Bridges in crypto
If you’ve been active around cryptoverse and crypto news, you’ve probably heard mention of bridges and/or wrapped tokens (like wrapped Bitcoin, or WBTC).
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Here’s an explanation of what these bridges do, how they do it, and what their relationship with wrapped tokens is.
What are Bridges
Bridges allow us to take assets from one chain and move them to another chain where they are not native assets. The Bitcoin-Ethereum bridge, for example, allows our BTCs to be moved from the Bitcoin network to the Ethereum network, allowing your BTCs to interact with the entire DeFi world on Ethereum. By using a DEX, you could, for example, buy ChainLink, an erc20 token native to the Ethereum network, with Bitcoin, which is not native to the Ethereum network. Aave, an Ethereum-based lending protocol, would allow you to lend your BTC.
There was no way to connect assets on one blockchain to assets on another before bridges. Each blockchain existed in isolation.
However, you might be thinking, “but we can already buy LINK with BTC on any CEX”. The answer is yes. However, LINK and BTC don’t actually interact or know about each other when they do. Neither chain actually performs a transaction on-chain.
In its place, the CEX just has one wallet for every major chain, and it keeps a giant pile of each of its assets in those wallets. CEX trades the BTC/LINK pair by crediting your account with a voucher for some of the LINK in their huge LINK pool, and debiting your account with a voucher for some of the BTC in their huge BTC pool. Because BTC and LINK are on different chains, they make it seem as if you can exchange them directly.
You can actually interact across chains when you use bridges. This is a major development in DeFi.
The Functions of Bridges
In other words, a wrapped coin is a token that resides on one network (usually Ethereum) while representing a coin from another network.
As an example, let’s look at wrapped Bitcoin, the biggest wrapped coin in crypto. WBTC can be created by sending bitcoin to the Bitcoin/Ethereum bridge. On the Ethereum side of the bridge, the equivalent amount of WBTC would be minted in place of your BTC.
With your WBTC on the Ethereum side, you can do anything you want with it within the Ethereum ecosystem. Because it’s an erc20 token, you can use it in the same way you would use any other token on Ethereum.
WBTC can be bridged back to the Bitcoin network by sending it to the bridge, where it will be burned, and you will then be able to use your locked BTC on the Bitcoin side.
The bridge will always allow you to exchange 1 WBTC for 1 BTC, and vice versa. By fixing the exchange rate, arbitrage traders are able to take advantage of any divergence in the prices of BTC and WBTC by sending some of the cheaper asset over the bridge in exchange for the more expensive asset, which would correct the price difference. Therefore, a wrapped coin is always pegged to its native version, since they are backed 1-to-1.
WBTC can also be redeemed for BTC even if it wasn’t constructed by them (say, they bought their WBTC from someone else on the Ethereum network), because the amount of WBTC in existence will always match the amount of BTC locked at the bridge. If ever you decide to redeem your WBTC, you know there is an equally-sized pile of BTC waiting for you on the other side of the bridge regardless of where you acquired it.