Scaling Bitcoin - Part 2: Wrapped Bitcoin

Even Bitcoin's "Competitors" Can't Get Away from Bitcoin

A Rising Tide Lifts All Boats — General Aphorism

Bitcoin is the ocean, and cryptocurrencies are the boats. Boats do not compete with the ocean, they float on top of it through calm, or stormy conditions. It is imperative to understand that Bitcoin is distinct from every other cryptocurrency, and does not compete directly with them. Any cryptocurrency that builds in conjunction with Bitcoin benefits greatly from doing so. In part 1 of this series of letters, I mention seven distinct ways that the Bitcoin network will scale. The focus of this letter is on one of those ways; wrapped or “pegged” Bitcoin.

What is a Wrapped Bitcoin?

The easiest way to explain wrapped Bitcoin is through an analogy. Long ago, (pre 1971) when the world was on a gold backed monetary system, paper money was redeemable for gold. In theory, this meant that if you took bills to the bank you could get gold in return. In this sense paper money was an IOU for gold.

Wrapped Bitcoin is an IOU for Bitcoin.

Wrapped Bitcoin is backed on a 1:1 basis with real Bitcoin. For every wBTC in existence, there is 1 BTC sitting “safely” tucked away in a wallet.

As you can see in the picture above, there are 185,811 Bitcoin locked in a special wallet, and as a result 185,811 wBTC are able to be used on the Ethereum blockchain.

Why is Wrapped Bitcoin Useful?

Wrapped Bitcoin is useful for two main reasons. Scalability, and Utility.

Increasing the Utility of Bitcoin

Ethereum has a thriving decentralized finance ecosystem. Within this ecosystem, you can lend your assets and earn a return. You can collateralize your assets, and borrow more money. But if you’ve got a big stash of Bitcoin, then you cannot use it within the Ethereum blockchain. This is why wrapped Bitcoin exists. It exists so you can make use of your Bitcoin, within Ethereum. In other words, wrapped Bitcoin creates more ways for you to use Bitcoin.

Increasing the Scalability of Bitcoin

As we already covered, the Bitcoin Blockchain is limited to processing just 6 tx/s. Ethereum on the other hand is able to process around 30 tx/s. It’s about 5 times faster in terms of transaction throughput. If you’re doing lots of transactions with Bitcoin, then this may be an appealing option.

What are the Tradeoffs?

Like with most things, there are tradeoffs. By converting your Bitcoin into wrapped Bitcoin, you are giving up access to the “real Bitcoin”, and exchanging it for an IOU. This begs the question, is Wrapped Bitcoin, actual Bitcoin? The answer depends on who you ask. If you’re asking me, then I will most definitely say NO. Wrapped Bitcoin is most certainly a completely separate and distinct asset that lives on a blockchain that is different from the Bitcoin blockchain.

Wrapped Bitcoin is minted, and maintained by a company called BitGo. They are the custodians of your actual BTC, and they are holding it for you until you “cash in” your wBTC IOU. Because wBTC is custodial in nature, there is the obvious counter-party risk.

  1. BitGo could go out of business

  2. BitGo could be hacked

  3. BitGo could be corrupt

If you own wBTC, then you are simultaneously trusting BitGo to act in accordance with the rules they’ve set out for minting and destroying wBTC. That being said, the wallet that is holding 185,811 Bitcoin is a 5 of 8 “multisig wallet”. This means that there are 8 keys for the wallet, and in order to move the Bitcoin within it, 5 of those keys are needed to sign a transaction. Whoever those 8 custodians are, 5 of them would need to collude to steal 185,811 Bitcoin (appx. $8 billion).

Are there Other Wrapped Bitcoins?

Yes there are, and we can expect that there will be more. Binance has its own version of wrapped Bitcoin called BTCB. It works exactly the same way that I described WBTC, except Binance is the ultimate custodian of your Bitcoin when holding BTCB.

In last week’s premium newsletter, I wrote about Crypto.org and Cardano, two projects that I am watching closely. They are two distinct blockchains, each with their own smart contract systems that I believe will undoubtedly be creating their own versions of wrapped Bitcoin.

The third wrapped Bitcoin worth mentioning is rBTC. It is a wrapped form of Bitcoin on the Sovryn network. Just like the bitcoin on Binance, Crypto.org, and Cardano, rBTC is based on the Ethereum Virtual Machine. However, on Sovryn, all fees are paid for in rBTC. The thing I like about Sovyrn is their dedication to building DeFi around Bitcoin. I think it has a long way to go to get a leg up on other forms of wrapped bitcoin however it is a welcome addition and one to watch closely.

Why Wrap Bitcoin at All? Don’t Cryptocurrencies Compete with One Another?

Any blockchain that has not created a way to use Bitcoin within the network is at a disadvantage against all other blockchains. This is why I started the article with the “rising tides lifts all boats” aphorism. Bitcoin is the lifeblood of the internet of money. Most people that hold cryptocurrency, hold at least a little bit of Bitcoin. Not everyone holds ETH, or BNB, or ADA, and thats why you don’t see those tokens wrapped on other networks. Bitcoin isn’t competing with these other networks, it is being used by them to increase the value offering of them.

So while Cardano, Crypto.org, Ethereum, and Binance all compete with one another, Bitcoin stands outside the competition. These blockchains are actually building systems that make it so you can use Bitcoin in new and innovative ways. One of the opinions that I hold is this.

The blockchain that best innovates new ways to use Bitcoin as money, will outcompete other blockchains.

This opinion has been one of my guiding principles when choosing new investments in altcoins.

Is Buying Wrapped Bitcoin a Good Investment?

The main reason you would want wrapped Bitcoin, would be to lend it out to earn interest on DeFi platforms. Anytime you’re doing this though, you have to keep in mind that there is the possibility that whatever lending service you are using is hacked, corrupt, or otherwise fraudulent. In each of these scenarios, you’ll face a total loss of your Bitcoin.

If you’re just buying wrapped Bitcoin to hold it long term, then I’d actually advise not to do this. You’re much better off just holding regular old Bitcoin in a hardware wallet.

The bottom line is, if you want to put your idle Bitcoin to work, wrapped Bitcoin is one way to do it, albeit, not the most direct way to achieve the goal of earning on your BTC.

All The Best,

Keegan