Let’s clear up some misconceptions about wrapped Bitcoin and Ethereum

There’s been a ton of chatter about wrapped tokens like Wrapped Bitcoin (WBTC) and Wrapped Ethereum (WETH) this week — some of it legitimate, some of it top-tier shitposting.

Earlier this week, several notable crypto Twitter accounts began peddling the idea that WETH was on the brink of collapse.

“NOTE: WETH is about to be insolvent,” tweeted crypto flu Cygaar. “I will reluctantly save everyone who has WETH at a rate of 0.5 ETH per WETH to save this space. You can thank me when the crisis is averted.”

“We may see a bank run on redeeming WETH soon,” tweeted Gnosis co-founder Martin Köppelmann.

None of this was true.

Unlike the bank-driven tweets that swirled around Twitter amid the FTX collapse, WETH does not have the same counterparty risk. There is no centralized organization that holds the underlying Ethereum. There are no over-leveraged funds in the Bahamas that take a massive risk with user funds.

Instead, the key risk here is smart contract risk.

To mint WETH, users deposit Ethereum into a smart contract instead of giving it to an exchange or a crypto lender to hold. The reason people use WETH instead of ETH (after all, they’re basically the same, right?) is that, unlike Ethereum, it’s also an ERC-20 token. This makes it much easier to integrate into various decentralized applications.

Thus, there was never a risk of insolvency or bank run on this asset. It is simply another example of the rather unpleasant sense of humor found in the industry. Sure, the smart contract could somehow break down, but it’s been around and working smoothly for so long that something like this would have already happened by now if there was some sort of glitch.

However, WBTC is much different.

“BitGo is the custodian for the BTC backing of wBTC,” wrote Rugdoc.io, a community-driven project evaluating smart contracts. “Bitgo froze FTX assets, creating a 4k surplus of BTC and wBTC depegen. It’s not your Bitcoin if you have wBTC.”

This resource basically allows you to create an Ethereum-compatible version of Bitcoin so that it can be used in various DeFi applications. Even simpler, it’s an ERC-20 token tied to the price of Bitcoin.

It is also backed by real Bitcoin, which, as mentioned above, is the depository of a company called BitGo. For every 1 WBTC in circulation, BitGo has 1 real Bitcoin.

When a user wants to “unwrap” their WBTC and redeem it for the real deal, they have to go through a merchant (this could be an exchange for example). To do this means to destroy (or burning) that WBTC and withdraw one of Bitcoin from custody.

Critically, you can also see this embossing and burning activity happening on the chain thanks to a handy dashboard.

Last week, WBTC depreciated from the underlying Bitcoin, which – given the design – was actually a bit more worrying (and not necessarily a malicious Twitter joke).

Normally, when a discount like this appears, market makers will step in and arbitrage the difference for profit by buying the cheaper WBTC and redeeming it for the real Bitcoin.

And that’s pretty much what they’ve done here as well. But because Alameda (the sister trading firm of the collapsed FTX) was a big WBTC user, their absence left a lot of arbitrage to be done.

Thus, the market is catching up a bit, in addition to fighting some serious R&D along the way.

Right now, WBTC is trading at about a $15 discount to the real deal. It’s peanuts. And it probably made some market makers all the richer along the way.

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