Is Wrapped Bitcoin the Next Terra Luna?

Bitcoin was originally designed as a self-sovereign, trustless monetary system. Yet as decentralized finance (DeFi) grew across Ethereum and other blockchains, Bitcoin faced a limitation: it could not easily interact with smart contracts outside its native network.

To solve this problem, the industry created Wrapped Bitcoin, a tokenized representation of BTC that can exist on other blockchains. Wrapped BTC unlocked billions of dollars of liquidity in DeFi and allowed Bitcoin holders to participate in lending, trading, and yield farming ecosystems.

But wrapped Bitcoin comes with a fundamental contradiction.

Bitcoin was created to remove trust from the financial system, yet most wrapped Bitcoin implementations reintroduce trusted intermediaries. Recent controversies, exchange collapses, and flash crashes have raised an uncomfortable question for the crypto industry:

Could wrapped Bitcoin become the next systemic risk similar to Terra Luna?

What Is Wrapped Bitcoin?

Wrapped Bitcoin is a tokenized version of Bitcoin that exists on another blockchain, usually Ethereum or other smart contract networks.

Each wrapped Bitcoin token is typically backed 1:1 with real BTC held in custody. When someone deposits BTC with a custodian, an equivalent amount of wrapped tokens is minted on another blockchain. When the wrapped tokens are redeemed, the underlying BTC is released.

For example:

1 BTC deposited with a custodian
1 WBTC minted on Ethereum

This mechanism allows Bitcoin holders to use their BTC in DeFi protocols, lending markets, and decentralized exchanges.

Wrapped tokens emerged primarily to solve the interoperability problem between blockchains, allowing assets from one network to operate within another ecosystem.

Today, billions of dollars worth of Bitcoin has been tokenized across multiple networks.

Major Wrapped Bitcoin Tokens in the Market

Several centralized exchanges and protocols have launched their own versions of wrapped Bitcoin.

1. Wrapped Bitcoin (WBTC)

WBTC is the largest tokenized Bitcoin asset in the DeFi ecosystem.

Launched in 2019
Created by BitGo, Kyber Network, and Ren
Uses a custodian model where BTC is held by BitGo
Governed by the WBTC DAO

WBTC alone represents a significant portion of tokenized Bitcoin circulating on Ethereum and other EVM networks.

2. Binance Bitcoin (BTCB / BBTC)

Binance introduced its own wrapped Bitcoin token on the BNB Chain ecosystem.

Key characteristics:

Custodied by Binance
Designed to bring Bitcoin liquidity to BNB Chain
Widely used across BSC DeFi protocols

However, like many exchange-issued tokens, users must trust the exchange to maintain the BTC reserves.

3. Coinbase Wrapped Bitcoin (cbBTC)

In 2024, Coinbase launched cbBTC, its own wrapped Bitcoin token.

The token rapidly gained traction, accumulating billions in total value locked shortly after launch. Coinbase holds the underlying BTC reserves and deploys the token across chains including:

Ethereum
Base
Solana

The launch of cbBTC intensified competition in the wrapped Bitcoin market and sparked debates around centralization and exchange dominance.

4. Liquid Bitcoin (LBTC)

Liquid Bitcoin (LBTC) is issued on the Liquid Network, a Bitcoin sidechain developed by Blockstream.

Unlike ERC-20 wrapped tokens, LBTC functions within a federated sidechain model where a group of trusted entities called functionaries manage the network.

LBTC allows:

faster Bitcoin settlements
confidential transactions
asset issuance on the Liquid network

However, the federation model still introduces elements of trusted control.

The Collapse of Earlier Wrapped Bitcoin Experiments

Wrapped Bitcoin is not a new concept, and several early versions have already failed.

renBTC

renBTC was once considered a decentralized solution for bringing BTC to Ethereum. The system used a network of nodes called Darknodes to custody Bitcoin.

However, the project became heavily dependent on Alameda Research and FTX. When FTX collapsed in 2022, renBTC lost its operational backing and minting eventually halted.

HBTC (Huobi BTC)

HBTC was another wrapped Bitcoin issued by the Huobi exchange.

After regulatory issues and restructuring around the exchange, the token lost credibility and liquidity, eventually fading from the market.

These failures highlight an important lesson:

Wrapped assets are only as strong as the institutions behind them.

Why Wrapped Bitcoin Is Fundamentally Custodial

Despite being used in DeFi, most wrapped Bitcoin systems rely on centralized custody.

The architecture usually involves three parties:

User - Deposits BTC
Merchant / Bridge - Initiates minting
Custodian - Holds the real BTC reserves

Once the custodian confirms the deposit, the equivalent wrapped tokens are minted on another blockchain.

This creates a critical dependency.

If the custodian:

goes bankrupt
gets hacked
faces regulatory seizure

then the backing for the wrapped tokens could disappear.

This is essentially the same counterparty risk that exists in traditional finance.

Wrapped BTC Ecosystem Comparison :

Control varies depending on the token.

Token	Issuer / Controller	Custody Model	Centralization Level	Blockchain / Network	Risk
WBTC	BitGo + WBTC DAO	Custodial (BitGo holds BTC reserves)	Semi-centralized	Ethereum & EVM chains	Custodian risk and governance changes
BTCB (Binance BTC)	Binance	Fully custodial	Highly centralized	BNB Chain	Exchange solvency risk
cbBTC	Coinbase	Fully custodial	Highly centralized	Ethereum, Base, Solana	Exchange custody risk
LBTC (Liquid BTC)	Liquid Federation (Blockstream)	Federated custody	Moderately centralized	Liquid Network (Bitcoin sidechain)	Federation trust risk

This raises a key concern.

While Bitcoin itself is decentralized, most wrapped versions are controlled by centralized institutions or federations.

If these entities fail or act maliciously, users holding wrapped tokens could lose access to the underlying Bitcoin.

Mechanism Behind Wrapped Bitcoin

The wrapped Bitcoin process follows a simple lifecycle.

Step 1 : Deposit

A user sends BTC to a custodian wallet.

Step 2 : Verification

The custodian verifies the deposit and locks the Bitcoin in reserve.

Step 3 : Minting

An equivalent amount of wrapped BTC tokens are minted on another blockchain.

Step 4 : Usage

The user can now use wrapped BTC in:

DeFi lending
decentralized exchanges
collateralized borrowing
yield farming

Step 5 : Redemption

When the user redeems the wrapped tokens, they are burned and the BTC is released.

This model works efficiently but introduces bridging risk and custody risk.

Warning Signs: Flash Crashes and Delistings

The wrapped Bitcoin market has already shown signs of fragility.

In November 2024, WBTC experienced a dramatic flash crash on Binance, briefly dropping from around $102,000 to roughly $5,200 before recovering. The event triggered massive liquidations and stop-loss cascades across the market.

Around the same time, Coinbase announced plans to suspend WBTC trading, citing listing standards and market concerns.

While the price recovered quickly, the incident exposed how liquidity shocks and exchange decisions can destabilize wrapped assets.

Could Wrapped Bitcoin Collapse Like Terra Luna?

Wrapped Bitcoin is fundamentally different from Terra Luna, but there are parallels.

Terra collapsed because its stability depended on a fragile system of trust and incentives.

Wrapped Bitcoin depends on:

custodians
centralized exchanges
bridge infrastructure
liquidity providers

If trust in these entities disappears, the peg between BTC and wrapped BTC could break.

A few scenarios that could trigger systemic issues include:

custodian insolvency
regulatory seizure of reserves
smart contract exploits
liquidity crises
governance disputes

If large amounts of wrapped BTC suddenly lose backing or liquidity, the DeFi ecosystem could face a chain reaction similar to stablecoin depegs.

Final Thoughts

Wrapped Bitcoin has played a significant role in expanding Bitcoin’s utility across the broader crypto ecosystem. By enabling BTC to move into DeFi, lending markets, and multi-chain applications, wrapped tokens unlocked billions of dollars in liquidity and created new financial opportunities for Bitcoin holders.

However, the model also introduces risks that Bitcoin itself was designed to eliminate.

Most wrapped Bitcoin implementations depend on centralized custodians, exchanges, or federations. This means users must trust that the underlying Bitcoin reserves are securely held, transparently managed, and always redeemable. History has shown that when trust in intermediaries breaks down, the consequences can be severe. The collapse of renBTC after the FTX crisis and the disappearance of HBTC following Huobi’s restructuring are reminders that wrapped assets can fail when the institutions behind them fail.

Recent controversies surrounding custody changes, exchange competition, and market flash crashes have further highlighted the structural fragility of tokenized Bitcoin systems. While wrapped BTC remains widely used across DeFi, it is fundamentally different from holding native Bitcoin.

Bitcoin itself operates without intermediaries. Wrapped Bitcoin does not.

This does not necessarily mean wrapped BTC will collapse like Terra Luna, but it does raise important questions about custody, transparency, and systemic risk within the multi-chain ecosystem.

As the industry evolves, the long-term solution may lie in trust-minimized bridges, decentralized custody models, and native Bitcoin DeFi innovations that preserve Bitcoin’s original ethos of self-sovereignty.

Until then, investors and users should understand the trade-offs between convenience and security when interacting with tokenized assets.

At Encapsulate, our mission is to break down complex crypto narratives, uncover the risks behind emerging trends, and help the community stay informed in an industry that moves faster than ever.

Because in crypto, education is the strongest form of risk management.