Traditionally, blockchains have existed in silos, unable to communicate with each other. For example, Bitcoin holders cannot spend their coins directly on the Ethereum network, nor can Ethereum users use their smart contracts on the Bitcoin blockchain. Basically, there is no one-size-fits-all blockchain solution, and each different design combination presents differences in security, privacy, efficiency, flexibility, platform complexity, developer ease of use, and even political values. The heterogeneity of user needs reflects the coexistence of multiple blockchains.
Blockchains are unable to communicate, limiting decentralized finance (DeFi) applications from fully leveraging assets held in various protocols. For example, owning BTC on the Ethereum blockchain and using it for smart contracts is a very thought-provoking idea, and is made possible by the introduction of encapsulated tokens. Encapsulated tokens are designed to overcome the lack of communication between blockchains to enable seamless cross-chain transfers of value and assets.
This article explains the concepts behind encapsulating Bitcoin. Additionally, it compares various packaged Bitcoin projects, highlighting their roles, uses, and drawbacks. It also recommends a fully trustless and secure version of encapsulated Bitcoin as the ideal solution, embodying Bitcoin’s decentralized and secure ethos.
Why encapsulate Bitcoin?
There are many reasons to encapsulate BTC. First, even as investors are interested in Ethereum and the Layer 2 scaling ecosystem, BTC still retains the largest liquidity segment. Therefore, the trading pairs of centralized exchanges (CEX) are mostly priced in BTC, while the trading pairs of decentralized exchanges (DEX) are mostly priced in ETH, USDT, SOL, BNB, etc., and the cumulative trading volume is far lower than the market value of BTC itself. . This explains the general lack of liquidity on decentralized exchanges compared to centralized exchanges.
Second, the Bitcoin network is known for low scalability and high transaction fees during periods of congestion. Therefore, it is not ideal for daily transaction volume (especially microtransactions). Finally, the native assets of each ecosystem, such as Ethereum, Binance Smart Chain, Arbitrum, Solana, etc., have different token standards. This makes it impossible to manage them through a smart contract. Furthermore, even within the same ecosystem, tokens may belong to different standards, such as ERC-20, ERC-223, TC-10, BEP 2, etc.
What are the different technologies for encapsulating BTC?
Minting certificates for BTC on other chains such as Ethereum is relatively easy. The challenging part, however, is making these credentials as acceptable as the underlying assets. First, the value of the encapsulated token must reflect the value of BTC, and the peg must be maintained. Secondly, the security of the locked BTC (collateral) and the freedom to redeem the tokens at any time must be guaranteed. Finally, encapsulated BTC must be easy to use for purposes other than just storing BTC in its native blockchain. Currently, there are three common BTC packaging methods:
Centralized packaging
Centralized encapsulation technology relies on one or more trusted entities to maintain the value of encapsulated BTC. The third party is responsible for providing a Proof of Asset (PoA) as proof that the locked BTC is securely stored and has not been misused in any other way. Additionally, the auditability of locked BTC must maintain unrestricted access over time, and the entity handling the protocol must ensure that packaged BTC can be redeemed at any time.
hybrid package
Hybrid encapsulation technology utilizes custodians and smart contracts to mint tokens. Centralized entities perform some special tasks that smart contracts cannot perform, such as the know-your-customer (KYC) process and ensuring that smart contracts are implemented correctly.
Synthetic packaging
Synthetic BTC encapsulation does not require BTC to be locked in a trusted vault or smart contract. Users lock up some asset equal to (or more than) the BTC represented. For example, users can lock 5,000 USDT worth of SNX and ETH to mint the equivalent value of sBTC. When a user wants to destroy sBTC, they do not get back the token (BTC) represented, but rather the asset that was provided.
Centralization, mixing, and synthesis are common technologies for encapsulating BTC. Recently, however, DLC.Link introduced a self-encapsulating technology that allows native BTC to be used in DeFi platforms without the need for encapsulation or bridging. The technology utilizes Discreet Log Contracts (DLC), which are protected by the full computing power of the Bitcoin network, ensuring Bitcoin-level security. Additionally, DLC ensures that only depositors have access to locked BTC, eliminating third-party escrow risk.
Different types of encapsulated BTC
Wrapped Bitcoin ( wBTC )
Wrapped Bitcoin ( wBTC ) is a tokenized representation of BTC on the Ethereum blockchain. It allows users to bring the value and liquidity of Bitcoin into the Ethereum ecosystem, enabling Bitcoin to be used in DeFi applications, smart contracts, and other Ethereum-based platforms. The process involves users (wBTC merchants, not retailers) depositing their BTC into an escrow account, and in return they receive an equivalent amount of wBTC on the Ethereum blockchain. This ensures a 1:1 peg between wBTC and BTC, maintaining value parity.
While wBTC promotes interoperability between the Bitcoin and Ethereum ecosystems, it also carries certain risks. The custodial nature of the process means users rely on a third party to hold and manage their Bitcoin during the encapsulation process. This creates counterparty risk, as the custodian becomes a single point of failure vulnerable to hacking, fraud, or mismanagement of funds. Additionally, a certain level of trust is required in the custodian’s ability to accurately maintain the 1:1 peg between wBTC and BTC.
Ren Bitcoin (renBTC)
renBTC It is an ERC-20 token minted by Ren Protocol, a decentralized network that enables interoperability between blockchains. The RenVM protocol allows users to convert their BTC to renBTC on the Ethereum blockchain, similar to wBTC. The process involves users locking their BTC in the RenVM smart contract and in return, they receive an equal amount of renBTC on the Ethereum blockchain. The token can be used in various DeFi applications and smart contracts within the Ethereum ecosystem.
One of the advantages of renBTC is its decentralized nature. The RenVM protocol exploit is called Darknodes node network to collectively manage Custody and minting of renBTC, reducing reliance on a single custodian and increasing security. However, risks remain. Users face potential smart contract vulnerabilities and centralized management. For example, since the Ren Protocol's treasury was managed by Alameda, the collapse of Alameda adversely affected the Ren Protocol. Additionally, the minting process occurs on the RenVM protocol, which means users do not enjoy Bitcoin-level security.
Stacks Bitcoin (sBTC)
sBTC is a non-custodial, programmable 1:1 BTC-backed token that facilitates the decentralized movement of BTC in and out of the Bitcoin layer. Essentially, it enables developers to unlock BTC as a fully programmable asset, making way for BTC-powered DeFi, NFTs, and more. With the launch of sBTC, the Stacks protocol will become the first Bitcoin layer to facilitate the movement of BTC in and out of the Bitcoin network, while ensuring transaction security with 100% of Bitcoin’s computing power.
sBTC provides Bitcoin writing functionality as the sBTC peg technology can write Bitcoin transactions to the Bitcoin blockchain in a completely decentralized manner. The team behind the project believes their product will unlock billions of dollars in potential BTC capital to build a BTC ecosystem that surpasses all other ecosystems. The main disadvantage of sBTC is that it only opens up BTC for use in Stacks - it does not solve the problem of bridging BTC for use in other chains.
Threshold Bitcoin (tBTC)
tBTC It is a decentralized and trust-minimized encapsulation form of BTC on the Ethereum blockchain. Threshold works by dividing the operation into Coin Maker and Guardian . Guardians are stakers of Threshold token T and they manage the Bitcoin wallets used to issue tBTC on Ethereum. Minters, on the other hand, are a group of Ethereum “blue-chip” decentralized autonomous organizations (DAOs), including Curve DAO, Aave, Alchemix, Yeran.Finance, and Euler.
While tBTC aims to solve the custody risks associated with centralized solutions like wBTC, it also faces challenges. As mentioned before, tBTC is not trustless – it is trust-minimized. Threshold believes that by creating a large number of minters, it can be made difficult (but not theoretically impossible) to abuse the power of minting. Therefore, mints are always monitoring the Threshold wallet for a lack of matching BTC.
Huobi Bitcoin (hBTC)
Huobi Bitcoin ( hBTC ) is a standard ERC-20 token issued by Huobi Global on the Ethereum blockchain. The token is designed to support the use of BTC in DApps and smart contracts within the Ethereum ecosystem. Obtaining hBTC typically involves users depositing their BTC into an escrow account provided by Huobi. In return, they receive an equal amount of hBTC on the Ethereum network.
hBTC allows users to interact with the broader DeFi ecosystem and benefit from the features and opportunities available within the network. Its main disadvantages include custody risks associated with reliance on a central entity, regulatory uncertainty, and the need to trust the custodian’s security measures.
DLC.Link Bitcoin (dlcBTC)
dlcBTC It is a non-custodial certificate of BTC on the Ethereum network, allowing BTC holders to participate in DeFi while retaining full ownership of their assets. It utilizes DLC to lock BTC in special multi-signature Unspent Transaction Outputs (UTXOs), where one key is managed by the depositor and the other is distributed across the decentralized network.
Unlike most versions of encapsulated Bitcoin, dlcBTC embodies the principle of user sovereignty by eliminating the need for intermediaries by self-encapsulating BTC in a lockbox. The token is secured by the full computing power of the Bitcoin blockchain and does not require depositors to lock or send their BTC to an external escrow address. Although dlcBTC has many similarities with sBTC, it is more competitive with wBTC and tBTC on Ethereum. also:
DLC Lockboxes only pay out to depositors, meaning that even if the system is hacked, deposits will only be sent to the rightful owner.
dlcBTC gives savers access to native BTC on the Ethereum blockchain.
in conclusion
The development of encapsulated Bitcoin projects has greatly expanded the possibilities for utilizing Bitcoin in various blockchain ecosystems. While centralized, hybrid, and comprehensive packaging approaches address interoperability challenges, risks related to escrow management and smart contract vulnerabilities remain. A comparative analysis of popular wrapped Bitcoin variants such as wBTC, renBTC, sBTC, tBTC, hBTC, and dlcBTC reveals the trade-offs between security, decentralization, and user control.
dlcBTC emerged as an excellent solution to provide non-custodial and secure credentials for BTC on the Ethereum network. Leveraging DLC, dlcBTC ensures user sovereignty, eliminates third-party custody risk, and allows native BTC to be used in DeFi platforms without traditional encapsulation or bridging. As the blockchain landscape continues to evolve, dlcBTC embodies the principles of decentralization and security, providing a promising path for BTC holders seeking to seamlessly participate in the booming DeFi ecosystem.
