How to use Bitcoin on Ethereum: The Easy Way to Create Cross-Chain Compatibility

When Ethereum launched back in 2015, it was a fundamentally different kind of blockchain than what had come before in use-cases like Bitcoin because it allowed for programable smart contracts and distributed apps (dApps). Basically, it meant that blockchain was no longer just some background technology that made a niche cryptocurrency function; it was the star of the show.

Ethereum was revolutionary at the time, giving rise to a countless number of ICO (initial coin offering) projects. Many of these were scams, it’s true, and they permanently damaged the reputation of the blockchain community. But they also changed the way we interact with digital assets, creating a way to buy them with digital payment standards.

While paying for tokens might seem common place now at a time when digital art tokens are going for $69Million, and anyone’s grandma can buy Bitcoin on their mobile, at the time this was revolutionary. The problem was that the Ethereum blockchain, where all the programable tokens and dApps were, required ETH, the chain’s native currency, to be used as payment. Ethereum wasn’t directly compatible with fiat currency, or even other popular cryptos like Bitcoin.

So the ICOs did the only thing that could be done at that time. They accepted ETH. In order to acquire ETH one first had to convert fiat or BTC on an exchange or OTC platform into ETH. A lot of people rightly thought “what the heck, why can’t we just use BTC on Ethereum natively?” This in turn kicked off several blockchain projects, such as Polkadot, designed to link the chains in order to create a more useful digital ecosystem.

The Technical Option

There are two very different approaches to solving this problem of blockchain exclusivity. The most obvious method is to integrate one blockchain’s protocols into another at the code-level, meaning that chain A can recognize and handle chain B’s tokens and smart contracts as if they were its own. Cardano, another major blockchain and smart contract platform similar to Ethereum, recently announced they had achieved just this. The major downside to this method is that it requires significant development effort and needs continuous improvement and maintenance to keep up with changing protocols. But, it has the significant advantage of not having to rely on third parties. Unfortunately, this native integration doesn’t really work with fiat currencies, since the SWIFT protocol, a centralized payment system that powers almost every bank in the world, will not concede anything to the competing decentralized world.

The Easy Option

While the technical solution is high-maintenance and lacks some of the most common payment options, the other solution might seem at first to be even more complicated. Assets such as Bitcoin, CHF, EUR, USD (and for that matter practically anything else) can be “wrapped up” into a token and offered on a different chain. In other words, you tokenize your payment method. Here’s how it works.

First of all, you need a blockchain that allows you to create tokens and smart contracts. Then, you have to deposit the assets in question. In the case of Bitcoin, you can put them in a hardware wallet such as a Ledger, Trezor, etc. In the case of fiat currencies, you can put them into a bank account, or even stash the cash under your mattress, as long as it’s safe and under your control. Then, you create a token for these assets. From a technical point of view, creating a token only takes a few minutes and requires no development effort. It also decouples the token from potential protocol changes and requires no permission from those who control the SWIFT protocol. Once your payment method is tokenized, then the token is ready for use. All in all, it’s pretty straightforward.

The Trust Issue

But like everything, this option too has its drawbacks. The most obvious one is trust. Because anyone can easily create an asset-backed token, the buyer of that token needs to be able to know if the asset backing it really exists. How can the buyer know that for sure? Well, realistically they can’t, unless they happen to know the seller and can look under their mattress.

So how can you, as an issuer, prove that your assets are really there? The first step is to provide information about the storage location that can be verified by a third party. Ideally, this information has an audit trail that is forge-proof and cannot be tampered with afterwards.

Fortunately, blockchain is perfect for documenting simple facts like this. You can document anything you want, together with the date and time that the information has been recorded. If you update the information later on, then the date and time of the update and the changes are also recorded on the chain. Blockchain by its very nature creates a seamless, unalterable audit trail every time something is recorded.

Proving ownership of cryptos such as Bitcoin couldn’t be simpler — just provide the Bitcoin holding address. Anyone with access to a blockchain explorer can verify whether or not the address holds the claimed amount of Bitcoin. But what if the wrong address is given? In order to ensure security, all you have to do is announce a Bitcoin transfer with the exact amount before it happens and document it on blockchain. Then do the transfer; a small amount from the holding address is sufficient. This is a proof that they hold the private key to the Bitcoin address and thereby control the amount.

With fiat currencies this is all a bit more complicated, but still possible. All you have to do is ask a credible third party, say an auditor with a good international reputation, to document your holdings on blockchain, the same blockchain where your tokens are. Then, the auditor has to link this asset-audit with your tokens. Verification of the auditor’s signature can be done online by anyone. This audit has to be repeated regularly of course, but it is a process that is known and has been proven feasible for centuries; it’s common practice in many standard transactions today.

A Simple and Practical Solution

“Wrapping up” assets into a token is quick and easy. It doesn’t require much development effort thanks to today’s much more advanced blockchain infrastructures. Tokenizing assets can be standardized too, so it doesn’t matter whether you’re working with Bitcoin, gold, or paper; it always works exactly the same way. The maintenance effort is also low. Frankly, the only real challenge to address is the age-old question of trust. Fortunately, the answer to this question is also age-old — 3rd party verification. With the exception of assets that are already on-chain, such as Bitcoin, this is, unfortunately, the only way to guarantee trust and security.

The Elephant in the Room

“But wait,” you might be saying now, “I thought blockchain’s strength was that you didn’t need middlemen?” Many on social media extol the virtues of blockchain as a ‘trustless’ technology and indeed this is a very real benefit, but only as long as everything is handled virtually and on-chain. Verifying the contents of a Bitcoin wallet is a perfect example of this. However, for off-chain assets, like fiat currency, or physical commodities like gold or oil, this problem can’t yet be solved with a technical solution. No blockchain, nor any digital solution we know of for that matter, can peek into a vault and count gold bars.
The only currently viable solution to ensure trust is an audit by a third party. It’s simple, practical, and commonly used in other settings. Yes, it goes counter to all the hype about removing middlemen, but as the saying goes, ‘if it ain’t broke, don’t fix it.’ And at least all the development effort that would otherwise have gone into developing coded links between blockchains can be better spent elsewhere.

The good old-fashioned audit mechanism is a tried and true method for verification. Blockchain technology merely adds an additional layer of security, and helps transition these trusted methods into our increasingly digital world. Think of it as a hybrid system.

Keeping it Real

Third-party auditing is certainly is not the most glamorous thing for a blockchain technology company to be advocating for. But at the end of the day, we’re blockchain realists. We know the technology’s true potential, but we also recognize its shortfalls. Rather than hype blockchain as a perfect miracle cure for everything, as so often happens, we want to be realistic about the technology and how it can be integrated today into existing use-cases. Ultimately, it’s just a tool, albeit a powerful one, that has an incredible amount of potential if it is used in applications that suit its strengths. Work-arounds like wrapping assets up in tokens can help extend blockchain’s applications and make it more useful right now.

CoreLedger’s mission is to help businesses of all sizes quickly and affordably access the benefits of blockchain technology. From issuing a simple token, to enterprise- grade token economy solutions, we have all the tools you need to integrate blockchain into your business. Interested in our results-focused, real-world approach? Then visit our website for more information, or get in touch with us directly to discuss your project.