The lack of a DeFi ecosystem native to the Bitcoin blockchain has sparked frantic attempts to create bridges between legacy blockchains. While research on interoperability is still ongoing, the Bitcoin community has come to rely on tokenized BTCs as a temporary gateway to the emerging DeFi market.
In this article, we will explore the importance of this solution and the various options involved in how to wrap Bitcoin. Before that, let’s quickly go through the concept of wrapped Bitcoin.
What is Wrapped Bitcoin?
Wrapped Bitcoin (WBTC) is an ERC-20 token that represents Bitcoin (BTC) on the ETHereum blockchain. Through a WBTC partner, 1 Bitcoin can be converted to 1 Wrapped Bitcoin, and vice-versa.
A key advantage of WBTC is its integration into the world of ETHereum wallets, dapps, and smart contracts since WBTC was created to allow Bitcoin holders to participate in decentralized finance (“DeFi”) apps that are popular on Ethereum.
Why Wrap Bitcoin?
Bitcoin has long maintained its dominance as the largest cryptocurrency by market cap. This is in part due to the perception that coin and its network deliver top-notch security and an unparalleled degree of decentralization. There is significant evidence that new investors are most likely to buy Bitcoin before exploring the altcoin market.
While this is a given, DeFi’s yield-generating opportunities rely upon smart contract-supporting altcoin blockchains. With Bitcoin remaining a siloed ecosystem, it’s almost impossible for BTC holders to directly engage with the DeFi market without giving up their Bitcoin positions in order to have a chance at accessing DeFi-compatible coins.
Thus, as part of DeFi proponents’ and developers’ efforts to lower the barrier to entering the DeFi market, these entities have devised various ways of representing Bitcoin on ETHereum and other popular smart contract-supporting blockchains. Predominantly, such systems issue tokenized Bitcoin via smart contract-supporting blockchains and maintain a 1:1 peg between Bitcoin and a tokenized version of the digital asset.
For example, wrapped Bitcoin or WBTC, which is by far the most popular DeFi-enabled version of Bitcoin, always reflects the market price of BTC. WBTC users can therefore explore the DeFi terrain and still reap the benefits of Bitcoin’s solid price performance.
How to Wrap Bitcoin: Bitcoin Wrapping Techniques
There are three different approaches to tokenizing Bitcoin, all of which require users to lock BTC or other digital assets in order to receive tokens pegged to the value of Bitcoin.
Centralized Wrapping
As its name implies, centralized Bitcoin wrapping involves intermediate processes governed by third parties. Here, you will need to send an amount denominated in BTC to a centralized custodial platform. Subsequently, this platform will lock your Bitcoin in a smart contract and mint an equivalent amount of tokenized Bitcoin on ETHereum or any other specified blockchain. Finally, the merchant will transfer the tokenized Bitcoin to your wallet.
Trustless Wrapping
When using a trustless wrapping model, you do not need to trust a centralized entity. You can directly send your Bitcoin to a smart contract programmed to mint tokenized Bitcoin equivalent to the amount of locked BTC. One example of a Bitcoin wrapping system utilizing a trustless technique is Keep Network.
Synthetic Wrapping
Lastly, some Bitcoin wrapping solutions allow users to receive synthetic assets pegged to the value of Bitcoin. Unlike the other two models, synthetic wrapping does not necessarily use BTC collateral to mint a Bitcoin-pegged synthetic token. Depending on the protocol, you can lock a combination of digital assets in order to mint synthetic Bitcoin.
Downsides of Wrapping Bitcoin
Using a wrapped version of Bitcoin trades away the decentralization and security of the Bitcoin network, since these tokens are native to other blockchain ecosystems, some of which are not as decentralized as Bitcoin. Tokenized Bitcoin therefore mirrors only the value of BTC and not the decentralization and security prowess of the Bitcoin blockchain.
Conclusion
As highlighted in this guide, tokenizing Bitcoin allows you to make the most of your BTC holdings. And now that you know how to wrap Bitcoin and the techniques used to do so, you can now create more value without completely dropping out from the value chain of the Bitcoin ecosystem. However, before rushing to wrap your Bitcoin balance, be sure to understand the downsides and to pick the most suitable wrapping technique for your needs.
