How does cryptocurrency move across blockchains? (Part 1 — Wrapping)
As the number of networks has grown and it’s now possible to access increasingly specialised services and functionalities in each ecosystem, it’s becoming more important to have interoperability between chains. This interoperability allows assets to easily (and ideally cheaply) move from one network to another; whether through asset standardization, new system architectures or the introduction of custody services connected to multiple chains.
Before we delve into the technicalities of how this works, it makes sense to first define what should be considered as a move between chains since the nomenclature is often confused when discussing this topic. For clarity, assets moving within an ecosystem e.g different ERC20 tokens being transferred on Ethereum and/or interacting with different service and dapps will be described as intra-chain activity and the term “cross chain” shall therefore be reserved for assets which move from one independent blockchain to another. In this case the movement of assets across the Cosmos and Polkadot ecosystems would be classified as cross chain movements.
However whilst there are many techniques which fall under the cross chain umbrella, the methods for this interoperability are vastly different under the hood. In this piece I will explore how asset wrapping is used to move crypto assets across blockchains.
What Exactly Is Asset Wrapping?
This is one of the most well established ways of moving assets across blockchains but can be done in centralized, hybrid/decentralised manner.
Centralised: This is where an asset is locked up with a trusted custodian on Blockchain A and then the custodian creates a corresponding amount of the asset as a token on Blockchain B.
The tokenized asset on Blockchain B is therefore a representation of the asset which actually ‘exists’ on Blockchain A. (I’ll leave the existential question of what it means for a virtual asset to ‘exist’ on the table 🤯)
Hybrid/Decentralised: A hybrid/decentralised model looks to get the best of both worlds, the ease of a custodian with the trust of no central counterparty.
An example of a decentralised model is where the the BTC is deposited into a multi-sig BTC address rather than with a specific custodian. An example of this model is tBTC where the depositer sends a request to the TBTC Ethereum smart contract along with a bond in ETH to ensure they behave. A subset of signers from a pool, who have each staked ETH to ensure they behave, then create a multi-sig BTC address which is used to community custody the deposit amount. Once the BTC is sent to the address then a 1-to-1 amount of TBTC will be created on Ethereum as an ERC20 token (although 0.005 TBTC is taken as a signer fee).
Slightly moving the needle back towards centralisation is the Ren project which has the most hybrid wrapped bitcoin within. Through their own blockchain with the renVM at its heart, users can wrap not only BTC but a host of other asset across a number of different networks. As such, users send bitcoin to the ren blockchain to be locked and the protocol will verify the BTC has been received before returning a minting signature which can then be used to mint renBTC on Etherem. However, the ren protocol also allows the easy movement of renBTC from one blockchain, such as Ethereum, to another e.g Polkadot. You simply create a burn transaction on Ethereum for your renBTC and include a withdrawal Polkadot account. The renVM then verifies this transaction and will provide a minting signature which can be used on the Polkadot blockchain to mint new renBTC. The Ren protocol takes a 0.15% fee per mint and burn but users would also need to pay the associated network fees for the blockchains they are moving between.
There are other hybrid/decentralised models which differ in detail from the Ren and tBTC projects, however they all look to remove the need for a single custodian and replace it with a protocol or smart contract instead.
The Benefits of Wrapping Cryptoassets
At the outset of the pieces I mentioned the benefit of being able to use your BTC to access Ethereum based dapps and services, however there are a host of benefits to wrapping up your BTC or even other crypto assets:
- Getting in on the NFT hype
The majority of NFT marketplaces allow ETH, ERC20 tokens, SOL or MATIC as payment. Therefore if you want in on the expensive jpeg game, then wrapping your BTC into WETH, WBTC or renBTC allows you to be part of the fun without first selling your BTC.
- Access the world of DeFi
With the defi ecosystem now holding almost $100billion of locked in value but being predominantly on the Ethreum blockchain, if you convert your BTC to WBTC then you can join the $15.97billion worth of liquidity being added to the space through BTC wrapping.
- Improving your settlement speed
Transferring BTC on the Bitcoin blockchain requires confirmations which take c10 minutes per block however the block time on Ethereum is just c13 seconds so you can move your bitcoin around much quicker by wrapping it (although fees are certainly not cheaper!).
It’s also worth noting that whilst bitcoin is the most wrapped asset, it’s possible to wrap a whole host of assets across a number of blockchains such as Binance Smart Chain and Polygon.
If you’re reading this and thinking, “this feels familiar, an asset is locked up and a new on-chain version is created which is backed 1-to-1” then you’re absolutely right …. this is basically how many stablecoins are created! Wrapping is therefore a very similar process to how traditional asset backed stablecoins are created, with the difference being that it’s a cryptoasset being locked up initially rather than some fiat.
Another key difference, especially in relation to the murky waters of USDT is that WBTC aims to be transparent and auditable in order to ensure the 1 BTC to 1 WBT peg is held. As such they share order book information and a proof of asset audit.
In part 2 we’ll take a walk through of the wrapping and unwrapping process to understand how this is working under the hood.