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Bitcoin on Ethereum: wBTC and tBTC

Lending the value and liquidity of Bitcoin to the extensibility of Ethereum and its smart contracts.

Gemini-Bitcoin on Ethereum- wBTC and tBTC

Summary

Currently, there are two main approaches to creating a bridge between Ethereum and Bitcoin: a centralized approach that relies on centralized custodians (wBTC) and a decentralized approach that uses a highly technical cryptographic process (tBTC). Tokenizing Bitcoin — that is, creating Bitcoin-backed assets by turning Bitcoin into an Ethereum-compliant ERC-20 token — via processes like wBTC and tBTC brings the value and liquidity of Bitcoin to Ethereum and expands the scope and strength of the DeFi ecosystem.

Collateral in DeFi

Decentralized finance (DeFi) platforms on Ethereum rely heavily on collateral to make up for a lack of a universal identity protocol on Ethereum. At present, many DeFi platforms do not have the capability to capture credit scores, employment information, or savings data to mitigate the risk that a borrower will default on a loan. Instead, decentralized lending protocols require that users deposit collateral as a guarantee that loans will be paid back.

Compound and MakerDAO, two popular DeFi platforms, both require collateral in order to create new loans. Both protocols require assets to be deposited before cryptocurrency can be borrowed. The more collateral that is locked up, the more you can borrow. If the value of your loan becomes too high relative to the value of your collateral, then your collateral is sold to pay back some or all of your loan. The amount that can be borrowed is therefore limited by the value of collateral in the system.

So far in the DeFi ecosystem, the most commonly collateralized asset has been ether, but bitcoin offers a higher market cap, more liquidity, and more collateral for DeFi projects.

Bridging BTC and Ethereum

The most recognized and highly capitalized digital asset in the world is Bitcoin, but the programmability of smart contracts on the Ethereum network drives much of the innovation in blockchain. By creating a Bitcoin-backed tokenized asset — that is, turning Bitcoin into an Ethereum-compliant ERC-20 token — some of its industry-leading market value and liquidity may enter the Ethereum ecosystem, while simultaneously offering Bitcoin users an on-ramp into the rapidly developing DeFi ecosystem. Ethereum wants to build a decentralized market where all cryptocurrencies can be traded, especially bitcoin, the most capitalized cryptocurrency. There are two fundamentally different approaches on how to build a bridge between these two protocols. The trusted, centralized approach represented by wBTC, and the trustless approach represented by tBTC — both of which achieve the same result: an ERC-20 token representing bitcoin.

wBTC 

Wrapped Bitcoin uses a fairly simple model in which a custodian or group of managers hold bitcoin and create wBTC. Every wBTC created represents one “real” bitcoin — that is, the original, un-tokenized BTC — in the custodian’s vault. Once created, the process can be reversed and wBTC can be redeemed for real BTC. Wrapped Bitcoin — or wBTC — is thus far the most dominant and valuable form of tokenized Bitcoin.

In this way, wrapped bitcoin is similar to a stablecoin pegged to fiat currency in a 1:1 ratio.  Stablecoins can be, like Gemini’s GUSD for instance, ERC-20 tokens that represent U.S. dollars. The benefit of wrapping bitcoin is that this process is a centralized, trusted approach that may be, and often is, compliant with financial regulations. Once wBTC is created, it functions just like any other ERC-20 token. Some consider this centralized approach to bringing bitcoin into the Ethereum ecosystem to be contrary to the decentralized and permissionless ethos of Bitcoin and cryptocurrency, broadly.

tBTC 

The other approach to tokenizing bitcoin on Ethereum is creating tBTC; however, this is much  more difficult to achieve from a technical perspective.

The tBTC approach to bringing bitcoin to Ethereum without custodians or intermediaries is being developed by the KEEP network. This system seeks to minimize trust by using random number generation, cryptographic proofs, and the KEEP token, which we cover in-depth in our guide to how tBTC works.

As a high-level overview, we review the steps you would need to take in order to mint tBTC tokens:

  • Request to mint a fixed amount of tBTC on the Ethereum network. Automatically receive a non-fungible token (NFT) called the tBTC Deposit Token (TDT) as a ‘receipt’ for your request.

  • Send the requested fixed amount of BTC to a designated address on the Bitcoin network and receive a number as ‘proof’ of your BTC deposit.

  • Submit the BTC deposit proof to the Ethereum network and wait for verification that your proof is correct.

  • Once verified, exchange the TDT token for newly minted tBTC tokens.

You now have tBTC tokens, which can be redeemed for BTC at any time. In order to receive your originally deposited BTC, simply reverse the steps above starting with the exchange of tBTC tokens for TDT tokens.

Tokenizing bitcoin through processes like wBTC and tBTC brings the value and liquidity of BTC to Ethereum, expanding the scope and strength of the DeFi ecosystem.

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