Wrapped Bitcoin (WBTC) offers a bridge for Bitcoin holders to engage with the Ethereum-based decentralized finance (DeFi) ecosystem. For Bitcoin holders, WBTC provides a new way to put Bitcoin to work. They can use other DeFi protocols, such as lending platforms or liquidity pools. This model comes with custodial risk and is fundamentally different from proof-of-stake (PoS) staking. Although WBTC provides new and exciting opportunities, users need to understand the risks that come with them.

What is Wrapped Bitcoin (WBTC)?

WBTC is an ERC-20 token on the Ethereum blockchain, with each WBTC backed 1:1 by Bitcoin. This implies that for each WBTC token in circulation, that same amount of BTC is being held in custody. Today, a centralized custodian—BitGo—holds the underlying Bitcoin that backs WBTC.

WBTC’s main goal is to connect Bitcoin and the Ethereum DeFi environment. Wrapping Bitcoin into an ERC-20 token to BTC holders helps BTC holders enter DeFi protocols. They should be able to do this without needing to custodial bridge their BTC to other blockchains. This combined with Bitcoin being the most widely accepted cryptocurrency enables Bitcoin to be used in many more financial applications on Ethereum.

WBTC can then be transferred to users’ Web3 wallets like MetaMask, allowing users to easily interact with various DeFi platforms. To interact with WBTC properly, always have a small amount of Ether (ETH) in your wallet. This will keep enough ETH in your wallet to cover gas costs on the Ethereum network.

DeFi Applications of WBTC

By being in ERC20 form, WBTC unlocks numerous opportunities for Bitcoin holders across the DeFi ecosystem. Users can earn yield by lending their WBTC on DeFi platforms like Aave, offering liquidity on Curve, or through other yield farming activities. These activities provide BTC holders with an opportunity to earn yield on their otherwise idle assets.

WBTC gives BTC holders a way to earn yield via decentralized lending platforms. Others give users rewards paid in tokens they can use on the platform, such as BABY tokens. These tokens are then shared between BTC and BABY stakers!

Other platforms target net annual returns of 4–8% in BTC. Yield Protocol provides a relatively safer way to earn yield on your capital thanks to WBTC. This creates a unique and distinct return profile compared to traditional Bitcoin mining or holding. Now, BTC holders have a significant incentive to explore DeFi.

Risks and Considerations

Though WBTC provides great ways to generate yield, it’s important to note the risks that come with it. Since WBTC is held by a centralized custodian, BitGo, users incur custodial risk.

Among other things, this risk encompasses potential loss from insolvency, hacking, or regulatory shutdown of BitGo. If BitGo fails to maintain the 1:1 backing of BTC for each WBTC, users could lose their funds.

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The risks of using WBTC are different from the risks of PoS staking because it involves the use of third-party services. Staking protects the assets by securing them with a distributed, decentralized network. In contrast, WBTC’s value is fundamentally based on the custodian’s solvency and security.

WBTC in the Evolving Crypto Landscape

WBTC is not the only method available for Bitcoin holders to earn yield on their assets. Further strategies involve utilizing centralized lending platforms and joining Bitcoin-focused ecosystems such as those offered by Babylon and Stacks. Each strategy has its share of risks and rewards.

The Merge on Ethereum also resulted in Ethereum becoming the largest PoS network, by far, in 2022. Despite this change, WBTC still largely relies on a proof-of-work (PoW) asset in the form of BTC. This heavy reliance speaks to Bitcoin’s continued crucial role within the broader crypto ecosystem.

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WBTC opens up an unlimited number of new possibilities for BTC to be used in other financial applications on Ethereum. Creating this integration significantly improves Bitcoin’s utility. It allows Bitcoin to be a part of the continuous and rapid innovation and growth of the DeFi space.