Wrapped Bitcoin (WBTC) officially launched on January 30th and represents the first one-to-one backing of an ERC-20 token backed by Bitcoin. WBTC is basically a tokenized version of Bitcoin that exists as a smart contract on Ethereum.
WBTC employs a similar model to centralized, fiat-collateralized stablecoins in its issuance, but instead pegs the ERC-20 token (WBTC) to BTC, while storing the reserves with a secure custodian. Users, merchants, and custodians interact in a fluid environment where the supply of WBTC expands and contracts based on demand.
The Benefits of WBTC
WBTC presents some unique advantages, particularly for decentralized exchanges (DEXs). DEXs in the Ethereum ecosystem are only compatible with P2P trading of ERC-20 assets, precluding the presence of Bitcoin from these exchanges.
As a result, DEXs have endemically low trading volumes, leading to a continual reliance on other mediums of exchange that often require third-parties. WBTC alters that dynamic by bringing Bitcoin’s liquidity to DEXs, enabling assets on those exchanges to be pegged against BTC like in a centralized model.
Payment applications, wallets, and even centralized exchanges can also benefit from the collateral effect of their infrastructure only needing an Ethereum node rather than various nodes for managing multiple transaction types. Similarly, decentralized applications (dapps) can use Bitcoin payments via smart contracts for lending protocols, token sales, and more.
How Does WBTC Work?
The design of WBTC includes three primary participants (custodians, merchants, users) and the WBTC Dao. The WBTC Dao is a series of multi-sig smart contracts that are controlled by institutions part of the DAO, which control the addition/removal of custodians and merchants.
Custodians play the critical role of locking the 1:1 Bitcoin reserves in a vault. BitGo currently is the custodian for WBTC. Merchants who seek WBTC send Bitcoin directly to the custodian (BitGo) who then ‘mints’ new WBTC and sends it to the merchant.
Users request WBTC through merchants who perform KYC/AML on the user and distribute the WBTC in exchange for BTC from the user. Merchants play the essential role of initiating the ‘burn’ and ‘mint’ features with the custodian by holding specific keys.
Minting requires merchants to request WBTC from the custodian, while burning requires the merchant to redeem BTC for WBTC through the custodian. In the burn process, the merchant selects the amount to be burnt, which is deducted from their WBTC balance, the corresponding amount of BTC is sent from the custodian to the merchant, and the custodian confirms the burning of the WBTC, contracting the supply.
Overall, the launch of WBTC opens up some intriguing opportunities for the broader transition towards open financial tools on blockchains.