Wrapped Bitcoin (WBTC) works through a process involving several parties to ensure that the WBTC tokens on the Ethereum blockchain are backed 1:1 by actual Bitcoin. Here’s a step-by-step explanation of how it works:

1. Initiation: A user or institution decides they want WBTC. They start by owning Bitcoin (BTC).
2. Custodian Involvement: The user sends their BTC to a custodian. A custodian in the WBTC network is a trusted and vetted entity responsible for holding the actual Bitcoin. BitGo, for instance, is one of the most well-known custodians in the WBTC network.
3. Minting WBTC: After receiving the BTC, the custodian then mints an equivalent amount of WBTC. This minting is done on the Ethereum blockchain, creating WBTC as an ERC-20 token, which is the standard format for tokens on Ethereum.
4. 1:1 Pegging: Each WBTC token is pegged to one Bitcoin. This means that for every WBTC in circulation, there is one BTC held by the custodian. This pegging ensures that the value of WBTC is closely tied to the value of Bitcoin.
5. Using WBTC in DeFi: Once the user receives WBTC, they can use it in the Ethereum ecosystem, particularly in decentralized finance (DeFi) applications. This includes lending platforms, decentralized exchanges (DEXs), yield farming protocols, and more.
6. Redemption: If a user wants to convert their WBTC back to BTC, they can do so. The process involves sending the WBTC to the custodian, who then “burns” (or removes) the WBTC tokens from circulation and releases an equivalent amount of BTC back to the user.
7. Transparency and Audits: To ensure trust in the system, the amount of BTC held by custodians is regularly audited and verified. This is to make sure that the number of WBTC tokens in circulation is always fully backed by an equivalent amount of BTC.
8. Decentralized Governance: The WBTC network operates under a decentralized autonomous organization (DAO) model, where key decisions about the network are made collectively by members, including custodians and other stakeholders in the WBTC ecosystem.

This process integrates Bitcoin into the Ethereum blockchain, allowing Bitcoin holders to interact with the DeFi space without having to sell their BTC for Ethereum or other ERC-20 tokens.

How it works

Wrapped Bitcoin (WBTC) is a type of cryptocurrency that represents Bitcoin (BTC) on the Ethereum blockchain. It’s called “wrapped” because it involves the issuance of an Ethereum-based token (ERC-20) that is pegged to the value of one Bitcoin. This means each WBTC is worth the same as one BTC.

The main purpose of WBTC is to bring the liquidity of Bitcoin into the decentralized finance (DeFi) ecosystem on Ethereum. By wrapping Bitcoin, users can use BTC for various activities in the DeFi world, like lending, borrowing, or yield farming, which are not directly possible with Bitcoin itself due to the different blockchain infrastructures.

To create WBTC, a user sends BTC to a custodian, who then mints an equivalent amount of WBTC. This process ensures that the WBTC remains fully backed by an equivalent amount of BTC. The use of a custodian and regular audits are meant to ensure trust and transparency in the pegging process.