Wrapped Bitcoin

Bitcoin offered users a decentralized, peer-to-peer currency that operated outside the control of any central entity or authority, and with that, the potential for autonomy over their finances. Ethereum expanded on the technology by facilitating smart contracts and decentralized applications (DApps), showing the world that blockchain technology can be deployed for more than just cryptocurrencies – that it has the potential to be built upon and scaled.

Bitcoin and Ethereum laid the foundations that are fundamental to cryptocurrencies, and that now underpin the majority of projects that have since been launched. However, Bitcoin and Ethereum are not interoperable, and this posed a headache for Bitcoin users who wanted to take advantage of Ethereum’s sprawling decentralized finance (DeFi) ecosystem.

This problem was solved with the introduction of Wrapped Bitcoin (WBTC), a form of Bitcoin that’s supported by Ethereum’s architecture and lets Bitcoin holders access Ethereum’s DeFi ecosystem.

This article will look at how WBTC works and the role it has played in the DeFi and the larger crypto space.

Wrapped Bitcoin Price Analysis

WBTC’s price is approximately $67,000 as of March 2024. This value is a drop from its all-time high of around $73,000 in the same month (March 2024) and a surge of over 1,900% from its all-time low of about $3,000 in February 2019.

Factors influencing Wrapped Bitcoin’s price

As it’s pegged to Bitcoin (meaning that its value is directly tied to Bitcoin), Wrapped Bitcoin price behavior will closely mirror Bitcoin’s. Also, with Bitcoin being the leading and most mainstream cryptocurrency, it makes for unique influencing factors. Here are some factors that influence the BTC and WBTC price:

• Institutional involvement: Institutional interest in Bitcoin, whether on its own or on account of Bitcoin derivatives such as ETFs, can lend it legitimacy and cause it to increase in value. At the same time, institutions – especially high-profile ones – abandoning Bitcoin can cause it to fall. This phenomenon was evident when Tesla halted BTC payments in 2021, leading the currency to tumble by 12%.
• Major network events such as the Bitcoin halving: The Bitcoin halving is a protocol change that occurs every four years and slashes the amount of mining rewards in half. The blitz of media coverage surrounding the event typically causes a bump in value for Bitcoin and Wrapped Bitcoin in the following weeks or months.
• Market sentiment: A massive shock to the entire crypto market can affect the market sentiment for BTC. An example is when Bitcoin shed by more than 14% in a single day after FTX (the popular cryptocurrency exchange) filed for bankruptcy in November 2022.

What is Wrapped Bitcoin?

Cryptocurrencies such as Bitcoin and Ethereum exist on their own blockchain and ecosystem, like islands. This creates a problem because if cryptocurrencies were compatible, it would mean better liquidity for traders and a more user-friendly, seamless experience for everyone.

That’s where Wrapped Bitcoin comes in. A version of Bitcoin, Wrapped Bitcoin coin is an ERC-20 token pegged to the value of the original Bitcoin, with the idea being to allow Bitcoin to run on Ethereum.

The Wrapped Bitcoin team envisioned an environment where users of Ethereum-based DeFi protocols, such as Compound, Yearn Finance and Uniswap, can use their Bitcoin for trading, lending, borrowing, yield farming and other DeFi activities.

How does Wrapped Bitcoin work?

The idea of wrapping Bitcoin might conjure up an image of physically wrapping Bitcoin on the blockchain, but this is not the case. So, what are WBTCs? In this context, wrapping Bitcoin refers to creating a copy of the pioneer crypto on the Ethereum blockchain as an ERC20 token – with a 1:1 ratio.Wrapping Bitcoin has several moving parts and counterparties. Here’s how it works: 

• Tokenization: A user sends their Bitcoin to a custodian, who then issues an equivalent amount of WBTC on the Ethereum blockchain. This process is managed by dozens of ‘merchants’, such as Kyber and Ren.
• Custodianship: The custodian holds the deposited Bitcoin securely and issues the corresponding amount of WBTC on Ethereum. This process ensures that each WBTC token is backed by an equivalent amount of BTC in reserve. (As of March 2024, California-based digital asset trust company BitGo is the only custodian for WBTC.)
• Redeeming: Once they’re finished using their WBTC, users can redeem their WBTC for Bitcoin by sending their WBTC back to the custodian, who then releases the equivalent amount of Bitcoin from the reserve. 

Some use cases of Wrapped Bitcoin include: 

• Provides liquidity: Wrapped Bitcoin (WBTC) increases liquidity by allowing Bitcoin holders to convert the currency into a version that can run on Ethereum, improving its liquidity in DeFi.
• Collateral: DeFi users can use WBTC as collateral in DeFi lending protocols to borrow other crypto assets against their Bitcoin without having to sell their Bitcoin.
• Cross-chain trading: As Wrapped Bitcoin can be easily exchanged with other assets supported by Ethereum, users can trade Bitcoin via Ethereum-based DEXes faster and with lower fees than using centralized exchanges (CEXes).

Bitcoin’s consensus mechanism 

Wrapped Bitcoin is an ERC-20 token – meaning that it relies on Ethereum’s proof-of-stake (PoS) consensus mechanism. In PoS, network participants who wish to be validators stake their Ethereum (ETH) to earn the right to verify transactions.For its part, Bitcoin deploys the proof-of-work (PoW) consensus mechanism, which involves miners expending a massive amount of computational power to find the next block and earn a reward for validating the transaction.

Who created Wrapped Bitcoin?

Wrapped Bitcoin was launched in January 2019 by BitGo, the decentralized exchange Kyber Network, and the DeFi platform RenProtocol. 

Wrapped Bitcoin quickly became the most popular wrapped Bitcoin token after it was adopted by major DeFi protocols such as Compound, Gnosis, Maker, DyDx, Set Protocol and Dharma. 

As of March 2024, a decentralized autonomous organization (DAO) is in charge of the project.

Wrapped Bitcoin market performance

As of March 2024, WBTC has a market capitalization (market cap) of about $10bn, which pales in comparison to Bitcoin’s original market cap of over $1tn, and to another leading crypto, Ethereum, whose market cap is around $400bn.

As WBTC is based on BTC, the two coins’ market movements are nearly neck to neck at any moment. Their difference in market cap is due to WBTC’s small total supply of 155,625. BTC’s total supply is 21 million. 

How to buy and store Wrapped Bitcoin

After answering the question of, what is WBTC, it’s importmat to know how to buy and store it. Several exchanges, including CEXes, Binance, KuCoin, ByBit, OKX, Bitget, Kraken and DEXes Balancer (ticker: BAL) and Uniswap (ticker: UNI), have listed Wrapped Bitcoin for trading. CEXes require you to sign up, unlike DEXes. 

If you don’t already have an account, follow these steps to create one and buy WBTC: 

• Step 1: Choose a reputable crypto exchange and follow its prompts to set up an account, including Know Your Customer (KYC) verification if required. 
• Step 2: Fund your account using any of the exchange’s supported methods.
• Step 3: Select WBTC from the trading section, enter the amount you want to buy, and place your order.

Crypto holders who wish to trade actively find it convenient to keep their tokens in exchange for easier access. However, if you want to store your WBTC tokens long term, consider using a self-custody wallet. 

A self-custody wallet gives you complete control over your crypto funds. Unlike an exchange wallet, which is vulnerable to hacks or being frozen if the exchange shuts down, a self-custody wallet gives you autonomy over your crypto funds.

Some examples of wallets that support WBTC include Ledger, Trezor, Electrum, Trust and MetaMask. 

Risks and challenges

Wrapped Bitcoin has opened up a whole world of possibilities for Bitcoin users who want to access Ethereum’s DeFi products. However, as is true for all cryptocurrencies, investing in WBTC is not without risks and challenges. 

One risk is centralization. To get WBTC, custodians have to hold onto your Bitcoin in exchange for WBTC. However, this means relying on a centralized system, which creates a single point of failure. If your custodian got hacked, your WBTC would lose value. This centralization also means that the custodian can choose not to honor the 1:1 backing.

This problem is what Ethereum founder Vitalik Buterin had in mind when he tweeted in 2020: “I’m worried about the trust models of some of these tokens. It would be sad if there ends up being $5b of BTC on Ethereum and the keys are held by a single institution.”

Security risks are another issue related to interacting with WBTC. As WBTC relies on smart contracts on Ethereum, hackers can target vulnerabilities in these smart contracts and steal user funds or manipulate the system one way or another.

Investing in WBTC also comes with the challenge of complexity. Wrapping Bitcoin into WBTC tokens and vice versa involves multiple steps, which can be intimidating for some users. 

How WBTC addresses security concerns 

The WBTC team had the above security risks in mind and instituted several guardrails to address them. Below are just some of them: 

• Quarterly audits: External third parties perform quarterly audits to confirm that all wrapped tokens minted (in circulation) have an equal amount of assets held by custodians. This helps to foster trust in the system.
• Transparency: The WBTC team has implemented several measures to achieve a transparent system, including having all key information about participants, such as merchants and custodians’ Ethereum addresses, and the names and details of all organizations involved.
• Community governance: The token wrapping process involves multiple parties, including custodians, merchants, developers, auditors and users. This mitigates a single point of failure to a certain degree. 

Regulatory and legal aspects of Wrapped Bitcoin

When it comes to Wrapped Bitcoin crypto, there hasn’t been much activity on the part of oversight agencies. However, if they were to regulate the token, they would first classify it as either a security or a commodity.

If classified as a security in the US, for instance, regulation for WBTC would fall under the purview of the Securities and Exchange Commission (SEC). 

On the other hand, if classified as a commodity, WBTC would fall under the regulatory scope of the Commodity Futures Trading Commission (CFTC). 

In both cases, overzealous regulation could potentially scare away users and cause decreased adoption for the token.

It could also put in jeopardy the use case for which WBTC was conceptualized: acting as a bridge between the Bitcoin and Ethereum ecosystems.

Comparing Wrapped Bitcoin to other cryptocurrencies

Wrapped Bitcoin is the most popular form of wrapped token, but there are other versions such as RenBTC by DeFi platform Ren Protocol and tBTC by blockchain privacy solution the Threshold Network. Let’s see how WBTC stacks up against them.

WBTC vs RenBTC

Both WBTC and RenBTC allow Bitcoin holders to interact with the Ethereum DeFi ecosystem. The difference between them is that WBTC is managed by institutions. 

For its part, RenBTC uses a decentralized approach by deploying a decentralized network of nodes called the Ren Virtual Machine (RenVM) to wrap tokens. 

While a decentralized system is more desirable, RenBTC has simply not caught on as much as Wrapped Bitcoin. The latter’s centralized nature, though a potential pitfall, also powers greater liquidity and ease of use for many users.

WBTC vs tBTC

tBTC is another wrapped Bitcoin solution that wants to address the centralization issue of WBTC. 

Instead of trusting a custodian, tBTC relies on cryptography and a randomly chosen group of operators on the Threshold Network to safeguard your Bitcoin. This group of operators is rotated weekly to prevent collusion for theft of holdings.

Even though this decentralized system ensures a more secure system, it hasn’t worked in tBTC’s favor in terms of gaining traction. WBTC remains the go-to wrapped Bitcoin for the vast majority of users.

FAQs

How can I convert WBTC back to Bitcoin?

To convert WBTC back to Bitcoin, send your WBTC tokens to a trusted custodian or exchange that supports exchanging WBTC for BTC. 

Who uses WBTC?

WBTC is used by Bitcoin holders who want to access Ethereum’s DeFi ecosystem to trade, borrow, participate in yield farming, or put up Bitcoin as collateral to borrow other assets against their BTC holdings.

Is WBTC safe to use? 

WBTC is relatively safe thanks to the guardrails that its founders have put in place, such as transparency. However, you should also consider doing your own background check before entrusting your Bitcoin to custodians.