Traditionally, blockchains exist in isolation and cannot communicate with each other. For example, Bitcoin holders cannot spend their coins directly on the Ethereum network, and Ethereum users cannot use their smart contracts on the Bitcoin blockchain. Basically, there is no one-size-fits-all blockchain solution, and each different design combination presents differences in security, privacy, efficiency, flexibility, platform complexity, developer ease of use, and even political values. The heterogeneity of user needs reflects the coexistence of multiple blockchains.
The inability of blockchains to communicate limits decentralized finance (DeFi) applications from fully leveraging assets held in various protocols. For example, owning BTC on the Ethereum blockchain and using it in smart contracts is a very thought-provoking idea, and it is made possible by the introduction of wrapped tokens. Wrapped tokens are designed to overcome the lack of communication between blockchains to enable seamless cross-chain transfers of value and assets.
This article explains the concept behind Wrapped Bitcoin. In addition, it compares various Wrapped Bitcoin projects, highlighting their roles, uses, and shortcomings. It also recommends a fully trustless and secure Wrapped Bitcoin version as the ideal solution that embodies the spirit of Bitcoin's decentralization and security.
Why wrap Bitcoin?
There are many reasons for wrapping BTC. First, even if investors are interested in Ethereum and the Layer 2 scaling ecosystem, BTC still retains the largest portion of liquidity. Therefore, the trading pairs of centralized exchanges (CEX) are mostly denominated in BTC, while the trading pairs of decentralized exchanges (DEX) are mostly denominated in ETH, USDT, SOL, BNB, etc., and the cumulative trading volume is much lower than the BTC market value itself. This explains the general lack of liquidity in decentralized exchanges compared to centralized exchanges.
Secondly, the Bitcoin network is known for its low scalability and high transaction fees during congestion. Therefore, it is not ideal for daily transaction volumes, especially microtransactions. Finally, the native assets of various ecosystems, such as Ethereum, Binance Smart Chain, Arbitrum, Solana, etc., have different token standards. This makes it impossible to manage them through one smart contract. In addition, even in the same ecosystem, tokens may belong to different standards, such as ERC-20, ERC-223, TC-10, BEP 2, etc.
What are the different technologies for packaging BTC?
It is relatively easy to mint certificates for BTC on other chains such as Ethereum. However, the challenging part is to make these certificates as acceptable as the underlying asset. First, the value of the wrapped token must reflect the value of BTC and the peg must be maintained. Second, the security of the locked BTC (collateral) and the freedom to redeem the token at any time must be guaranteed. Finally, the wrapped BTC must be convenient to use, and its uses are not limited to keeping BTC in its native blockchain. Currently, there are three common ways to wrap BTC:
Centralized Packaging
Centralized packaging technology relies on one or more trusted entities to maintain the value of the wrapped BTC. The third party is responsible for providing proof of assets (PoA) as proof that the locked BTC is securely stored and not abused in any other way. In addition, the auditability of the locked BTC must maintain unrestricted access over time, and the entity processing the protocol must ensure that the wrapped BTC can be redeemed at any time.
Hybrid Packaging
Hybrid wrapping technology utilizes custodians and smart contracts to mint tokens. Centralized entities perform some special tasks that smart contracts cannot perform, such as Know Your Customer (KYC) processes and ensuring that smart contracts are implemented correctly.
Synthetic packaging
Synthetic BTC wrappers do not require locking BTC in a trusted vault or smart contract. Users lock up some assets of equal value (or more) to the BTC represented. For example, a user could lock up 5000 USDT worth of SNX and ETH to mint an equivalent amount of sBTC. When a user wants to destroy sBTC, they do not get back the represented token (BTC), but rather the provided asset.
Centralization, mixing, and synthesis are common techniques for wrapping BTC. However, recently, DLC.Link introduced a self-wrapping technology that allows native BTC to be used in DeFi platforms without wrapping or bridging. The technology utilizes the Discreet Log Contract (DLC), which is protected by the full computing power of the Bitcoin network, ensuring Bitcoin-level security. In addition, DLC ensures that only depositors can access the locked BTC, eliminating third-party custody risks.
Different types of wrapped BTC
Wrapped Bitcoin ( wBTC )
Wrapped Bitcoin (wBTC) is a tokenized representation of BTC on the Ethereum blockchain. It allows users to bring the value and liquidity of Bitcoin into the Ethereum ecosystem, enabling Bitcoin to be used in DeFi applications, smart contracts, and other Ethereum-based platforms. The process involves users (wBTC merchants, not retailers) depositing their BTC into a custodial account, and in return they receive an equal amount of wBTC on the Ethereum blockchain. This ensures a 1:1 peg between wBTC and BTC, maintaining value parity.
While wBTC facilitates interoperability between the Bitcoin and Ethereum ecosystems, it also introduces certain risks. The custodial nature of the process means that users rely on a third party to hold and manage their Bitcoin during the wrapping process. This introduces counterparty risk as the custodian becomes a single point of failure susceptible to hacking, fraud, or mismanagement of funds. Additionally, the custodian’s ability to accurately maintain a 1:1 peg between wBTC and BTC requires a certain level of trust.
Ren Bitcoin ( renBTC )
renBTC is an ERC-20 token minted by Ren Protocol, a decentralized network that enables interoperability between blockchains. The RenVM protocol allows users to convert their BTC into renBTC on the Ethereum blockchain, similar to wBTC. The process involves users locking their BTC in a RenVM smart contract, and in return they receive an equal amount of renBTC on the Ethereum blockchain. The token can be used in various DeFi applications and smart contracts within the Ethereum ecosystem.
One of the advantages of renBTC is its decentralized nature. The RenVM protocol utilizes a network of nodes called Darknodes to collectively manage the custody and minting of renBTC, reducing reliance on a single custodian and enhancing security. However, risks remain. Users are exposed to potential smart contract vulnerabilities and management centralization. For example, since the Ren protocol’s vault is managed by Alameda, the collapse of Alameda had an adverse impact on the Ren protocol. In addition, the minting process occurs on the RenVM protocol, which means that users cannot enjoy Bitcoin-level security.
Stacks Bitcoin ( sBTC )
sBTC is a non-custodial, programmable 1:1 BTC-backed token that facilitates the decentralized movement of BTC in and out of the Bitcoin layer. Essentially, it enables developers to unlock BTC as a fully programmable asset, making way for BTC-backed DeFi, NFTs, and more. With the launch of sBTC, the Stacks Protocol will become the first Bitcoin layer to facilitate BTC in and out of the Bitcoin network while securing transactions with 100% of Bitcoin’s hashing power.
sBTC offers Bitcoin write functionality as the sBTC peg technology can write Bitcoin transactions to the Bitcoin blockchain in a completely decentralized manner. The team behind the project believes their product will unlock billions of dollars of potential BTC capital to build a BTC ecosystem that surpasses all other ecosystems. The main drawback of sBTC is that it only opens up BTC for use in Stacks - it does not solve the problem of bridging BTC for use in other chains.
Threshold Bitcoin（ tBTC ）
tBTC is a decentralized and trust-minimized wrapper of BTC on the Ethereum blockchain. Threshold does this by splitting operations into minters and guardians. Guardians are stakers of Threshold tokens T who manage Bitcoin wallets used to issue tBTC on Ethereum. Minters, on the other hand, are a group of Ethereum “blue chip” decentralized autonomous organizations (DAOs), including Curve DAO, Aave, Alchemix, Yeran.Finance, and Euler.
While tBTC is designed to address the custody risks associated with centralized solutions like wBTC, it also has its challenges. As mentioned earlier, tBTC is not trustless - it is trust-minimized. Threshold believes that by creating a large number of minters, it can make it difficult (but not theoretically impossible) to abuse minting power. Therefore, the mint always monitors the mints that lack matching BTC in the Threshold wallet.
Huobi Bitcoin ( hBTC )
Huobi Bitcoin (hBTC) is a standard ERC-20 token issued by Huobi Global on the Ethereum blockchain. The token is designed to support the use of BTC in DApps and smart contracts within the Ethereum ecosystem. Obtaining hBTC typically involves users depositing their BTC into a custodial account provided by Huobi. In return, they receive an equal amount of hBTC on the Ethereum network.
hBTC allows users to interact with the broader DeFi ecosystem and benefit from the functionality and opportunities offered within the network. Its main drawbacks include custody risks associated with reliance on a central entity, regulatory uncertainty, and the need to trust the security measures of the custodian.
DLC.Link Bitcoin ( dlcBTC )
dlcBTC is a non-custodial certificate for BTC on the Ethereum network, allowing BTC holders to participate in DeFi while retaining full ownership of their assets. It uses DLC to lock BTC in a special multi-signature unspent transaction output (UTXO), where one key is managed by the depositor and the other is distributed across the decentralized network.
Unlike most versions of wrapped Bitcoin, dlcBTC eliminates the need for intermediaries by self-wrapping BTC in a lockbox, embodying the principle of user sovereignty. The token is secured by the full computing power of the Bitcoin blockchain and does not require depositors to lock or send their BTC to an external escrow address. Although dlcBTC has many similarities to sBTC, it is more competitive with wBTC and tBTC on Ethereum. In addition:
DLC lockboxes only pay out to depositors, which means that even if the system is hacked, deposits will only be sent to the rightful owner.
dlcBTC gives depositors access to native BTC on the Ethereum blockchain.
in conclusion
The development of wrapped Bitcoin projects has greatly expanded the possibilities of leveraging Bitcoin in various blockchain ecosystems. While centralized, hybrid, and comprehensive wrapper approaches address interoperability challenges, risks associated with custodial management and smart contract vulnerabilities remain. A comparative analysis of popular wrapped Bitcoin variants (e.g., wBTC, renBTC, sBTC, tBTC, hBTC, and dlcBTC) reveals the trade-offs between security, decentralization, and user control.
dlcBTC emerges as an outstanding solution, providing non-custodial and secure credentials for BTC on the Ethereum network. Leveraging DLC, dlcBTC ensures user sovereignty, eliminates third-party custody risks, and allows the use of native BTC in DeFi platforms without the need for traditional wrappers or bridges. As the blockchain landscape continues to evolve, dlcBTC embodies the principles of decentralization and security, providing a promising path for BTC holders seeking to seamlessly participate in the thriving DeFi ecosystem.