Let’s start with some basics: There are 2 major cryptocurrency blockchains- Bitcoin and Ethereum.
To understand Wrapped Bitcoin, one must understand the difference between the two.
Bitcoin is merely a currency, Ethereum is a super-computer
The native currency of the Bitcoin blockchain is also called Bitcoin. The native currency of Ethereum Blockchain is called Ether.
Bitcoin has established itself as the poster child of the crypto world- an investment asset, that though volatile, has given mouth-watering returns, and a robust blockchain that has never been hacked (touchwood).
However, it’s important to understand that the Bitcoin blockchain is a very basic blockchain. It does one thing and one thing only (albeit it does it very well)- It maintains the bitcoin cryptocurrency system by maintaining an immutable ledger of bitcoin transactions in a decentralized manner.
Ethereum is the more ambitious cousin. It aims to be a global super-computer. And on this super-computer run many dApps (Decentralized Apps), somewhat like many Apps running on iOS. Ether is not the raison d’etre of the blockchain. Ether exists merely to give financial incentives to the participants of the ecosystem built on Ethereum.
DeFi runs on Ethereum
The exciting projects of DeFi (Decentralized Finance) exist mainly on Ethereum- exchanges, lending platforms, margin trading platforms, payments platforms, etc all run on Ethereum.
DeFi projects have their own token and tokenomics to incentivize participants. In order to be operable on Ethereum, the token must be ERC20 compliant. When everyone uses ERC20 compliant tokens, it is possible for the different DeFi platforms to interact with each other and not remain siloed islands. In other words - Dai can be used in Compound and COMP can be used in Aave and AAVE can be used in Uniswap and UNI can be used in Yearn Finance and so on and so forth.
Bitcoin cannot participate in DeFi
Bitcoin is not ERC20 compliant. Therefore, it cannot participate in DeFi directly.
In order to participate in DeFi, an owner of Bitcoin has to sell her Bitcoin and buy an ERC20 token. If she believes that the value of Bitcoin is likely to go up and doesn’t want to sell it then she cannot participate in DeFi. And this has been a cause of huge frustration.
An owner of any ERC20 token can lend it out, earn passive income on it, easily convert it to stablecoins on-chain. An owner of Bitcoin can only Hodl.
This is where Wrapped Bitcoin (WBTC) comes in.
WBTC is an ERC20 token that is pegged to Bitcoin- An owner of Bitcoin can convert her tokens to WBTC and use it to participate in DeFi i.e. it can be used as collateral in protocols like Compound, MakerDAO, Dharma, Khyber, etc. WBTC has the same value as Bitcoin and can be converted back to Bitcoin anytime.
=> WBTC allows users to continue to hold bitcoin and simultaneously participate in DeFi.
What is in it for Ethereum?
Since some people consider Bitcoin and Ether competing cryptocurrencies, one wonders why would Ethereum developers want to help out Bitcoin holders? It seems bizarre that the push for Wrapped Bitcoins seems to have come from Ethereum dApps.
This is because Wrapped Bitcoins helps Ethereum as well. It brings more liquidity to Ethereum. The market cap of Bitcoin currently is materially higher than all the rest of the tokens combined. With Bitcoin tradable on Ethereum, the volume of transactions and depth of the DeFi market goes up which adds to the credibility of DeFi and Ethereum.
Some history and technicals regarding Wrapped Bitcoins
Wrapped Bitcoin was launched in January 2019 and is the result of a collaboration between Bitgo, Ren, Dharma, Compound, MakerDAO, Khyber, and Set Protocol. It is managed by the WBTC DAO (Decentralized Autonomous Organization), Custodians, and Merchant.
* WBTC DAO- Decides on upgrades and changes to the protocol as well as who can function as a merchant or custodian.
* Merchants - Conduct user identification and ensure KYC/AML compliance
* Custodians - Mint and burn WBTC and hold Bitcoin securely in custody.
Who checks if the Wrapped Bitcoins are backed by sufficient Bitcoins?
The conversion from Bitcoin to WBTC is happening off-chain and requires us to trust the 3 centralized authorities mentioned above.
In order to enhance trust, WBTC undergoes regular audits. When Bitcoin is wrapped, the underlying bitcoin is held in reserve by the Bitgo Trust. The amount of WBTC in circulation is made public with proof that the underlying bitcoin is being held securely in custody.
Anyone can check how much bitcoin was sent to WBTC addresses on the Bitcoin blockchain and how much WBTC tokens have been created on the Ethereum blockchain.
Conclusion
Wrapped bitcoin is a safe tool that enables bitcoin holders to lend, stake, or offer as collateral their tokens and participate in the world of DeFi which already has over $13bn TVL (Total Value Locked).