What is Wrapped Bitcoin (WBTC)?
According to BTC on Ethereum, there is now more than $2 billion worth of wrapped Bitcoin on Ethereum. What’s impressive isn’t just the total amount of BTC locked up; it’s the growth.
At the beginning of 2020, there was less than $20 million worth of BTC on Ethereum. Eleven months later and we’re at $2 billion. If this trend continues, by mid-2021, there will be $10 billion worth of BTC on Ethereum.
In this article, we’ll consider the advantages and disadvantages of wrapped Bitcoin, how it works, some of the different protocols, and what the future might hold for BTC on Ethereum.
What is Wrapped Bitcoin?
Wrapped Bitcoin is a way to lock up Bitcoin (BTC) in a smart contract on the Ethereum (ETH) blockchain. A smart contract can turn the BTC into an ERC20 token, which is the standard token type used on Ethereum.
The process of locking up the Bitcoin and turning it into an ERC20 token is known as “wrapping.” Once the BTC is turned into an ERC20 token, it can be used in Ethereum’s rapidly expanding DeFi ecosystem. Traders can,
- Deposit wrapped Bitcoin into a yield aggregator and earn interest on their deposit
- Supply liquidity to Uniswap and earn a percentage of trading fees
- Deposit wrapped Bitcoin in MakerDAO and take out a collateralized loan
There are lots of different reasons that someone might want to use wrapped Bitcoin. We even wrote an article explaining how Ethereum could scale Bitcoin. This isn’t possible yet since Ethereum can’t scale; however, if Ethereum can scale in the future, then wrapped Bitcoin could take advantage.
Ethereum could function as a second layer scaling solution to Bitcoin, not dissimilar to the lightning network.
The Advantages of Wrapped Bitcoin
You can’t really do much with normal Bitcoin, which is great! Bitcoin is not supposed to be flashy and exciting; it’s supposed to be the world’s most secure cryptocurrency. Which it is. However, if you want to earn interest with your Bitcoin, or do anything else “interesting” with it, you’ll need to use wrapped Bitcoin.
You can deposit wrapped Bitcoin in a DeFi protocol like MakerDAO and take out a loan. Or another way to look at it: decentralized leverage. Take out a loan with WBTC, use the money to buy even more WBTC.
WBTC and other wrapped Bitcoin alternatives can also be traded on decentralized exchanges like Uniswap. In addition to trading WBTC, you can also put it on Uniswap to earn a return based on trade fees. Or you could lock it up in a platform like Compound to earn interest on your deposit.
In general, having wrapped Bitcoins gives the trader way more flexibility in how they use their coins. Instead of just holding BTC, with wrapped Bitcoin you can take out loans, provide liquidity, earn a passive income, trade on a decentralized exchange, etc.
The Disadvantages of Wrapped Bitcoin
Bitcoin’s value proposition is security, security, security. We saw a great example of this when the Bitcoin community decided to reject larger block sizes. They wanted to keep the blockchain small to maximize the number of people who could run a node.
On the Bitcoin network, security is more important than anything else. Bitcoin is what you want to have when the global financial system melts down.
Given Bitcoin’s role as a secure asset, holding BTC on the Ethereum blockchain somewhat defeats Bitcoin’s purpose. The smart contract holding the Bitcoin could be exploited, leading to a massive loss. Or, in the case of WBTC (more on this in the following section), the company could start freezing wallets so that the Bitcoin can’t be redeemed.
We can draw a good parallel between wrapped Bitcoin and gold. A lot of people buy gold to hedge against the collapse of the financial system. The serious investor will hold physical bullion in a safe, where they can access it even if the financial markets go offline. Having gold in a safe is akin to holding Bitcoin in a non-custodial wallet like Exodus, where the user has 100% control over their coins.
The less serious investor will buy gold via an ETF, so-called “paper gold.” The problem is that in the event of a severe disruption to the financial system, nobody can say what will happen to these paper gold products. They don’t offer the same level of security as holding physical gold. This is the same as holding Bitcoin on Ethereum. Although it may be convenient, the investor is sacrificing security.
The Different Flavors of Wrapped Bitcoin
There are a couple of types of wrapped Bitcoin. All of the coins use the ERC20 token standard; however, some different protocols and companies do the wrapping.
By far, the largest type of wrapped Bitcoin is WBTC. This was the original wrapped Bitcoin and is controlled by the company BitGo. The advantage of BitGo is that there is a long security track record. It’s unlikely that there is an exploit lurking deep in the code.
The disadvantage of WBTC is that BitGo is a centralized company that controls the wrapping and redemption process. They can freeze accounts and prevent people from redeeming their Bitcoin.
Several decentralized wrapped Bitcoin protocols are quickly gaining ground. RenBTC already has $250 million in Bitcoin locked up, and TBTC recently relaunched, although the protocol only has about $13 million worth of BTC locked up so far.
It will take a while for these decentralized protocols to gain the trust of users. However, if they prove reliable, they’ll probably overtake the centralized wrapping services in the future.
The First Step
The key to taking advantage of Bitcoin on Ethereum is to perform an honest accounting of the benefits and drawbacks. For the person holding Bitcoin to hedge against the financial system’s collapse, ultimate security is ideal. They should probably consider keeping their BTC in a non-custodial wallet.
However, so long as you’re aware of the risks, there are many opportunities to earn a passive income with BTC on Ethereum. At this point, WBTC has been around for several years and has proven itself to be a relatively safe product, at least by crypto standards. For more information about WBTC and other wrapped Bitcoin products, you can check out DeFi Pulse as well as DeFi Rate.
This content is for informational purposes only and is not investment advice. You should consult a qualified licensed advisor before engaging in any transaction.