In this lesson, we will be covering wrapped tokens. Unlike ordinary tokens, wrapped tokens have the special function of allowing users from one network to use their tokens on a different network.
Much like stablecoins, wrapped tokens are tokenized representations of other assets that help bridge the gap between various on-chain systems. In the case of Wrapped Bitcoin (the most used wrapped token), cryptocurrencies like WBTC and renBTC help investors with gaining access to Ethereum’s vast DeFi ecosystem.
The problem of blockchain interoperability still persists. Without any improvements in the field of interoperability, users cannot interact with different networks from an existing one.
With DeFi interoperability is far more important than ever. Why? Because Ethereum once again stands in the market’s spotlight with its DeFi segment - and anyone willing to participate in it has to fulfill one fundamental prerequisite: own ETH or ERC-20 tokens.
Investors cannot simply march into DeFi with Bitcoin alone. Or at least they were not able to do so until developers found an innovative way of surpassing the obstacle with wrapped tokens.
Wrapped tokens (like wrapped Bitcoin) are assets that represent a tokenized version of another crypto asset. In this case, a cryptocurrency like WBTC is simply the ERC-20 version of the real Bitcoin, whose price is pegged to BTC’s market value.
Stablecoins often help with understanding wrapped tokens. A token like Tether (USDT) is simply an on-chain representation of the dollar that is pegged to the fiat currency’s real price. Apart from that function, stablecoins also serve the purpose of enabling the market to switch between fiat and cryptocurrencies. Wrapped tokens fulfill the same function.
WBTC owners can wrap and unwrap their assets at any time. Numerous projects offer the ability to do so, and the process itself is relatively cheap. A hardcore BTC maximalist could, at one point, hold onto his coins and then switch to wrapped bitcoin in order to temporarily diversify his assets by swapping WBTC for a DeFi token.
As previously explained, wrapped Bitcoins were created for the purpose of establishing a bridge between the Ethereum and Bitcoin networks. Since the DeFi market exploded in value last year, BTC whales were interested in joining the yield farming and governance token craze, but they had no way of doing so without selling their precious coins.
Without hardcoded interoperability, neither projects are able to communicate with each other or facilitate transactions that transfer assets between the two. But with the ingenious design of wrapped tokens, users can seamlessly switch between either network with ease.
Think of the interoperability problem as a real-world environment in which people would, for imaginary reasons, not be able to exchange dollars for euros or yens for rubles. How would an investor trade on the Russian stock market without its domestic currency?
There are two major wrapped tokens for Bitcoin: WBTC and RenBTC. Other notable examples include HBTC (Huobi BTC) and SBTC (Synthetic BTC). For the sake of this lesson, we will limit ourselves to the first two options.
The concept of Wrapped Bitcoin (WBTC) appeared following the announcement of a partnership between Kyber Network and BitGo in October 2018. The two had planned to collaborate together on creating a bridge that would be capable of creating ERC20 tokens pegged to Bitcoin’s real market value.
The project finally launched in January 2019, at a time where DeFi was hiding in shadows, and almost no one heard of the ‘wrapping tokens’ concept. But nevertheless, BitGo and Kyber paved the road for widespread adoption, and by October 2020, the platform hit a milestone by reaching $1 billion in collateralized assets. By May 2021, WBTC hit $7B.
Wrapped Bitcoin is essentially an ERC-20 token that is fully backed by BTC at a 1:1 ratio. Unlike Tether’s reserves, WBTC’s main custodian holds the same number of coins for its entire ERC20 token supply, which can be proved thanks to the Proof-of-Reserve concept.
BitGo is the main custodian of WBTC and it manages the project’s entire reserve. We also note that WBTC is decentralized since it hosts a governance model called the WBTC DAO, on which users can voice their opinions and vote on important decisions.
To keep prices stable and ridden of volatility, BitGo uses Chainlink’s decentralized oracles to track prices.
A majority of DeFi platforms have integrated WBTC. One can find the wrapped tokens directly on platforms like Uniswap, Kyber, dYdX, and Yearn Finance.
The only drawback is that the project favors whales when processing BTC/WBTC swaps. When swapping tokens, the project will often first process larger transactions rather than smaller transactions created by retail traders.
renBTC is the second Bitcoin wrapping platform to come out after WBTC. It is developed by Ren Protocol, an open-source liquidity protocol that aims to bridge the gap between various blockchain networks.
renBTC arrived at the very start of the DeFi bull run, launching in May 2020. Since it became a viable option for wrapping tokens, the project always had a problem with liquidity and becoming on-par with WBTC. While the rival achieved $1 billion in October, renBTC only got to $250 million in TVL. By May 2021 the project only doubled in value and was surpassed by HBTC.
An enormous lack of liquidity is not an issue for retail traders. However, the story is different for institutional investors seeking to swap millions.
Another reason why retail traders would have a better time with renBTC is that the project is fully decentralized. Wraps take place on the RenVM, a virtual machine supported by a high number of darknodes.
Darknodes are VMs replicated across thousands of machines. As a result, renVM is not only decentralized but faster at wrapping Bitcoins in comparison to WBTC. Not to mention, the protocol is secure as well, and renVM will still work even if a third of the nodes suddenly go offline.
Another important feature is the support for assets other than BTC. Ren Protocol enables its users to wrap Bitcoin Cash, ZCash, and DOGE as well. In the future, we expect the list of tokenized assets to vastly improve.
To summarize, renBTC is a technologically superior BTC wrapping platform that does a great job at bridging the gap between Bitcoin and Ethereum. However, the lack of serious liquidity is a major problem.
Until DeFi, there was no need for bridging the gap between Bitcoin and Ethereum as investors could simply exchange tokens on the market.
This changed drastically with DeFi’s arrival as Bitcoin maximalists and whales had no way to interact with flash loans, dApps, yield farming strategies, and governance tokens, without selling BTC and purchasing ETH - which does not make sense as offloading BTC to profit in a riskier environment loses its purpose since a price dump for Bitcoin implies an even larger drop for altcoins.
On that account, the only solution is interoperability in the form of wrapped tokens. Seeing how wrapped Bitcoins account for nearly 13% of DeFi’s entire market value, we can confidently state that the new asset class is a success.
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