Regarding wBTC to BTC conversion and Bitcoin cross-chain solutions, most people are familiar with wBTC (Wrapped Bitcoin). It allows Bitcoin (BTC) holders to use their BTC on the Ethereum network, where Bitcoin can’t interact with smart contracts. But why do users need to move their BTC to Ethereum, and how does wBTC to BTC work? Let’s explore this in detail and introduce mBTC, a decentralized solution to address wBTC’s centralization risks.
What Is wBTC
wBTC is an ERC-20 token on the Ethereum blockchain, representing Bitcoin (BTC). The reason for using wBTC over BTC is simple: Bitcoin’s native blockchain doesn’t support smart contracts, meaning that $BTC can only be used for simple transactions. On the other hand, Ethereum supports a vast ecosystem of decentralized applications (dApps), decentralized finance (DeFi) protocols, and other smart contract-based services. Thus, users who want to take advantage of Ethereum’s capabilities might convert their BTC into wBTC to participate in DeFi, yield farming, lending, and other Ethereum-based applications.
The process of converting BTC into wBTC is relatively straightforward. A custodian like Bitgo locks Bitcoin on the Bitcoin chain and issues an equivalent amount of wBTC on Ethereum. However, this method has a significant issue: centralization risks.
The Centralization Problem with wBTC
While wBTC serves a valuable purpose, it relies on a single custodian, Bitgo, to hold all the BTC in the system. This creates a centralized point of failure, making the system vulnerable to risks like hacking, mismanagement, or single-party control over issuance and redemption processes. Additionally, the merchant approval process for wBTC adds another layer of centralization, as merchants needs to approve by Bitgo to participate in the system.
This reliance on a single custodian and merchant approval has led to growing concerns within the cryptocurrency community about the security and decentralization of Bitcoin’s movement across blockchains.
A Decentralized Cross-Chain Solution
To solve centralization issues, the Merlin Protocol introduced mBTC, a decentralized cross-chain solution designed to move Bitcoin across different blockchain networks without the risks associated with wBTC.
The mBTC system is similar to wBTC in that it represents Bitcoin on other blockchains (like Ethereum), allowing users to convert wBTC to BTC on the Bitcoin network or bridge their Bitcoin to Ethereum. However, unlike wBTC, mBTC operates on a decentralized model where the roles of custodians and merchants are combined into “cross-chain gateway providers.” This means multiple entities can issue and redeem mBTC without permission from a central authority like Bitgo.
How mBTC Works
1. Issuance: Users can issue mBTC by staking BTC with any cross-chain gateway provider. These providers are decentralized entities responsible for issuing mBTC on the Ethereum network once the BTC is locked in their custody. After receiving the BTC, the provider issues an equivalent amount of mBTC to the user’s Ethereum address.
2. Redemption: Users simply reverse the process When they wish to redeem mBTC for BTC. They can send their mBTC to the cross-chain gateway provider, who then releases the equivalent amount of BTC back to the user’s Bitcoin address.
By combining the functions of custodians and merchants into a decentralized provider network, mBTC avoids the single-point failure risks associated with wBTC to BTC conversion.
Over-Collateralization and Security
To ensure the system remains secure and trustworthy, mBTC introduces an over-collateralization mechanism. As a security guarantee, cross-chain gateway providers must stake collateral (in Ethereum, USDT, USDC, or ETH). The amount of mBTC they can issue is limited to two-thirds of the value of the collateral they have staked. Moreover, to prevent under-collateralization, the providers must maintain a collateral value of 105% of the mBTC issued. If this threshold is breached, the provider’s collateral is liquidated to cover the potential loss, ensuring users are protected from defaults.
In addition to the over-collateralization mechanism, Chainlink price oracles are integrated into the mBTC system, ensuring real-time tracking of the prices of Bitcoin and collateral assets.
Incentivizing Participation with Economic Rewards
MBTC has introduced an economic incentive model to encourage further involvement and liquidity. When users redeem mBTC, cross-chain gateway providers earn a 1.5% fee. This fee model encourages more providers to join the system, increasing its liquidity and decentralization.
Moreover, mBTC is not just a cross-chain bridge—it is a decentralized system with no central authority to manage or maintain it. Every participant, from cross-chain gateway providers to users, plays a role in keeping the system running smoothly.
The Future of mBTC and Bitcoin Cross-Chain Solutions
Moving forward, mBTC plans to extend its cross-chain capabilities beyond Ethereum and into Layer-2 solutions on Ethereum, which are becoming increasingly crucial in crypto. As demand for Bitcoin cross-chain functionality grows, mBTC aims to be a key player in providing decentralized solutions that make bridging BTC and other networks seamless and secure.