Have you heard about wrapped cryptocurrency but weren't sure what it was? You may just be surprised by some of the ways they can be used.
If you're only just starting to get your feet wet exploring decentralized finance and cryptocurrencies outside of bitcoin, you may have begun to notice wrapped cryptos or even wrapped bitcoin. So what is wrapped bitcoin anyway, and how can it be useful?
What is the Purpose of Wrapped Cryptocurrencies?
Wrapped cryptocurrencies enable some of the attributes of a cryptocurrency to be transferred to alternative blockchains to which the digital asset is not native. While wrapping cryptocurrencies does lose the source network’s benefits, it shares some valuable variables such as price discovery and demand.
Not all blockchains can do all things well or in the same ways; this leads to interest in combining a cryptocurrency with another network to create a form of hybrid asset, a wrapped cryptocurrency or wrapped tokens. Even on Ethereum, one of the most popular networks for wrapped tokens, wrapped Ether is actively traded and used in various ways.
Why Do We Need WBTC?
Wrapped BTC (WBTC) makes Bitcoin's liquidity more accessible to decentralized exchanges (DEXs) and allows token traders to leverage some of the benefits of the Bitcoin ecosystem without having to use the network directly. While the majority of trading volume taking place on centralized exchanges is with Bitcoin directly, WBTC brings Bitcoin to DEXs and decentralized finance applications (DeFi dApps).
Even though you may never need to use a wrapped token as a Bitcoin user at all, you may stumble on a use case that is only possible by using WBTC to take advantage of something offered by an alternative blockchain. As DeFi applications become more advanced inside the Ethereum ecosystem and beyond, wrapped tokens are likely to become more of a staple of the cryptocurrency space. It’s entirely possible they will continue to spread the benefits of bitcoin beyond the bitcoin blockchain in a way that effectively brings BTC into markets with greater liquidity opportunities, allow for more exchange options, and alternative markets that otherwise may not have been possible without exploring other blockchains.
Is Wrapped Bitcoin the Same as Bitcoin?
No, but it doesn't mean it can't maintain a peg to the value of the underlying asset, which in the case of WBTC tokens is, as you have likely guessed, Bitcoin. If you've ever used a stablecoin like Tether (USDT), you'll find this concept relatively easy to understand, as, at its core, the idea is very similar.
One of the crucial things to remember is that you can't send wrapped bitcoin to a regular bitcoin wallet as the tokens will exist only on the network they are minted. So, for example, if you were using a wrapped bitcoin ERC-20 token on the ethereum blockchain, you'd need to use an ethereum wallet to send and receive it. This is because while the tokenized version of bitcoin can hold the same or similar value, the tokenized form is very much a different cryptocurrency in the more literal sense.
Benefits of using wrapped tokens
- Wrapped tokens allow for use in a given blockchain without native tokens
- Wrapped tokens can be traded on many DEXs that may not otherwise be possible
- Wrapping crypto on other chains can connect otherwise isolated liquidity
- Wrapped tokens can be used on a blockchain with faster confirmation times
- Depending on the chain, it can be cheaper to move a wrapped cryptocurrency
Is Wrapped Bitcoin Real?
Several of Bitcoin's features are lost after being converted to WBTC tokens, including the security of the Bitcoin network and the ability to send instant payments via the Lightning Network. However, DeFi users, in general, have been relatively receptive to tokenized bitcoin (especially on the Ethereum blockchain) in the growing decentralized finance market to leverage bitcoin's dominance alongside a range of DeFi protocols and for the additional decentralized exchange options that are provided by bitcoin holders tokenizing some of their BTC into wrapped BTC.
Wrapped Cryptos and DeFi Interoperability
Wrapped crypto tokens allow the use of crypto assets on non-native blockchains. This interoperability means that a cryptocurrency such as bitcoin can interact with the ecosystem of decentralized software on this new network, interact with smart contracts, or even act as collateral against types of credit in a DeFi lending protocol or similar projects.
Is Wrapped BTC Safe?
To wrap bitcoin requires the bitcoin to be held securely (or at least as securely as possible) and avoid it being exposed to the market. When a wrapped token is minted that represents bitcoin, the bitcoin in question mustn’t be accessible; otherwise, the token becomes essentially useless. The actual mechanisms used and the specifics of how the "wrapping" is performed vary from project to project. When exploring how safe a wrapped token is, it's best to look specifically at the type of wrapper you plan to use and look at things like the track record of the project.
The Future for WBTC Tokens
As more novel approaches to wrapped tokens are explored on the ethereum network and beyond, the risk profile for wrapped tokens may change with time, as will some of the use cases for these forms of tokens. While you won't see much in terms of smart contracts or liquidity pools popping up on the bitcoin network any time soon, you will see them on the many other blockchains starting to provide options for wrapped bitcoin (WBTC) and other crypto assets.
Is wrapped bitcoin the solution to bringing bitcoin into the DeFi ecosystem, or are there other surprising advancements on the horizon? Only time will tell what the creativity of the cryptocurrency community will create.