Wrapped Bitcoin

We continue exploring the Bitcoin ecosystem by looking into Wrapped Bitcoin (WBTC), which was launched with the purpose of bringing Bitcoin’s liquidity and value into Ethereum. It was launched in October of 2018 as the result of the collaboration between several actors:

• Kyber Network

• REN (formerly Republic Protocol)

• BitGo

The initial consortium of founders released the first whitepaper in 2019. WBTC was initially launched with 8 merchants who facilitated Bitcoin-to-WBTC conversions. More merchants have been added since.

The project quickly gained support across many DeFi protocols like MakerDAO and Compound. WBTC is currently operated by the WBTC DAO.

Due to Bitcoin’s limited programmability, BTC can’t be used on DeFi dApps, hence why it needs to be wrapped in another network.

Wrapped Bitcoin (WBTC) is, at last, established as an ERC-20 token representing Bitcoin on the Ethereum network. Users are able to swap it 1:1 for BTC. WBTC tokens allow holders to participate and provide liquidity to Ethereum's DeFi ecosystem.

How it Works

Custodian Model

WBTC utilizes a custodian model where a single centralized entity, BitGo, holds Bitcoin while the equivalent WBTC is issued on Ethereum. While this model provides a straightforward solution for tokenizing Bitcoin on Ethereum, it introduces custodial risks.

To address security concerns with custodians, WBTC undergoes security audits to ensure the custodian’s security and more features are implemented to improve the overall system’s security.

Users cannot mint or burn WBTC directly as these processes are controlled by a consortium of merchants and custodians. To acquire WBTC, users must go to pre-approved merchants that have passed initial KYC and AML processes. The minting and burning process works as follows:

• Minting

Users send Bitcoin to merchants and they send a request to the custodian to lock up the user’s Bitcoin. An equivalent amount of WBTC is minted on the Ethereum network.

Once the custodian confirms the Bitcoin in question was received, they authorize the minting of Bitcoin on the user’s Ethereum address.

• Burning

The minting process is reversed. First, the user sends back the WBTC to the merchant who burns the requested amount and sends a request to the custodian to release the equivalent amount of Bitcoin to the user’s Bitcoin address.

The value of WBTC is updated in real-time and the price is publicly available at all times via crypto data aggregators like CoinMarketCap. Its value is updates using several oracles and price feeds including:

• Chainlink: they provide WBTC/USD and BTC/USD price feeds to determine the WBTC price in real time.

• DIA: they have a Wrapped BTC API that provides real-time data for WBTC, the data is sourced from multiple CEXs and DEXs.

• Aave: WBTC’s price is based on a feed that properly prices the WBTC component and not just assumes that the price of WBTC is equal to BTC’s.

Thanks to its custodian approach, the peg between BTC and WBTC is kept thanks to the burning and minting process where a 1:1 peg is always maintained. This approach, while effective, is also one of the main concerns as it introduces counterparty and centralization risks.

WBTC DAO

The protocol is controlled by a DAO that currently has 17 members that represent stakeholders from the DeFi ecosystem and they hold a key to the multi-signature wallet that secures the system. With their keys, members can vote to add or remove members as well as making changes to the smart contracts the system uses.

Security

• BitGo audits the system regularly and performs a proof of reserve transaction on the Bitcoin blockchain, which allows users to verify that bitcoin reserves are valid.

• The DeFi community is enabled to view both the minting and burning of WBTC on Ethereum and Bitcoin blockchains.

Stakeholders

1. Users

These are individuals who want to use Bitcoin on the Ethereum network.

2. Custodians

Entities who are responsible for holding and managing Bitcoin. The custodian is in charge of ensuring that the peg is stable and that the deposited Bitcoin is safe.

Custodians are selected based on their trustworthiness, security measures, and track record. They are normally regulated financial institutions or specialized custodial services. There is not much information regarding the selection process, but as mentioned above, the WBTC DAO members can vote to add or remove members.

3. Developers

Those who integrate WBTC into apps or build atop Ethereum.

The Wrapped Bitcoin Landscape

While WBTC is by far the most popular option for making Bitcoin compatible with other networks (Ethereum), there are more options available. Other options include:

• BTC.b: A wrapped Bitcoin on the Avalanche Network that doesn’t require a custodian.

• tBTC: A wrapped Bitcoin that uses the Threshold network for decentralized custody.

• HBTC: Huobi’s version of wrapped Bitcoin that is centralized on that platform.

• BBTC: Or Binance Wrapped Bitcoin, is a wrapped Bitcoin backed by BTC reserves custodied by Binance.

• xBTC: A custodial Bitcoin peg on the Stacks blockchain.

• sBTC: it brings Bitcoin to Stacks. It is fully decentralized and has no central custodian, thus no trust issues and no custodial fees, keeping costs low.

 Wrapped Bitcoin Downsides

• WBTC has several challenges that include centralization risks attributed to their custodian model as well as limited interoperability since the flow is tied between Bitcoin and Ethereum only.

• WBTC has a Single point of failure, as if the custodian collapses, all deposited BTC could be used to pay off debts and investors, causing users to lose their funds.

• Since WBTC is tied to Ethereum’s development, any upgrade to the Ethereum blockchain can directly affect WBTC.

• Efforts to make WBTC multichain have not been successful as it is challenging to expand its presence to other blockchains as it means involving more custodians and approved merchants.

It seems that there needs to be a solution that isn’t as centralised, nor is tied to Ethereum.

And we know just the protocol for that…

Stayed tuned.