Bitcoin is the most recognizable cryptocurrency or digital asset in the world, but since the Bitcoin protocol doesn’t natively support general smart contracts, there isn’t an easy way to use it in decentralized finance (DeFi). WBTC is one solution to this problem. In this article we go into more detail about what exactly WBTC is, and why there is a need for it.
What is WBTC?
WBTC is an ERC-20 token on the Ethereum and other blockchains that is backed one-to-one with Bitcoin (BTC). It was the first widely adopted form of wrapped Bitcoin on Ethereum. Before WBTC, the only way to use Bitcoin as a financial derivative was through centralized entities, like centralized exchanges (CEXs). WBTC was launched in January 2019 as a way to give decentralized applications (DApps) on Ethereum access to Bitcoin. Now, WBTC is routinely swapped on decentralized exchanges (DEXs) and used as collateral on lending platforms and derivatives platforms.
Learn more about the different types of wrapped Bitcoin.
What is the need for WBTC?
Bitcoin's lack of native smart contract functionality limits its direct use in DeFi. WBTC was among the first to solve this by creating a tokenized representation of Bitcoin on Ethereum and other blockchains. This offered several advantages:
- DeFi Accessibility: WBTC unlocked Bitcoin's value for DeFi, expanding its utility beyond a store of value. Explore the world of decentralized finance: What is DeFi?.
- Liquidity Boost: WBTC injected Bitcoin's value into DeFi, increasing liquidity and facilitating efficient trades. This is crucial for DeFi market growth and stability. Understand liquidity's importance: What is liquidity?.
- Faster Transactions: WBTC transactions on Ethereum benefit from faster block times than native Bitcoin transactions, crucial for capitalizing on market opportunities. Learn about Bitcoin's transaction speed: How do Bitcoin transactions work?.
- Expanded Utility: WBTC allowed Bitcoin holders to participate in DeFi activities like lending, borrowing, and yield farming. Discover DeFi use cases: DeFi Use Cases.
How is WBTC created?
Creating WBTC is called, “minting." To mint WBTC, submit a request to a WBTC merchant along with payment. The payment will be the amount of WBTC you want plus a fee for minting. The merchant will complete Anti Money Laundering (AML) and Know Your Customer (KYC) on the submitter. If everything checks out, the merchant will send BTC to the custodian, who will mint the equivalent amount of WBTC. This minting occurs at known addresses that anyone can track. The custodian deposits the BTC at known reserve addresses. The custodian sends the newly minted WBTC to the merchant. Upon receiving the WBTC, the merchant will send it to the submitter.
To get back BTC, simply reverse the process. Pay a fee and submit WBTC to a merchant. The merchant will pass the WBTC to the custodian, who burns the WBTC and sends back the appropriate amount of BTC from the reserves address. The merchant forwards the BTC to the submitter.
Risks of Using WBTC
- Smart Contract Risk: WBTC relies on smart contracts, which can have vulnerabilities. Learn about common dApp risks here.
- Custodian Risk: Trust is placed in custodians holding the reserve Bitcoin. Learn about custodial vs. self-custodial solutions here.
- Market Risk: WBTC's value is tied to Bitcoin's volatile price. Learn more about volatility in the crypto markets here.
Are there other types of wrapped Bitcoin besides WBTC?
Several types of wrapped Bitcoin tokens have emerged besides WBTC, each with its own approach to security, custody, and use cases. Learn more about the the various types of wrapped Bitcoin here.
Conclusion
WBTC is a crucial bridge between Bitcoin and Ethereum's DeFi ecosystem. It allows Bitcoin holders to participate in DeFi, enhancing liquidity and expanding Bitcoin's utility. While risks exist, WBTC's transparency and security measures make it a valuable tool for navigating the DeFi landscape. As both Bitcoin and Ethereum evolve, WBTC's role will likely adapt to the changing DeFi environment.
