Wrapped Tokens: A Brief Introduction to WBTC & WETH
Since the development of Bitcoin´s blockchain in 2008, more cryptocurrencies have risen to prominence. These new tokens took Bitcoin’s promise of a decentralized and censorship-free digital currency to new heights.
Ethereum (ETH) introduced smart contracts and decentralized applications to blockchain technology. Litecoin (LTC) offers fast payment settlement and cheap transaction fees. Privacy coins like Monero (XMR) and Zcash (ZEC) are used for anonymous blockchain transactions.
There are hundreds of cryptocurrencies in existence today but they are all largely disconnected from each other. A digital token native to one blockchain can not be used on another blockchain. This is where wrapped tokens are important. A wrapped token´s value is pegged to another cryptocurrency and it can be used on a non-native blockchain.
Wrapped tokens are usually related to blockchain bridges. They have a stable value and offer cross-functionality between blockchains. Their value is always derived from the value of the crypto token they are pegged with.
Wrapped bitcoin, popularly known as WBTC was the first Wrapped Token. It is an ERC20 token pegged with a 1:1 ratio to Bitcoin. In this guide we will analzye wrapped tokens, their importance on DeFi and RSK’s RBTC Wrapped Token.
Understanding Wrapped Tokens
As per an estimate, there were more than 4,500 cryptocurrencies in existence by February 2021. The current bull market has brought more attention to cryptocurrencies and as a result, there are more digital coins being developed.
Each cryptocurrency has its own blockchain and native coins of one blockchain cannot be spent on another blockchain. This led to the development of wrapped tokens. A wrapped token is a tokenized version of another digital currency. They allow different tokens to be used on a non-native blockchain. A wrapped token is a cross-chain token that can be used on different blockchain networks. The process to convert a native crypto token into its wrapped form is called tokenization.
The tokenization of a cryptocurrency to a wrapped token is done by a custodian or a decentralized organization. A user sends his token to a custodian, the custodian mints a wrapped token and transfers them to the user. The custodian holds tokens equivalent in value to ones minted while the wrapped token remains in circulation.
A custodian could be a decentralized organization or a smart contract. When a user deposits digital tokens, the smart contract is triggered to mint wrapped tokens of equivalent value. These newly minted wrapped tokens are transferred to the user’s wallet. A wrapped token can be unwrapped or redeemed by the user at any given time. The original tokens are released back to the user as soon as he deposits an equivalent amount of wrapped tokens to the custodian.
Wrapped tokens make it easier to use a digital token on a non-native blockchain network. They are an important part of decentralized finance and also help to provide liquidity.
Why are Wrapped Tokens Important in the Crypto Market?
A wrapped token eliminates the need for exchanging or swapping tokens. They act as a bridge between different blockchain networks. They make interoperability possible between different blockchains. Blockchain networks are unique and have their own set of advantages. However, in the absence of wrapped tokens, these cryptocurrency networks would be isolated from each other. As a result, they would be less efficient and difficult to use.
Wrapped tokens help improve the speed and efficiency of transactions. New blocks on the Bitcoin blockchain are created once every ten minutes on average. On the other hand, the average time difference between two blocks on the Ethereum network is three minutes. Wrapped BTC popularly known as WBTC is an ERC20 token that helps users spend Bitcoin in the Ethereum network.
Transparency and decentralization are the building blocks of cryptocurrency and blockchain technology. Wrapped tokens further strengthen this philosophy. Users interact with merchants for converting native digital tokens into wrapped tokens. Minting and burning wrapped tokens is controlled by a custodian.
The process of minting and burning wrapped tokens is highly decentralized and cannot be influenced by a single party. Custodians are responsible for issuing new tokens but they do not control distribution. It lies in the hands of merchants. A decentralized organization votes to add or remove custodians and merchants.
Custodians cannot mint new tokens on their own. All relevant data is publicly available on the blockchain. Anyone can check the number of tokens held by the custodian and the number of wrapped tokens issued. This transparency builds trust in the system and also helps the larger DeFi community.
Wrapped Tokens on Different DeFi Protocols
Wrapped tokens allow users to participate on different DeFi protocols without liquidating their digital coins. These wrapped tokens allow users to interact with DeFi dapps. Users can participate in yield farming, liquidity mining and earn interest by lending their wrapped tokens. Most popular wrapped tokens are BTCB, WBTC, RBTC, WETH and renBTC.
BTCB is a BEP20/BEP2 wrapped token on the Binance Smart Chain. It has a 1:1 peg with Bitcoin. 1 BTCB is always equal to 1 BTC. Users can swap their BTC for BTCB and interact with dapps built on the Binance Smart Chain.
RBTC is a wrapped token that allows users to spend Bitcoin on RSK´s mainnet. It is primarily used for interacting or using services on the RSK network. Users can convert their BTC to RBTC through the PowPeg or exchanges. RBTC has a 1:1 peg with Bitcoin and allows users to unwrap RBTC back to BTC whenever they want.
RenBTC is an ERC20 standard wrapped token. It operates through the lock and mint transaction model. When a user swaps his Bitcoin for RenBTC, there are two transactions that take place. A smart contract is created in Ethereum to mint new RenBTC as ERC20 tokens while the Bitcoin sent by the user is locked through an HTLC transaction.
The Ren Virtual Machine, popularly known as RenVM handles the minting and custody of RenBTC. When a user locks his Bitcoin for obtaining RenBTC, the RenVM grants a minting signature. This allows the user to obtain RenBTC equal to the number of Bitcoin locked. The newly minted RenBTC tokens are cross-chain and allow users to spend Bitcoin on the Ethereum network. It is similar to WBTC.
Wrapped Bitcoin (WBTC)
WBTC standardizes Bitcoin to the ERC20 format. It allows users to spend Bitcoin on the Ethereum network. In the case of WBTC, the custodian holds an equal number of BTC against WBTC tokens issued.
To receive WBTC, a user needs to initiate a request with one of the merchants. Merchants handle requests to mint and burn wrapped tokens. They are responsible for managing the distribution of WBTC in circulation. A merchant performs KYC and AML procedures on the user who sends a request to initiate a transaction.
Once the process is complete, the user can send Bitcoin to a wallet address issued by the merchant. The merchant then places a request with the custodian to mint new wrapped tokens. It informs the custodian of an incoming transaction and transfers relevant data.
Once the Bitcoin sent by the user is received in the wallet, the custodian transfers the wrapped tokens to the merchant. It is important to note that the ownership of wrapped tokens never lies in the hands of a merchant when they receive it from a custodian. A merchant merely acts as a medium for transferring WBTC between the custodian and user.
The wrapped token is transferred to the user’s wallets and the process is complete. The WBTC tokens obtained are ERC20 standard and can be used on the Ethereum network. The user can interact with any dapp built on the Ethereum network and spend his WBTC. If a user wants to receive his Bitcoin back, then he needs to place a request with a merchant. The merchant will issue a wallet address for the user to deposit WBTC and initiate a burn request with the custodian.
Once the user has successfully transferred WBTC to the provided wallet, he will receive his Bitcoin back. In the background, the custodian releases BTC equal to the number of WBTC transferred by the user. The received WBTC tokens are burned and the merchant handles the transfer of BTC back to the user.
Decentralized exchanges built on the Ethereum network rely on WBTC for bringing liquidity to the market. It acts as a bridge between Bitcoin and Ethereum. A user would have to spend transaction fees and exchange fees to swap Bitcoin for Ethereum if he wanted to trade through a DEX. WBTC allows users to save transaction and exchange fees by incorporating Bitcoin in the Ethereum network.
Wrapped ETH (WETH)
Wrapped ETH (WETH) refers to the ERC20 standard compatible version of ETH. It is created by sending ETH to a smart contract. WETH has a 1:1 peg with ETH and is primarily used while trading other ERC20 standard tokens at a decentralized exchange.
WETH was created to eliminate the need for a central authority to swap ETH with other ERC20 tokens. A typical ETH to ERC20 standard digital token swap initiated by the user would need extra steps and lead to more transactions in the network. By first swapping ETH to WETH, the extra steps are eliminated and there are no unnecessary transactions clogging the network.
WBTC brings Bitcoin to Ethereum but the base currency is ETH and not Bitcoin. Transaction fees are also paid in ETH while the dapps are native to the Ethereum network. Smart contract platform RSK makes it possible to build dapps leveraging Bitcoin´s blockchain.
RBTC is the native digital currency of the RSK network. Also known as Smart Bitcoin, it is used to pay for transactions on RSK´s network. It is a wrapped token and pegged 1:1 with Bitcoin. The bridge smart contract is used for minting and burning RBTC tokens. As RBTC is pegged to BTC, the maximum supply of RBTC is the same as Bitcoin and stands at 21 million.
PowPeg is used to wrap Bitcoin into RBTC, the native token of the platform. It has two basic functions called peg-in and peg-out. The term peg-in is used when Bitcoin is transferred to the RSK network while peg-out is used when Bitcoin is transferred out of the RSK network.
PowPeg is a multisig management system where nodes have no control over private keys. They are controlled by HSMs who obey commands coming from an RSK smart contract. In this case, the smart contract is called bridge which is used for peg outs.
Peg-ins are highly decentralized and nodes inform RSK about Bitcoin deposits. When a user deposits Bitcoin, he is issued RBTC. RSK’s RBTC is not only a native token of the network but also a wrapped token of Bitcoin. Its value relies on Bitcoin and cannot be influenced by any external factor.
To perform peg-outs or obtain Bitcoin, a user needs to send a request to the bridge. The user then deposits their RBTC into a wallet and waits for the transaction to be confirmed. Once the transaction is confirmed, the bridge sends a peg-out transaction. It commands PowHSMs to sign and authorize the transaction. Once the transaction is signed by PowHSMs, the user receives his locked Bitcoin back into a wallet.
The bridge not only serves as a tool for wrapping and unwrapping RBTC but also as an oracle. Blockchain oracles connect blockchain networks to data outside the network. The bridge helps data from Bitcoin´s blockchain be shared to the RSK network and vice versa.
Similarities and differences between WBTC and RBTC
WBTC has a custodian for minting wrapped tokens and relies on merchants for their distribution. A user cannot directly interact with the custodian. In the case of RBTC, the Bridge Smart Contract is responsible for minting and burning RBTC tokens. There are no merchants in the case of RBTC. A user interacts with the bridge which verifies data and orders minting RBTC tokens or unlocking of BTC tokens.
WBTC doesn’t have a native blockchain network. It is merely a wrapped token that allows Bitcoin to be used on the Ethereum network whereas RBTC is the native coin of the RSK network and also a wrapped token. Both can be minted by a user or brought from a cryptocurrency exchange.
One of WBTC’s purpose is to enhance liquidity on Ethereum´s network. On the other hand, RBTC is used to pay for services on the RSK network. They are both wrapped tokens pegged to Bitcoin but have different use cases.
WBTC opens the door of decentralized finance products built on the Ethereum (ETH) blockchain to Bitcoin (BTC) users. RSK brings smart contract functionality to Bitcoin´s blockchain. RBTC tokens can be used to access DeFi and other products on the RSK network.
Both WBTC and RBTC are highly decentralized and secure. WBTC depends on a multisig wallet for voting on the addition or removal of merchants while RBTC has PowHSMs for burning RBTC and releasing Bitcoin. Both wrapped tokens publicly publish their reserves and holdings. They are reviewed independently for security flaws.
WBTC can be staked on various Ethereum based decentralized finance projects. A user can earn interest on his idle Bitcoin holdings by converting them to WBTC and then lending it. WBTC provides an opportunity for users to earn interest on their Bitcoin without selling it either by simply lending or by providing liquidity to DEXs.