What is Wrapped Bitcoin – NerdWallet

Wrapped Bitcoin (wBTC) is a token that mirrors the value of Bitcoin (BTC) and is interoperable with decentralized applications built on the Ethereum network. Released in 2019, wrapped Bitcoin tracks the value of real Bitcoin, which means each wBTC token’s value has a one-to-one relationship with Bitcoin.

Bitcoin and Ethereum have different protocols, so the blockchains on which they run are unable to communicate with each other. Wrapped Bitcoin is one of many wrapped cryptocurrencies created as a solution to this issue: It lets BTC holders “wrap” their Bitcoin and create a token compatible with Ethereum’s protocol so it can communicate and transact with a different blockchain.

How does it work?

Wrapped Bitcoin allows applications and smart contracts on the Ethereum blockchain to interact with cryptocurrency that is backed by real Bitcoin reserves. When users exchange BTC for wBTC, the original Bitcoin is stored in a digital vault, and newly minted wBTC is then released to the user.

Wrapped Bitcoin is redeemable on a one-to-one basis with BTC, which means users can wrap or unwrap Bitcoin whenever they choose. Generally, exchanges will charge a small fee for these transactions, so check the fee to wrap or unwrap a cryptocurrency before making a transaction.

“Wrapping” Bitcoin or any other cryptocurrency basically means you are making it compatible with other ERC-20 tokens that run on the Ethereum blockchain network.

What are ERC-20 tokens?

ERC-20 tokens — which stands for Ethereum Request for Comment 20 tokens — are sets of fungible tokens on the Ethereum blockchain network. In this case, “fungible” means each token is interchangeable with other ERC-20 tokens (as opposed to non-fungible tokensor NFTs, which are unique tokens that show ownership of digital assets).

ERC-20 is a standard by which these digital tokens are created so they can transact with each other. Tokens that meet the ERC-20 standard must meet requirements that dictate how transactions are approved, how tokens are transferred and smart contract usage.

Although Ether (ETH) is the native coin on Ethereum’s blockchain network, it is not ERC-20-compatible and cannot interact with other ERC-20 tokens on the Ethereum network directly. As a solution, wrapped Ether (wETH) was created to allow ETH holders to transact directly with ERC-20 cryptocurrency tokens on the network.

What can you do with wrapped Bitcoin?

  • Staking: Generally, proof-of-work cryptocurrencies like Bitcoin do not support strike, which is a way for investors to earn rewards by helping to secure a proof-of-stake network. In September 2022, Ethereum migrated from a proof-of-work protocol to proof of stake in an event called “the merge.” Investors who hold BTC and are looking for ways to earn passive income in the cryptocurrency market can now stake their wBTC on the Ethereum network.

  • Using decentralized finance, or DeFi, products. You can also borrow, lend and swap your wBTC for other ERC-20 compatible tokens using DeFi platforms on the Ethereum network such as Uniswap or MakerDAO.

Is wrapping Bitcoin a taxable event?

It’s unclear. The IRS has not offered specific guidance on how wrapping coins, such as Bitcoin, should be taxed. But if you want to take a conservative approach, you might consider moving Bitcoin to wrapped Bitcoin as trading one virtual currency for another, which would be a taxable event.

How to buy wrapped Bitcoin

There are a few different ways to acquire wrapped Bitcoin:

Buy it directly on an exchange

You can buy wrapped Bitcoin directly on a cryptocurrency exchange. First, you’ll need to make sure the exchange you’re using supports wrapped Bitcoin, and then you’ll need to create an account. Once your account is created, you can fund it using a bank account via ACH, a wire transfer or a debit card.

Some exchanges will let you use a credit card to fund your account, but taking on debt to buy crypto is risky. In general, borrowing money to buy highly volatile assets is a bad idea. Additionally, many banks treat credit card deposits to a crypto exchange as a cash advance, which often carries a fee of 3% to 5%. If you aren’t able to pay off the debt immediately, cash advances often carry interest payments. So if the cryptocurrency you bought loses value, you could quickly find yourself paying high interest rates — sometimes 20% or more — on an asset that is no longer worth the amount you paid for it.

Once you have funded your account, enter an order to purchase wBTC in your desired amount and complete your purchase. If you’re planning to hold on to your wBTC for a while, you may want to consider moving the funds to a crypto wallet separate from the exchange where you bought it. This move can protect your assets in case the exchange you’re working with files for bankruptcy — as was the case with FTX spirit BlockFi — or gets hacked. But a wallet still won’t shield you from the volatility of crypto.

Exchange another cryptocurrency for wrapped Bitcoin

If you already own some cryptocurrency, check to see if it’s ERC-20 compatible. If it is, you should be able to trade your existing crypto for wBTC tokens, provided that the exchange you’re using supports wBTC.

Convert Bitcoin you already own

If you already own Bitcoin, you can swap it for wBTC. Typically, you’ll have to pay a small fee to an exchange to undergo the process of wrapping or unwrapping your BTC.

Neither the author nor editor held positions in the aforementioned investments at the time of publication.

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