DeFi has taken cryptocurrency by storm, proving that payment isn't the only sector of finance where decentralization is possible. DeFi, in fact, aims to reconstruct all financial services in a decentralized, open, and permissionless way. Furthermore, it enables the creation of previously impossible-to-create financial applications. DeFi may be used by Ether and other tokens that are native to the Ethereum network. In lending protocols like Compound or Aave, these tokens can be used as collateral. UniSwap also allows them to be taded in a permissionless way. Furthermore, these tokens have the potential to generate yield, by being lent out or providing liquidity to a decentralized exchange, for example.
Although incredibly safe, BTC on the Bitcoin network has a very restricted use case. You may either send your BTC to another address or keep it and wait for it to increase in price. You'll have to rely on centralized firms for other financial services. Take lending as an example: if you want to earn a return on your BTC or use it as collateral to get a loan, you'll need to go via a centralized company like BlockFi. This implies you'll have to give up custody of your BTC and supply KYC information, which isn't ideal for those who believe in the decentralized and permissionless nature of cryptocurrencies.
One of the primary factors for making BTC available on Ethereum was the inability to utilize it in DeFi. It's also logical to use BTC in DeFi. Bitcoin, for example, may be excellent collateral since it is a fixed supply store of value asset with a long history. In a decentralized finance system, a person might lock their BTC and borrow against it. There are currently over 140,000 BTC on Ethereum, valued at over 2.5 billion dollars; an incredible number considering there were only approximately 1000 BTC on Ethereum at the start of 2020.
Wrapped BTC or wBTC, is an ERC20 token backed one-to-one by Bitcoin, which has around 115,000 coins in circulation. wBTC is the most common method of transferring BTC to Ethereum at the moment. Merchants can mint and burn wBTC using the Wrapped BTC protocol. When a merchant wishes to convert BTC to wBTC, they start the minting process by giving the wrapped token contract an Ethereum address. The merchant then sends the actual Bitcoin to a custodian as the following step. WBTC is minted by the custodian and sent to the merchant's Ethereum address.
The custodian now holds the original BTC, and the overall quantity of wBTC grows by the amount of BTC provided. The merchant must request a withdrawal if they want to redeem their BTC on the Bitcoin network. The merchant burns their wBTC by sending them to the wrapped token contract after the withdrawal procedure is started. The merchant receives the BTC when the custodian verifies the burn. The overall supply of wBTC reduces by the amount of BTC burnt after the initial BTC is withdrawn.
Companies or protocols that may mint and burn wBTC are known as merchants. DeFi customers may buy wBTC on a variety of exchanges, including UniSwap. They may also transfer their BTC to wBTC via services like wbtc.cafe, which is powered by RenVM. wBTC is compatible with a variety of DeFi protocols. It may, for example, be used as collateral on the Compound or Aave. It may be used to provide liquidity to a UniSwap liquidity pool like the 50/50 wBTC/ETH pool.
RenVM is an open protocol that allows assets to be bridged to Ethereum. It allows for the exchange of value between blockchains without the need for authorization. Bitcoin is, of course, one of the most popular assets to transfer across blockchains. Ren's ERC20 equivalent of Bitcoin is renBTC. Ren, like wBTC, allows for the creation of renBTC by giving BTC and the redemption of BTC by burning renBTC. Each renBTC is backed by BTC at a 1:1 ratio. The primary distinction is that Ren decentralizes BTC custody and makes the minting/burning process accessible to everybody, not only merchants.
The Ren protocol relies on a network of Darknodes, which are decentralized nodes. It also makes use of several fascinating cryptographic features like Shamir's Secret Sharing and Secure Multiparty Computation. With roughly 17,000 renBTC in use, renBTC is presently the second most popular alternative.
tBTC is the next challenger for the title of go-to protocol for decentralized Bitcoin-to-Ethereum conversion. KEEP, the team behind tBDC, solved the core flaws and successfully relaunched the protocol after a bumpy start. With tBDC, like in renBTC, no central party has custody of the locked Bitcoin, and each tBTC is backed 1:1 by BTC.
tBTC uses a network of signers to allow people with BTC to mint tBTC. Signers are picked at random, and each minted tBTC has a new set of signers. To guarantee that they do not walk away with locked BTC, the signers must offer ETH as collateral. In fact, they must over-collateralize their investment by putting up 1.5 BTC in ETH. The signers are prepared to lock away their ETH since they will be compensated with fees when they redeem it. tBDC is gaining traction, with roughly 1,900 BTC committed to the system. In compared to renBTC, tBTC takes a different strategy to accomplish the same goal: BTC custody is centralized.
Another option to make Bitcoin useful in DeFi is to utilize sBTC. sBTC is different from the other choices since there is no underlying Bitcoin in this scenario. The Synthetix protocol creates synthetic assets such as sBTC. Synthetic assets, often known as synths, are financial instruments that monitor the value of various assets such as the S&P 500 index, oil prices, and Bitcoin. All synths in Synthetix are backed up by collateral in the form of the SNX token. Currently, the protocol is 750 % over collateralized. This is primarily to absorb any significant price fluctuations in synthetic assets. There are around 1,700 sBTC in existence.
sBTC, wBTC, renBTC, and tBTC all have somewhat different pricing, which are generally at the premium of the true BTC price. This is due to the fact that the demand for each of these tokens differs. It also important for all but sBTC how difficult it is to redeem the underlying BTC.
Is it therefore worth to switch your Bitcoin to one of the mentioned protocols? It depends. First and foremost, we must determine whether there is a viable strategy to profit from the conversion of BTC to Ethereum. Perhaps we'd want to utilize it as collateral in one of the DeFi lending protocols and take out a loan against it, or perhaps we've discovered a fantastic yield farming opportunity. It was possible to earn about 20% APY by contributing liquidity to UniSwap's wBTC/ETH liquidity pool, for example. Of course, providing liquidity on UniSwap involves with its own set of concerns, such as the risk of temporary loss. UniSwap liquidity mining, on the other hand, contributed a large quantity of BTC to the Ethereum network in the form of wBTC.
Even after discovering that BTC can be useful in DeFi, there are still a few things to consider. For example, how comfortable we are with the protocol's decentralization and security assumptions. We must also be wary of any smart contract or admin key risks, particularly in DeFi protocols that are less well-known. Also, even if we decide to move our BTC to Ethereum, we should only do so with a small fraction of our overall BTC allocation to protect ourselves against unknown unknowns.
It's also worth noting that BTC is never stored on Ethereum, thus this is only a mental shortcut. The BTC is locked on the Bitcoin network in wBTC, tBTC, and renBTC, and the protocols issued a locked BTC equivalent on the Ethereum network. There is no Bitcoin in sBTC; it is merely a synthetic asset, a derivative backed by SMX collateral.
