allows them to interact with the network they're built on. For example, a wrapped Bitcoin token can be deployed on the Ethereum blockchain and function as an ERC-20 token, enabling interaction with decentralized applications (dApps).

The aim is for wrapped tokens to have the same value as the original asset they are mimicking (although this may not always be the case), typically with a 1:1 peg. Using the example above, one wrapped Bitcoin token would be equivalent in value to a regular bitcoin (BTC) on the Bitcoin main chain.

Stablecoins are widely considered to be the early form of wrapped tokens, although they differ from the established wrapped tokens that we now know. Stablecoins are usually pegged 1:1 to another fiat currency or cryptocurrency.

What is the Purpose of Wrapped Cryptocurrencies?

Wrapped cryptocurrencies are designed to address issues of interoperability between non-compatible cryptocurrencies and blockchains. Traditionally, cryptocurrencies are built for use on a specific blockchain, which means they cannot be used to interact with a different blockchain network.

Wrapped tokens enable cross-functionality between blockchains, allowing assets from one blockchain to be used on another. In essence, wrapped cryptocurrencies act as a bridge, connecting separate blockchain networks.

This cross-chain capability provides benefits for the decentralized finance (DeFi) space, including more efficient movement of funds and increased liquidity. Wrapped assets can be seamlessly transferred and utilized across various blockchain platforms.

How Do Wrapped Cryptocurrencies Work?

Generally, the process of creating wrapped tokens involves transferring an amount of original asset to a custodian address on the original block. The custodian then locks the original assets in a digital vault or wallet. An equivalent number of tokens are then minted and issued on the target blockchain.

By locking away the original assets, it ensures the wrapped tokens are a representation of the original tokens, not a duplicate. The process of locking tokens away is published on-chain and can be publicly verified.

Wrapped tokens typically require a custodian to guarantee that assets are redeemed on a 1:1 basis. This custodian will normally take the form of a smart contract, a multi-signature wallet or a decentralized autonomous organization (DAO).

When the owner decides to convert the wrapped asset back to the original asset, the custodian will verify the request before burning the received wrapped token. The original locked assets are then released back to the owner.

What is Wrapped Bitcoin?

A wrapped Bitcoin token is a tokenized representation of Bitcoin on another network, such as the Ethereum blockchain, in the form of an ERC-20 token. Wrapped Bitcoin tokens are pegged 1:1 to the value of Bitcoin, effectively bridging the original Bitcoin blockchain with the network the wrapped Bitcoin is deployed on.

There are key differences between Bitcoin and its wrapped counterpart:

• Bitcoin operates on its own blockchain network and is primarily designed for peer-to-peer transactions. It is renowned for its decentralization and security, but arguably has limited functionality due to the nature of the Bitcoin network.
• In contrast, wrapped Bitcoin tokens—especially those designed for use on the Ethereum blockchain—are compatible with smart contracts, enabling their integration within the Ethereum DeFi ecosystems for activities like borrowing, lending and yield farming. This expands the utility of the original Bitcoin asset.

However, it's important to note that regular Bitcoin transactions are fully trustless, thanks to Bitcoin's Proof of Work consensus mechanism. Wrapped Bitcoin tokens, on the other hand, utilize a custodian model to maintain a 1:1 peg, potentially introducing a degree of centralization (depending on the approach) that goes against the foundational purpose of the original Bitcoin blockchain. This tradeoff is the price paid for the increased functionality of wrapped Bitcoin tokens.

Why Do We Need Wrapped Bitcoin?

Wrapped Bitcoin tokens offer several key benefits. Firstly, by being compatible with smart contract-enabled networks, users gain access to extensive DeFi ecosystems and the dApps within them.

Secondly, EVM-based wrapped Bitcoin transactions often offer faster settlement times and lower fees compared to transacting directly on the Bitcoin main chain. This can provide a smoother user experience within DeFi applications.

Finally, the integration of wrapped Bitcoin also benefits the target blockchain, such as Ethereum, by increasing the overall liquidity available on the network through Bitcoin-denominated transactions and interactions.

As technology continues to evolve, it is likely that we will see the development of additional use cases for wrapped Bitcoin tokens and other wrapped cryptocurrency assets. Furthermore, the adoption and utilization of wrapped cryptocurrencies is expected to grow within the DeFi application space. Potentially, new ways to customize or create wrapped tokens in the future (e.g., renBTC, sBTC) could decrease the reliance on a centralized custodian, providing more decentralized and self-sovereign options for users.

Examples of Wrapped Bitcoin

There are lots of examples of wrapped Bitcoin tokens, some of which have become more widely adopted than others:

• WBTC – The original Wrapped Bitcoin, WBTC is an ERC-20 token backed 1:1 by Bitcoin, held in custody by a trusted third-party.
• BTCB – Bitcoin BEP2 is a Bitcoin stablecoin built on the Binance Chain backed 1:1 by Bitcoin, held in custody by a trusted third-party.
• cbBTC – Coinbase Wrapped BTC is an ERC-20 token launched by Coinbase backed 1:1 by Bitcoin, held in custody by Coinbase.
• renBTC – RenBTC is an ERC-20 token facilitated by the decentralized RenVM network backed 1:1 by Bitcoin, reducing reliance on a single custodian.
• sBTC – sBTC is a trustless two-way peg system part of the Stacks protocol backed 1:1 by Bitcoin.

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