Tokenized Bitcoin on Ethereum
What is Tokenized Bitcoin?
First, we should figure out a few things so as not to cause confusion. If you have read our What is Bitcoin? In this article, you will know that the uppercase b of Bitcoin represents the network, and the lowercase b represents the unit of account .
The idea behind tokenized Bitcoin is relatively simple. You lock BTC through some mechanism, mint tokens on another network , and use BTC as a token on that network. Each token on the other network represents a specific amount of bitcoin. The two should always be linked and this process should be reversible. That is, you can burn these tokens, thereby unlocking the “original” bitcoins again on the bitcoin blockchain.
In the case of Ethereum , this refers to the ERC-20 token genrator that represents Bitcoin . This allows users to conduct transactions on the Bitcoin-denominated Ethereum network. This also makes it possible to program Bitcoin like any other token on Ethereum.
You can view the current total amount of tokenized Bitcoin on Ethereum at btconethereum.com .
As of July 2020, there are approximately 15,000 tokenized BTC on Ethereum. That sounds like a huge number, but it pales in comparison to the roughly 18.5 million that make up circulation . However, this may just be the beginning.
Notably, sidechains and layer 2 solutions such as Bitcoin’s Lightning Network or Liquid Network are designed to address similar challenges. Intriguingly, Bitcoin on Ethereum is more than ten times as large as Bitcoin on the Bitcoin Lightning Network.
Even so, the competition between these different solutions is not that simple, and it is not a zero-sum game. In fact, many believe they complement each other rather than compete with each other. Tokenized projects can enrich options for Bitcoin holders, while token-free projects can improve the overall infrastructure. This could lead to more consolidation within the space, benefiting the industry as a whole.
So it all sounds interesting, but what’s the point? Let’s explore why Bitcoin was tokenized in the first place.
Why Tokenize Bitcoin on Ethereum?
Bitcoin’s design intent is simple. By design, Bitcoin has a lot of features and performs well. However, these properties have some inherent limitations.
Bitcoin captures most of its value and does not benefit significantly from innovations in other areas of the digital currency industry. While technically you can execute smart contracts on Bitcoin , the scope is quite limited compared to Ethereum or other smart contract platforms .
Tokenizing Bitcoin on other chains can increase the utility of the network. In what way? It enables features that Bitcoin does not natively support. At the same time, the core functions and security model of Bitcoin remain unchanged. There may be some other advantages such as increased transaction speed, homogeneity and privacy.
Here’s another potential reason. One of the most outstanding aspects of DeFi is the idea of composability. This means that since all of these applications are running on the same open source , non-licensed common base layer, they can work together smoothly with each other.
Many see the introduction of Bitcoin into this layer of composable financial building blocks as an exciting prospect. It could lead to many new types of applications using Bitcoin that would not otherwise be possible.
How does tokenized Bitcoin work?
There are many ways to tokenize Bitcoin on Ethereum and other blockchains . They all have varying degrees of decentralization, make different assumptions about trust and risk , and may maintain pegs in different ways.
The two main types can be defined as managed and unmanaged. The first type involves a centralized custodian, and tokens may also be minted by that party. This introduces counterparty risk, as the entity hosting the Bitcoin must be trusted (and must remain in business). On the other hand, this implementation might be considered more secure than the alternative.
Other solutions are slightly different. No trusted entity is required, as the entire minting and burning process is performed by an automated on-chain process . Collateral assets are locked and tokens are minted on another chain through some on-chain mechanism. These funds are locked on-chain until they are unlocked again when the tokens are destroyed. This eliminates counterparty risk while increasing potential security risks. Why? In this case, the burden of risk is entirely borne by the user. If funds are lost due to user or contract errors, these funds may be lost forever.
Paradigm of Tokenized Bitcoin
These make up a huge percentage of the current tokenized bitcoin supply. Most of the value locked is in Wrapped Bitcoin (WBTC). How does it work? Users transfer their bitcoins to a centralized custodian who stores them in a multi-signature cold storage wallet and mints WBTC tokens in return. It is worth noting that this process requires proof of their identity to comply with Know Your Customer (KYC) / Anti- Money Laundering (AML) regulations. This approach requires trust in the entity that is minting the token, but also brings some security advantages.
Binance also has a tokenized version of BTC called BTCB . This is the BEP-20 token issued on Binance Chain . erc20 token development If you want to try it out, you can trade it on Binance DEX .
The non-custodial solution runs entirely on-chain and requires no transaction from a centralized custodian. In short, you can think of them as similar to Wrapped BTC. However, this is not a centralized custodian, but a smart contract or virtual machine that secures funds and mints tokens. Users can deposit BTC and mint their tokenized bitcoins in a trustless and permissionless manner .
Some of these systems also require over-collateralization, which means that users must deposit more than the value ( collateral ) they plan to mint. They do this to prepare the system for black swan effects and large market crashes . Even so, these systems may not be able to handle a significant drop in collateral value. create erc20 token