Wrapped Bitcoin: Everything to Know
By Beluga Research July 6, 2023
- Wrapped Bitcoin brings the functionality of Bitcoin to the Ethereum ecosystem
- It is created by locking up bitcoin and minting an equivalent amount of wrapped bitcoin tokens on the Ethereum blockchain
- Wrapped Bitcoin enables bitcoin holders to access the decentralized finance (DeFi) ecosystem and participate in various Ethereum-based applications
- Due to the wrapping process, Wrapped Bitcoin tends to be more complicated for users
Wrapped Bitcoin is a token that represents Bitcoin on the Ethereum blockchain and is always pegged to the value of Bitcoin. It is an ERC-20 token, which is a standard that means it is fully compatible with Ethereum's smart contracts. Most importantly, it means Wrapped Bitcoin can be traded on decentralized exchanges (DEX). Wrapped Bitcoin was created to bridge the gap between Bitcoin and Ethereum, allowing bitcoin holders to use it on the Ethereum blockchain and reap the benefits that come with doing so. These include expanded utility for bitcoin and faster block creation times given transactions are settled every 15 seconds on the Ethereum blockchain while Bitcoin transactions take approximately 10 minutes to settle.
A Brief History
Wrapped Bitcoin was launched in January 2019 by a group of companies, including BitGo, Kyber Network and Ren. The idea behind Wrapped Bitcoin was to create a token that was backed by Bitcoin, but also compatible with Ethereum's smart contracts. This would allow bitcoin utilization on the Ethereum blockchain, opening up new possibilities for decentralized finance (DeFi) applications.
The process of creating wrapped bitcoin involves a custodian holding bitcoin and minting an equivalent amount of wrapped bitcoin on the Ethereum blockchain. The custodian is responsible for ensuring that the amount of wrapped bitcoin in circulation is always backed by an equal amount of bitcoin in their custody. This creates a decentralized system that allows users to trade wrapped bitcoin on DEX without having to trust a centralized authority.
What Is Wrapped Bitcoin?
Wrapped Bitcoin is a cryptocurrency token that is pegged to the value of Bitcoin. This means that one wrapped bitcoin is always equal to one bitcoin. The process of wrapping bitcoin involves depositing bitcoin with a custodian, which then mints an equivalent amount of wrapped bitcoin on the Ethereum blockchain. The custodian is responsible for ensuring that the ratio of wrapped bitcoin in circulation to the amount of bitcoin in their custody is always equal.
Wrapped bitcoin can be used on the Ethereum blockchain in the same way as any other ERC-20 token. It can be traded on DEX, used as collateral for loans and integrated into DeFi applications. For example, wrapped bitcoin can be used to provide liquidity on decentralized exchanges, allowing users to trade bitcoin without actually holding it.
The use of wrapped bitcoin on the Ethereum blockchain has opened up new possibilities for DeFi applications. For example, wrapped bitcoin can be used as collateral for loans on decentralized lending platforms. This allows bitcoin holders to use bitcoin to access liquidity without having to sell their bitcoin.
Wrapped bitcoin, a cryptocurrency attached to the value of Bitcoin, is an ERC-20 token that is backed by Bitcoin at a ratio of 1:1. This means that for every wrapped bitcoin issued, there is an equivalent amount of bitcoin held in reserve. So, why not just stick to bitcoin? Because prior to the creation of wrapped bitcoin, there was no way to trade bitcoin outside of centralized exchanges. By wrapping it as an ERC-20 token, Wrapped bitcoin can be traded on DEX or used in decentralized applications (dapps) that support ERC-20 tokens. Not only does this offer investors expanded utility for bitcoin, but it also enables them to settle transactions on the Ethereum blockchain, which is an inherently faster process than doing so on the Bitcoin blockchain.
To create Wrapped bitcoin, a specified amount of BTC is locked into a smart contract, which then mints an equivalent amount of tokens. To get started with Wrapped Bitcoin, a user must first acquire bitcoin in a wallet. The user can then use a Wrapped Bitcoin minting service to convert their bitcoin into wrapped bitcoin. The wrapped bitcoin can then be utilized on any blockchain network that supports ERC-20 tokens. Thus, if a user wants to use wrapped bitcoin on the Ethereum network, they will need an Ethereum wallet that supports ERC-20 tokens.
Wrapped Bitcoin has several unique aspects that make it an attractive option for investors and traders. Firstly, Wrapped Bitcoin allows bitcoin holders to use it on other blockchain networks whereas prior to its creation, bitcoin investors were limited to trading bitcoin on centralized exchanges. This is particularly useful for those who want to use bitcoin in DeFi applications. DeFi applications are built on top of blockchain networks and allow users to lend, borrow and trade cryptocurrencies without the need for intermediaries such as banks.
In addition, wrapped bitcoin is more liquid than bitcoin because it can be traded on DEX that are built on different blockchain networks, offering expanded utility for the cryptocurreny. For example, wrapped bitcoin can be traded on Ethereum-based DEX such as Uniswap and SushiSwap, as well as on Binance Smart Chain-based DEX such as PancakeSwap. This means that wrapped bitcoin can be easily traded for other cryptocurrencies, providing investors and traders with more flexibility and trading options.
Wrapped Bitcoin is also more transparent than traditional Bitcoin exchanges. This is because the creation and destruction of wrapped bitcoin can be tracked on the Ethereum blockchain. This allows investors and traders to verify that the amount of wrapped bitcoin in circulation is backed by an equivalent amount of bitcoin held in reserve. This transparency is not available on traditional Bitcoin exchanges, where the amount of bitcoin held in reserve is often not disclosed.
- Liquidity . Wrapped bitcoin is an ERC-20 token, which means it can be traded on any DEX that supports ERC-20 tokens. This makes it easier to buy and sell bitcoin, as it is more readily available on a DEX than it would be otherwise.
- Accessibility . By wrapping bitcoin, it becomes more accessible to users of other blockchain networks, such as Ethereum. This allows users to take advantage of the benefits of both Bitcoin and Ethereum, without having to choose between them.
- Transparency . The Ethereum blockchain is more transparent than the Bitcoin blockchain, as it allows users to view all transactions on the network. This makes it easier for users to track wrapped bitcoin transactions and ensures that all transactions are publicly visible.
- Security . Wrapped Bitcoin's value is directly tied to the value of bitcoin. This provides a level of security that is not available with other cryptocurrencies, as the value of wrapped bitcoin is directly tied to a tangible asset.
- Centralization . Wrapped Bitcoin is not truly decentralized. It is managed by a consortium of companies rather than being fully decentralized like Bitcoin. This means that there is a risk that the companies managing Wrapped Bitcoin could make decisions that are not in the best interests of the users.
- Counterparty Risk . Wrapped Bitcoin is backed by bitcoin, but it is still subject to counterparty risk. This means that if the companies managing Wrapped Bitcoin go bankrupt or suffer a security breach, users could lose holdings.
- Complexity . Wrapped bitcoin is more complex than simply holding bitcoin. It involves wrapping bitcoin and converting it into an ERC-20 token. This can be confusing for some users, and may deter them from using wrapped bitcoin.
- Cost . There are fees associated with wrapping bitcoin and converting it into wrapped bitcoin. These fees can be higher than the fees associated with simply buying and holding bitcoin.