The Problem with BTC on the Bitcoin Main Chain
Bitcoin is the leading digital reserve asset among both institutional and retail investors.
Many investors believe in BTC because of the foundation upon which it is built upon. Since its inception, Bitcoin has consistently displayed its security and stability. It is highly decentralized, and has had an uptime over 99.98% since 2009, and 100% since 2013.
While BTC has reached higher levels of adoption, there is still limited utility for the asset on Bitcoin’s main chain. Bitcoin’s base layer lacks complex smart contracts and decentralized applications, key aspects of cryptocurrency and Web3 for many users.
This is especially true for users who are accustomed to using decentralized financial (DeFi) applications and making their capital productive on other blockchains like Ethereum.
Even with the current limitations, there are solutions that enable productivity to the mass amounts of BTC liquidity.
This is where the benefits of tokenization come in.
What Are Tokenized Bitcoin Assets?
Tokenized bitcoins are synthetic assets that represent BTC on Bitcoin layers and other blockchains. Bitcoin-based synthetic tokens simply mimic the value of BTC and therefore rely on BTC as the underlying asset. In a way, tokenized bitcoins work similarly to how a stablecoin pegs to a fiat currency, such as the US Dollar, at a 1:1 ratio. Therefore, one tokenized bitcoin should always be redeemable for one native bitcoin with the exact same value.
(For clarification within this article, Bitcoin with an uppercase “B” will refer to the network, while bitcoin with a lower-case “b” and BTC will refer to the asset).
What are the Benefits of Tokenized Bitcoin Assets?
By design, Bitcoin’s base layer is extremely simple. Tokenized bitcoins created away from the mainchain have 3 key advantages:
Programmability - The purpose of tokenized bitcoins is to have the ability to interact with decentralized applications (dApps) using bitcoin-derived cryptocurrency.
Accessibility - Anyone can buy tokenized bitcoin, with many centralized and decentralized exchanges providing liquidity. Many chains also have bridges, which allow users to manually convert their BTC to the network’s bitcoin equivalent digital token.
Frictionless movement - The mechanism for minting tokenized assets makes it easy to convert back and forth between native BTC and other tokens.
How Do Tokenized Bitcoin Assets Work?
For a tokenized asset, each token represents a specific amount of native BTC. This mechanism most often follows these basic principles:
- While holding BTC, you request a certain amount of tokenized BTC.
- The corresponding amount of BTC is locked away, while an equivalent amount of BTC is minted on the other network.
- You may now use the tokenized bitcoins away from the mainchain..
- At any time, your tokenized funds can be converted back to native BTC. In this process, the tokenized bitcoin will be burned (permanently deleted), and will trigger an equivalent amount of fungible tokens to be unlocked and transferred back to your wallet.
There are many Bitcoin synthetic assets, each of them having differing degrees of decentralization, trust, and risk. Before exchanging native BTC, it is important to review and understand a synthetic assets peg mechanism (how it maintains the same value as BTC).
Tokenizing mechanisms are managed one of two ways: custodial or non-custodial.
With a custodial mechanism, a centralized entity holds the BTC funds in a vault, and creates the tokenized version in return. Using a custodian requires trust in the entity to properly manage the BTC and tokenized BTC.
With a non-custodial mechanism, BTC funds are secured and tokenized bitcoins are minted in a completely trustless manner through smart contracts or a virtual machine (VM). Currently, there are networks like Stacks working to create innovative peg-in/peg-out mechanisms that are fully decentralized.
List of Tokenized BTC Assets
While BTC assets have been created for many blockchains, we will focus on the two main chains for which they are issued: Ethereum and Bitcoin.
BTC for Ethereum DeFi
The main appeal for acquiring Ethereum-based BTC is the vast ecosystem of leading blockchain finance applications on the network. For example, Maker, a lending protocol, and Uniswap, a decentralized exchange, allow users to make their BTC productive on Ethereum. However, Ethereum still has issues with network congestion and expensive gas fees, which can hinder the experience of interacting with these dApps.
Let’s take a look at the most popular bitcoin ERC-20 tokens on Ethereum.
WBTC: Wrapped Bitcoin
WBTC is the largest (by market cap) and most well known bitcoin synthetic asset. Launched in January of 2019, WBTC was created to seamlessly bring bitcoin liquidity to Ethereum dApps, more specifically its DeFi ecosystem. The token was originally created by a group of projects within Ethereum DeFi, but is now governed by a DAO (Decentralized Autonomous Organization) known as the wBTC DAO. WBTC’s primary use cases on Ethereum include lending, borrowing, yield farming, and margin trading.
renBTC: Ren Bitcoin
Ren is an Ethereum-based protocol for bridging blockchains and converting cryptocurrencies like BTC into ERC-20 tokens. With Ren, users can easily bring BTC liquidity to the Ethereum ecosystem.
Through the Ren Virtual Machine, the entire asset tokenization process for renBTC is fully decentralized. Smart contracts facilitate the minting, custody, and burning for all tokens. In turn, Ren has no intermediaries, and can complete cross-chain transactions with lower costs, higher speeds, and greater privacy.
hBTC: Huobi Bitcoin
Created by the centralized cryptocurrency market Huobi Global, hBTC is an Ethereum token that connects the CeFi and DeFi markets. Every hBTC issued is strictly backed by an equivalent amount of BTC, which ensures that users can always perform a 1:1 swap between hBTC and BTC. Users of the Huobi exchange can simply deposit BTC and withdraw hBTC within a matter of minutes. Likewise, trading back to BTC is as easy as depositing hBTC and selecting BTC for withdrawal.
sBTC: Synthetix BTC
sBTC was the first synthetic Bitcoin token available on Ethereum, allowing users to access BTC without having to own a Bitcoin-based wallet. Created on the Synthetix protocol, sBTC tracks the price of bitcoin through data provided by a network of oracles on Chainlink.
Holding sBTC allows Ethereum users to get non-custodial exposure to Bitcoin, which means they do not need to trust a counterparty to hold the underlying asset.
tBTC: Keep Network Bitcoin
tBTC is an open-source, fully-backed bitcoin token on Ethereum created by the KEEP Network. Users can send their BTC to a smart contract and receive tBTC in return. All BTC funds are protected by a group of signers, which are nodes who manage all deposits and withdrawals. By supplying ETH, nodes are incentivized to act honestly and properly when processing transactions. In return, signers are rewarded with KEEP - the network’s native token.
tBTC has integrations with some of the top Ethereum dApps, such as Compound, Loopring, and 1inch. Users can also trade tBTC from centralized exchanges, including Kraken and Gate.io.
BTC for Bitcoin DeFi
DeFi on Bitcoin is rapidly growing with the emergence of layers solutions with smart contracts and decentralized applications. Now, developers can use layers to build smart contracts directly on top of Bitcoin, enabling Bitcoin-based technologies, applications, and other infrastructure.
All transactions are processed on layers but ultimately reach final settlement on the Bitcoin base layer. This makes for further security and stability measures that cannot be achieved with tokenized assets on other blockchains.
Here are some of the most common tokenized BTC assets.
sBTC: Stacks Bitcoin-pegged Asset
sBTC is the first fully decentralized peg mechanism for BTC, utilizing unique interactions between Stacks and Bitcoin mainchain. There are no federations or centralized entities that manage sBTC. Instead, the protocol uses Stacks fully-expressive smart contracts, which have the ability to send back (peg-out) BTC to the Bitcoin mainchain in a trustless manner.
xBTC: Wrapped Bitcoin on Stacks
xBTC on Stacks was created by Wrapped.com, a collaboration between industry stalwarts Tokensoft and Anchorage. Because the Stacks 2.0 update settles to Bitcoin in a shared consensus mechanism, xBTC is uniquely the first tokenized BTC asset actually backed by the Bitcoin blockchain. To change the history of asset definition or transfer for xBTC, an attacker would need to attack Bitcoin itself, which is highly unlikely.
xBTC removes the need to trust a separate blockchain with capital since Stacks is built on top of the mainchain, and inherits Bitcoin’s immutability. Developers can use xBTC to create innovative DeFi applications for BTC users, leveraging the scalability and security of Clarity smart contracts on Stacks. xBTC can be redeemed for native BTC at any time, and funds are always secured by the custodian, Anchorage.
rBTC: RSK Smart Bitcoin
rBTC is the native token of RSK (Rootstock), a layer built on top of Bitcoin for DeFi. The general purpose of rBTC is to pay transaction fees for smart contracts on the network. RSK is a unique layer in that it has EVM compatibility, which allows developers to seamlessly port Ethereum smart contracts over to RSK’s platform.
Users can convert BTC to rBTC through the RSK Powpeg. The Powpeg is a proof-of-work, peg-in / peg-out mechanism that provides a permissionless method of connecting the RSK sidechain to the base layer. The Powpeg has evolved to become more decentralized and secure over time, making it one of the most trusted multi-signature systems today.
rBTC is also available to purchase on centralized exchanges and RSK dApps like Sovryn.
L-BTC: Liquid Bitcoin
L-BTC is the native token for the layer, Liquid Network. Liquid Network adds unique functionality including asset issuance, faster transactions, and higher confidentiality to transactions.
The supply of L-BTC is always verifiably backed 1:1 with BTC held by the Liquid Federation on the Bitcoin mainchain. The Liquid Federation is a group of cryptocurrency businesses that fulfills a number of tasks that are integral to the upkeep of Liquid Network’s operations.
A subset of these members are known as “functionaries”, and are responsible for signing new blocks, managing the L-BTC supply, and securing BTC in the Federation’s multisignature wallet. Liquid Network also utilizes a two-way peg for sending BTC back and forth between Liquid sidechain and the mainchain.
L-BTC can be used to interact with Liquid protocols and pay transaction fees for transfers on the network.
Tokenized assets enable users to access an entirely new level of utility with their BTC. With hundreds of billions in market capitalization, there is massive potential for transforming BTC capital into a productive asset.
There are hundreds of unique DeFi applications across layers and other blockchains that have integrations with tokenized bitcoins. Converting between BTC and tokenized bitcoin is a straightforward process, which makes accessing DeFi even more convenient for Bitcoin users. Moreover, tokenized bitcoin can be acquired from centralized and decentralized markets in exchange for other currencies. This means that users do not have to operate cross-chain every time they want to go off of the main chain.
With so many tokenized bitcoins constructed through different mechanisms, users have plenty of options that yield varying levels of utility, decentralization, risk, and other considerable factors for investors.