What is Wrapped Bitcoin? – The Defiant

by James · September 16, 2022

Incompatibility is inevitable when you have dozens of blockchain networks with their own smart contract formatting. This is why Bitcoin cannot simply be transferred to Ethereum in its original state. Bitcoins can be wrapped as Ethereum-compatible ERC-20 tokens, making it Wrapped Bitcoin (WBTC).

Wrapped Bitcoins are to Bitcoin what the USDT stablecoin is to the dollar. Both work around incompatibility via a new, compatible digital asset rooted in the original. But is there more to packaging than meets the eye?

Table of Contents

Why do we need wrapped tokens?

The easiest way to convert tokens is through a centralized exchange. For example, Binance Convert allows cryptocurrencies to be exchanged without a fee. If one were to convert Bitcoin to Avalanche, these coins can be sent to a non-custodial wallet that plugs into the Avalanche ecosystem of dApps.

Likewise, the same can be done for BTC-ETH conversion. The question then is, why do we need wrapped tokens? The answer is related to cryptocurrency volatility. For example, what if one wants to use Bitcoin as collateral for Ethereum’s lending dApp like Aave? As the dominant cryptocurrency with the largest market cap, Bitcoin is the least volatile cryptocurrency.

This means that Bitcoin will be a better security for a loan than a more volatile cryptocurrency. Otherwise, more volatile collateral may trigger liquidation of loans. On smart contract platforms that have an even lower market cap than Ethereum, this is even more important to consider.

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This is where wrapped tokens come in. A wrapped token represents cryptocurrency on another blockchain, so it can be used as such, with its price tied to the original. Similarly, USD Coin stablecoin represents paper USD bills on a blockchain so that dollars can be spent on blockchain networks as stable digital assets.

Loose blockchain interoperability

Each blockchain network has its own set of validators, governance rules, native tokens, and even smart contract formatting. For example, while Ethereum has the ERC-20 smart contract standard, TRON (TRX) has TRC-20 tokens. Similarly, Binance Smart Chain (BSC) uses the BEP-20 standard to distribute its tokens.

There are two main ways to deal with this incompatibility mess and interface with different blockchain networks, i.e. transfer digital assets:

Create 0 networks: Cross-chain networks such as Polkadot or Cosmos that create an ecosystem of interoperable blockchains, acting as the internet of blockchains.
Blockchain bridges: Cross-chain network protocols that convert tokens using smart contracts. Once a user deposits their tokens into a smart conversion contract, they are locked. The user can then withdraw them as tokens compatible with the blockchain network.

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It is the second interoperability method that generates wrapped tokens. In the case of WBTC, the bridge will typically convert deposited Bitcoin into ERC-20 tokens. This gives Bitcoin all the functionality and compatibility of any other ERC-20 based altcoin.

Depending on the target network, Bitcoin can also be wrapped in other token standards. With that said, not all blockchain bridges are created equal.

Blockchain Bridge Types

When dealing with digital assets, we need to consider how they are managed. This is the difference between custody and non-custodial custody. For example, depositing cryptocurrencies into a Binance account is equivalent to depositing them into a custodial wallet.

One would give up control over them because Binance would hold the user’s private keys. The exchange will then be the custodian, able to freeze crypto funds or the funds may be stolen by hackers. Also, the crypto exchange itself can go bankrupt, as happened with Voyager digital.

In contrast, using a non-custodial wallet means that users have their private keys and control over their crypto assets. Likewise, users will be responsible for protecting them. The same custodial dynamics are present in blockchain bridges:

Reliable or custodial bridges: These centralized bridges are usually faster, making it convenient to convert a large sum of tokens.
Faithless Bridges: Acting as decentralized networks, their security is equal to the underlying blockchain network. For example, xDai bridge converts Dai stablecoin from Ethereum to xDai stablecoin on the Gnosis blockchain.

When using decentralized services, there is naturally no customer support to call for help if something goes wrong. This is why one should always check the bridge’s track record.

What are the most popular Blockchain bridges?

Because Bitcoin and Ethereum are the two largest cryptocurrencies, they are the most targeted for wrapper conversion. Similarly, because Binance is the world’s largest cryptocurrency exchange, it is the most widely used to wrap tokens.

To convert BTC to WBTC, visit Binance Bridge and connect your Binance account. Originally contained to Binance Smart Chain (converted to BNB Chain), it has expanded to support Tron, Ethereum and Solana.

Therefore, one must first select the supported target chain for bitcoins to be wrapped. After Bitcoins are deposited into the Binance Bridge address for that chain, the bridge sends an equivalent amount of WBTC to the designated wallet.

You can use Binance Bridge to connect two other most popular cross-chain bridges, both of which are trustless.

Celer cBridge: supports 13 blockchain networks and their Layer 2 scalability solutions.
AnySwap: rebranded to Multichain, this decentralized cross-chain exchange protocol can convert any digital asset that uses EdDSA or ECDSA signature algorithms, which includes BTC and ETH, among many others.

Low gas taxes

To take full advantage of both wrapped Bitcoin and low gas fees, a conversion from WBTC to Ethereum’s Polygon sidechain is also very popular. After the completed conversion using one of these bridges, an additional step would be required – connecting the wallet filled with WBTC to the Polygon Bridge.

Wrapped Bitcoin (WBTC) is not the only compatible version of Bitcoin. There is also Binance Wrapped BTC (BBTC), Huobi BTC (HBTC), renBTC (RENBTC) and interest-bearing Bitcoin (ibBTC). To move them around across nine blockchain networks, Zapper Bridge should also be considered the most convenient option.

Is it safe to use blockchain bridges?

In the first half of 2022, hackers stole over $1.3 billion from blockchain bridges. This accounted for 69% of crypto-related hacks, according to the Chainalysis report. Cyber security expert from Elliptic, Tom Robinson, described this hacking spree in unflattering terms.

“Blockchain bridges have become the low-hanging fruit for cybercriminals, with billions of dollars worth of cryptoassets locked away in them,”

Robinson further noted that due to the variety of successful hacks, blockchain bridges have lower security than is typically found on blockchain networks. Also, hackers see blockchain bridges as easy pickings because they store assets. Therefore, they represent a centralized point of failure.

From this trend, it is safe to say that the development of lesser-known bridges is still in its infancy. Consequently, most users stick to Binance to simply convert BTC to WBTC, using the aforementioned Binance Convert. It is then easy to send WBTC to a MetaMask wallet that can be connected to Ethereum/Polygon.

Series disclaimer:

This article series is intended for general guidance and informational purposes only for beginners participating in cryptocurrencies and DeFi. The contents of this article should not be construed as legal, business, investment or tax advice. You should consult your advisors for all legal, business, investment and tax implications and advice. The Defiant is not responsible for lost funds. Use your best judgment and perform due diligence before interacting with smart contracts.