At Crypto Explained, we are on the mission of making crypto easy for everyone.
If you appreciate our effort, don’t forget to subscribe to receive our weekly Newsletter directly in your email! I’m grateful for the support!
When I first encountered the likes of wBTC (or wrapped Bitcoin), I was quite confused about what it was, how it was different from a regular Bitcoin, and what was the point of having it to begin with.
So today, I’ll be answering these questions.
Wrapping a coin is a term used to describe the process of taking a cryptocurrency and create a tokenized version to be able to use in another blockchain.
Let’s use the
example of wBTC
to understand this better:
BTC is a cryptocurrency that is built on the Bitcoin network,
Bitcoin network has limited functionalities. This means that it’s not like Ethereum or other smart contract platforms, where a lot of projects and applications are built, creating a large ecosystem of use cases around DeFi, NFTs, DAOs;
Given the fact that blockchains today operate like siloed ecosystems without the ability to interact and exchange assets and data between each other (aka the
interoperability challenge
), you can’t get your Bitcoin on Ethereum’s DeFi apps to say, earn passive income.As a result, if you hold Bitcoin, there is not much you can do with it but just hold it, waiting for the value to go up… or can you?
Enters, wrapped Bitcoin, an interoperability hack.
Some background… How did it all start?
As the crypto developers tackle the interoperability challenge, the rise of Decentralized Finance has injected some major FOMO into the crypto world.
With Ethereum leading the way in DeFi development, the question was how to get all those non-Ethereum based cryptocurrencies to gain access to these DeFi protocols, especially Bitcoin.
As a result, “wrapping” came up as one of the solutions.
So what is Wrapping?
Basically, “wrapping” refers to the process of creating a tokenized representation of a cryptocurrency in order to make it compatible and be used in another blockchain.
Think of it like when you go traveling: you will need to convert whatever currency you are holding, to the acceptable currency in the destination country you are going. Say if I’m holding Argentinian Pesos (ARS) and I’m going to the US, I will need to make sure I have USD to be able to buy things, as my ARS over there has no validity, it would just be paper with no value.
So same thing happens in the crypto world. Following the example used, if you want to use your Bitcoin in Ethereum, then you gotta convert your Bitcoin into a compatible version with that new ecosystem you are getting into.
Why do people bother doing it?
Well, each blockchain has different capabilities, and some of these capabilities can be quite attractive, especially in the DeFi space.
So instead of having assets laying there, the idea is to move it to the blockchain where you can leverage your crypto in a number of ways, such as:
lending it out for some passive income,
borrowing,
provide liquidity in the likes of Aave, Uniswap, etc,
staking it to earn rewards,
access to more trading pairs
etc…
The point is to increase liquidity, put your holdings to work.
How does it work?
Let’s continue with the example of using Bitcoin on Ethereum.
Typically, wrapped assets work on a 1:1 basis, which means in order to get 1 wBTC, you will need to use 1 BTC as collateral.
There is a custodian that can be a third party, or a protocol, that will:
Verify the amount of Bitcoin you have,
Lock up (therefore the term “wrapping”) your original Bitcoin to avoid double-spending issues,
Mint a wrapped Bitcoin in return to you.
This wrapped Bitcoin will be an ERC20 token version of the original BTC, which means is compatible with Ethereum applications.
(If you are not familiar with the difference between coin and token, and what ERC20 tokens are, you can read this article here)
This process works in reverse as well, if you want to convert your wBTC back to the original BTC, you just need to follow the inverting process.
Now, here are a few call outs to clarify some things:
Getting a tokenized version of your crypto doesn’t mean you are any richer than before, just like writing a check doesn’t create a new asset, it balances off.
We use Bitcoin as an example here, but you can wrap many other cryptocurrencies.
Ethereum is also not the only smart contract platform you can do this on.
Other players in this space…
Well, wrapping is originally a term coined by a particular custodian, and the tokenized version of the assets minted by them carries the signature “w” in front of it, such as wBTC or wETH.
However, wrapping became a term used to represent the overall process of tokenizing an asset.
In reality, there are other players, who provide the same function, which is why you see so many differnet kind of Bitcoins.
They are all tokenized versions of Bitcoin, just done by different custodians.
Some examples of players in this field are:
wBTC - created by BitGo, Kyber and Ren in 2019, a more centralized option.
renBTC - REN is an open protocol which allows for bridging assets to Ethereum. It’s a more decentralized option.
tBTC - it is a permissionless project created by Keep, Summa and Cross-Chain Group.
sBTC - created by Synthetix Protocol, in this case we are talking baout a synthetic asset, so there is no underlaying BTC at all. Instead, as the rest of the synthetic assets, they are secured by collateral in form of snx token, which is highly over collaterilized, to absorb any sharp price changes.
This image illustrates that wrapping crypto happens more often than you imagine… this is just a screenshot focused only on BTC, and just wBTC only is currently positioned in the top 17th rank, with a market cap of over $11 Billion.
Final thoughts - What are some of the trade-offs?
There are a few that comes to mind that I’d highlight before ending today’s post:
Weaker security (for example, in the case of BTC, Bitcoin’s security is stronger that the smart contract platforms),
Some custodians are centralized companies, like the case of BitGO, which means you are giving them access to your crypto,
Potential smart contract or admin key risks, especially in less established DeFi protocols.
Thanks for making it this far. Coming up soon is “Types of NFTs!” so don’t forget to subscribe if you don’t want to miss out!
Also, if you enjoyed this article, help support by liking and sharing. I’m grateful!