But in bearish markets, the perceived value of the wrapped tokens can drop faster than that of the originals. So, it may seem that the two have the equivalent value for a time. Wrapped tokens, in this way, require three layers of trust that the original token doesn’t need. In the analogy, the value of the briefcase IOU depends on three things: the quality of the livesteam and the integrity of the vault and the briefcase holding it together. This common misconception is why many lose money in liquidation crisis events. No: wBTC should not be considered a fundamental equivalent to BTC. Is a wrapped token fundamentally the same as the original? And unlike wrapped tokens, these reserves are not audited through an automated protocol. Because custodians link wrapped tokens to the value of other crypto assets, they fall under the pegged currency classification.īut they do not classify stablecoins such as USDT as a wrapped token because it pegs its value to the US dollar in off-chain cash reserves. The value of a pegged token or currency can be linked to that of another asset - digital or physical - using a variety of approaches. What is the difference between a pegged and wrapped token? If BitGo were to mint more wBTC than the BTC it holds in reserve, every application using Chainlink’s protocol would stop receiving wBTC. Other dApps (decentralized applications) in the Ethereum ecosystem use this protocol to monitor BitGo’s balance sheet when accepting wBTC as collateral or exchange equivalency.
This auditing system is called proof of reserve. The user will be responsible for any gas fees used in transferring wBTC on the Ethereum blockchain.īecause this exchange requires trust from multiple parties, BitGo partnered with Chainlink to provide an automated auditing system - similar to the direct live feed from the previous analogy. Typically, there aren’t any merchant fees in this transfer because they only charge fees for exchanging wBTC for BTC. The custodian then sends the wBTC to the merchant, where the user finalizes the transaction. This token is a smart contract representation, or IOU briefcase, of the original bitcoin. Once BitGo receives the bitcoin from the merchant, it then mints the equivalent in wBTC - an ERC-20 token on the Ethereum blockchain. In the previous analogy, the vault containing every bitcoin and wrapped bitcoin represents the custodian.
When a user requests wBTC in exchange, the merchant takes their BTC and sends it to BitGo, a custodian managed by the wBTC DAO (a decentralized autonomous organization). How wrapped bitcoin worksĪll users access wBTC through third-party merchants such as AAVE and Maker. This innovation unlocks a flood of capital efficiency that enables diverse investment instruments across most chains. Wrapped tokens break down those silos by offering native tokens utility outside their blockchain. Without this technology, blockchains can’t benefit from the entire industry’s growth. Demand for that specific token is contingent on the applications built on that network.ĭeFi (decentralized finance) and its complex credit and lending ecosystem needs immediate settlement technology that works across all blockchains. Think of each blockchain and its native token as a silo. Wrapped tokens offer a solution to a critical problem in DeFi: cross-chain liquidity.
Think of wrapped bitcoin like an IOU briefcase. They are used to provide liquidity to a growing DeFi ecosystem. Wrapped crypto tokens such as wrapped bitcoin (wBTC) are smart contracts representing locked collateral of the original asset (i.e., BTC) on a separate blockchain.
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