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tl;dr
- WBTC is a cryptocurrency backed by Bitcoin and built on the Ethereum blockchain.
- WBTC was created to address the limitations of Bitcoin in the DeFi ecosystem.
- To get WBTC, a user must first request tokens from a merchant.
- The creation of new WBTC tokens is known as minting, and the opposite process of burning WBTC tokens is performed when users want to redeem them for Bitcoin.
- Wrapped tokens enable users to take advantage of the features and benefits of a different blockchain network without having to sell or convert their original assets.
- WBTC offers increased liquidity, interoperability between Bitcoin and Ethereum networks, transparency, and security.
What is WBTC?
Wrapped Bitcoin, or WBTC, is a cryptocurrency backed by Bitcoin and built on the Ethereum blockchain. It is the first ERC20 token backed 1:1 with Bitcoin, meaning each WBTC token represents one Bitcoin.
There were other cryptocurrencies that mirrored Bitcoin's value on Ethereum and other smart blockchains, including renBTC. None, however, have reached WBTC’s level of popularity. Ren Protocol, the creator of renBTC, was purchased by the now-defunct Alameda Research and eventually closed operations after their collapse.
Why do we Need WBTC?
WBTC was created to address the limitations of Bitcoin in the DeFi ecosystem. Bitcoin, being a non-Ethereum asset, cannot be used natively in Ethereum-based applications such as DEXs and lending platforms. WBTC solves this problem by allowing Bitcoin holders to convert their Bitcoin into WBTC, which can then be used in DeFi applications.
By creating an ERC-20 token that mirrors the worth of Bitcoin, WBTC brings the liquidity of Bitcoin to the Ethereum ecosystem. This allows holders of WBTC to participate in DeFi applications, earn interest on their holdings, and trade their tokens in a trustless and decentralized manner.
How Does WBTC Work?
In order to obtain WBTC, a user must first request tokens from a merchant. The merchant then carries out the necessary KYC/AML procedures to verify the user's identity. Once the verification process is complete, the user and merchant can proceed with the swap. During the swap, Bitcoin from the user is transferred to the merchant, while WBTC from the merchant is transferred to the user.
The creation of new WBTC tokens is known as minting, which is initiated by a merchant and carried out by a custodian. The custodian is responsible for holding the Bitcoin that supports the WBTC token and issuing new WBTC tokens when Bitcoin is deposited. Similarly, they also perform the opposite process of burning WBTC tokens when users want to redeem them for Bitcoin.
Many average WBTC holders and traders purchase the token from a centralized exchange or DEX, sidestepping the wrapping process.
How to Unwrap WBTC back to Bitcoin?
If you want to unwrap WBTC to Bitcoin, you need to burn your WBTC tokens. Burning is the process of redeeming or unwrapping Bitcoin for WBTC tokens. However, only merchant addresses can perform this action. To initiate the burning process, merchants need to deduct the amount to be burnt from their WBTC balance on-chain, which will then reduce the supply of WBTC.
Merchants play an essential role in the WBTC community as administrators who initiate the process of minting newly wrapped tokens and burning wrapped tokens. The burning process is performed by the custodians. Custodians are responsible for holding the Bitcoin that backs the WBTC token and issuing new WBTC tokens when Bitcoin is deposited. Similarly, they also perform the opposite process of burning WBTC tokens when users want to redeem them for Bitcoin.
WBTC token holders can also swap their WBTC for BTC using an exchange or swap protocol such as ThorChain’s ThorSwap.
Wrapped vs. Unwrapped Tokens
Wrapped and unwrapped tokens are two types of digital assets that are commonly used in blockchain-based systems. Unwrapped tokens are native tokens that are specific to a particular blockchain network, such as Bitcoin on the Bitcoin network or Ether on the Ethereum network. They can be used for a variety of purposes, such as paying transaction fees, participating in governance, or being used as a means of exchange.
Wrapped tokens, on the other hand, are tokens that represent other assets, such as Bitcoin or other cryptocurrencies, on a different blockchain network. They are created through a process called wrapping, where the original asset is locked in a smart contract, and an equivalent amount of the wrapped token is issued on the target blockchain network. Wrapped tokens enable users to take advantage of the features and benefits of a different blockchain network without having to sell or convert their original assets.
WETH vs. WBTC
WETH and WBTC are two types of wrapped tokens that are commonly used in the Ethereum network. WETH, or Wrapped Ether, is an ERC-20 token that represents Ether on the Ethereum network. It is created through a wrapping process, where Ether is locked in a smart contract, and an equivalent amount of WETH is issued on the Ethereum network. WETH can be used for various purposes, such as trading on decentralized exchanges or participating in other Ethereum-based applications.
WBTC, or Wrapped Bitcoin, is another type of ERC-20 token that represents Bitcoin on the Ethereum network. Like WETH, WBTC is created through wrapping, where Bitcoin is locked in a smart contract, and an equivalent amount of WBTC is issued on Ethereum. WBTC enables Bitcoin holders to use their assets in Ethereum-based applications and exchanges, providing greater liquidity and flexibility.
Advantages and Disadvantages of WBTC?
WBTC offers various benefits for those interested in using Bitcoin in Ethereum-based dApps and exchanges. For instance, it provides increased liquidity, interoperability between Bitcoin and Ethereum networks, transparency, and security. These advantages make it easier for users to transact with Bitcoin on the Ethereum blockchain, which expands the usability of Bitcoin beyond its own network.
However, there are some potential drawbacks to using WBTC. For example, one of the main concerns is the reliance on custodians to manage the backed Bitcoin. This reliance on centralized entities may increase counterparty risks and reduce the decentralization aspect of blockchain technology. Another concern is the KYC/AML requirements for users that may limit the privacy aspect of cryptocurrency. Moreover, the process of wrapping and unwrapping Bitcoin may be complex and time-consuming for some users, which may deter them from using WBTC.
