Token duplication - What are wrapped tokens

What are wrapped tokens

If you look at the list of cryptocurrencies, you will notice such strange entities as WBTC, HBTC, renBTC and other "Bitcoins" with the  prices that match the original BTC. Are these coins a scam? Fraud? Not at all. What is it?

Any assets should work and bring additional income to their owners, however, the leading cryptocurrency, Bitcoin, has little functionality and therefore it is extremely difficult to create an ecosystem of decentralized finance with smart contracts on it.

What to do? You need to create a token backed by the original Bitcoin. This is the model used by the projects wbtc.network, renproject and other services that transfer Bitcoin to the Ethereum blockchain. They act as a notary, custodian, escrow account holder, etc. They store the original Bitcoin, providing in return its "digital copy" in another blockchain. In general, the scheme of work is as follows:

  • The user specifies the address of the Ethereum wallet to which he wants to receive the wrapped tokens.
  • The user transfers his BTC to a specific address on the Bitcoin blockchain, where the original Bitcoin is blocked. The private key from the wallet where the BTC is stored remains with the service.
  • Instead of the blocked Bitcoin, the corresponding amount of Bitcoin token is created in the Ethereum network and sent to the address of the Ethereum wallet, mentioned above. 
  • If the user wants to return the original BTC, he will have to return the wrapped Bitcoin to the service. After the return, the token in the Ethereum network is burned (destroyed) by the service, and the original Bitcoin is unlocked and returned to the owner. A number of projects  provide such services (of course, for a small commission) in a decentralized manner in order to avoid the risk of compromise of the private key from the wallet where the original Bitcoin is stored, as well as the risk of non-return of the original bitcoin for any reason.

The problems of the need to trust the service are solved through appropriate technical solutions, including smart contracts, multisignatures and nodes.

Such bridges from the Bitcoin blockchain can lead not only to Ethereum, but also to other networks (for example, there is a BTCB token in Binance SmartChain).

In addition to the option when the Bitcoin token is backed by the original Bitcoin on the custodian’ escrow account, there is also a "synthetic" option for creating a Bitcoin token, when it is secured not directly by the underlying asset (BTC itself), but by other means. In this case, a scheme similar to the creation of a decentralized dollar works. An example of such a token is sBTC from the Synthetix project – the price support of this token is ultimately guaranteed by the value of the project's service tokens – SNX.

It should be borne in mind that the use of such synthetic assets is associated with high risks typical for financial derivatives (derivatives). 

Any cryptocurrency can be "wrapped" in another blockchain, and not only by custodian, but also by a "synthetic" method. Moreover, it is even possible to wrap ETH in the Ethereum network, and this action will not be meaningless for a number of reasons. The only question is technical implementation and demand for the tokens being created. Demand can be estimated by analyzing the trading volume on centralized crypto exchanges (CEX) and decentralized exchanges (DEX).

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WRITTEN BY

Viktor Ihnatiuk

Founder at Boosty Labs, SNO Growth Lead at Storj Labs

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