Bitcoin has long been the largest value pool in the crypto market, but native BTC cannot directly enter the Ethereum smart contract system. To address this limitation, Wrapped Bitcoin (WBTC) was designed as an ERC-20 token pegged to the price of Bitcoin, allowing holders to bring their value into Ethereum DeFi without selling their BTC exposure.

How WBTC Works

WBTC's basic structure is 1:1 reserve backing. For every WBTC issued, there is one real Bitcoin held in custody by a custodian. The article states that the goal of this model is to bring Bitcoin liquidity to Ethereum, enabling it to be used for scenarios such as lending, staking, trading, and liquidity pools.

The reason for needing such encapsulated assets lies in the different designs of the two chains. The Bitcoin network itself is not well-suited for running complex smart contracts, while most DeFi applications on Ethereum rely on the ERC-20 standard. WBTC solves the compatibility issue between the two by mapping BTC to Ethereum tokens.

Casting and Destruction Mechanism

The article explains that WBTC mainly operates through a "minting-burning" model, involving three types of participants: custodians, merchants, and users.

• The custodian is responsible for safeguarding the actual Bitcoin reserves.
• Merchants are responsible for user verification, distribution, and redemption processes.
• Users complete the conversion between BTC and WBTC.

When a user wants to obtain WBTC, they typically first submit an application to a merchant. After the merchant completes identity and compliance checks, they entrust the corresponding amount of Bitcoin to a custodian, who then mints an equivalent amount of WBTC on Ethereum. For reverse redemption, the user submits WBTC, the tokens are destroyed, and the custodian releases the corresponding BTC.

The article mentions that these minting and burning records can be viewed on the blockchain, and the reserve status is also subject to proof-of-reserve checks to verify whether the circulating WBTC is backed by a corresponding Bitcoin.

What can be done, and what risks are involved?

At the usage level, WBTC allows Bitcoin price exposure to go directly into Ethereum DeFi. Holders can use it for lending, staking, exchanging, or providing liquidity without having to sell BTC first and then exchange it for other assets.

However, the article emphasizes that holding WBTC is not the same as holding native Bitcoin. The biggest difference lies in the fact that WBTC adds additional trust elements and technical risks, including:

• Custody risk, meaning the underlying BTC is held in custody by a third party.
• Smart contract risks refer to the potential vulnerabilities in the contracts themselves.
• The bridging or encapsulation risk means that the cross-chain mapping structure may fail.

This means that while WBTC improves the usability of BTC in DeFi, it comes at the cost of introducing more intermediaries. The article also mentions other alternatives in the market, such as Coinbase's cbBTC and tBTC, which emphasizes a more decentralized custody structure. The main difference between these products lies in the type of custody and trust assumptions users are willing to accept.