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- 1 Wrapped tokens are the solution to the problem of interoperability among blockchains.
- 2 Wrapped tokens are pegged with assets stored in a digital vault.
Bitcoin and Ethereum are the most famous blockchains that everyone must have heard. They are different from one another due to their functionality, different protocols, and differences in algorithms. This is why they lack interoperability. They are separate and cannot communicate easily with each other. There are many blockchains that facilitate interoperability like Polkadot.
Bitcoin can not be used directly on the Ethereum blockchain. Hence, to find a solution to the problem of interoperability and communication in blockchains, wrapped crypto tokens were created.
What Are Wrapped Tokens?
Wrapped tokens were created as a solution to make the movement of assets between blockchains possible. Thus, easy transfer of native assets from one blockchain to another blockchain is feasible.
Wrapped crypto tokens are cryptocurrencies that are pegged with the value of original crypto or assets like gold, stocks, shares, and real gold and put to work on the DeFi platform. The assets can be art, collectibles, fiat currencies, and stocks.
The original asset is wrapped in a digital vault and a newly minted token is created to transact on other platforms. Wrapped tokens allow non-native (that do not belong to the particular blockchain) assets to be used in blockchains. Wrapped tokens build bridges and facilitate interoperability between two different chains.
The wrapped tokens are pegged with other assets so they need to be considered and managed by some custodial entity that will wrap and unwrap the assets. Wrapped Bitcoin represented as ‘wBTC’ were the first wrapped Bitcoin tokens used in the Ethereum blockchain through smart contracts. Apart from Bitcoin, some other wrapped tokens include other assets mainly compliant with Ethereum ERC-20.
ERC-20 tokens are issued in the Ethereum platform but ETH is not compliant with them as it was developed before them. So, like Bitcoin, Ether needs to be wrapped to comply with other ERC-20 token standards. A tokenized version of Ether on the
the Ethereum platform is thereby created.
Other blockchain like Solana, and Polkadot experiments with wrapped tokens to facilitate access to DeFi applications. Wrapped tokens are used to facilitate cross-chain transactions and to bring liquidity to decentralized finance platforms.
Wrapped Bitcoin is pegged with equal Bitcoin (BTC). It means one wBTC should always equal one BTC. But unlike BTC, WBTC is available as ERC-20 or TRC-20 tokens, which means it can be used and traded on the Tron and Ethereum blockchain.
Types of Wrapped Tokens and their Working
It is widely regarded that stablecoins are the first type of wrapped tokens, besides it shows a lot of difference with more established wrapped coins. The stablecoin like USDT is backed with physical USD. It is pegged with the equal value of assets like cash equivalents, investments, etc.
Wrapped tokens are just not pegged 1:1 to the price of another asset but also the technology and the way by which its value is maintained.
There are two types of wrapped tokens redeemable and cash-settled. The redeemable tokens allow investors to exchange wrapped tokens with underlying assets. Other blockchains host the wrapped tokens.
Wrapped tokens are created and destroyed by a process called burning and minting. For example: To mint a wrapped token such as WBTC, the underlying asset in the case of BTC, is sent to a custodian who stores the BTC in a digital vault. Once the underlying BTC has been locked away, an equivalent amount of WBTC can be minted.
The process of creating and managing the wrapped tokens is handled by custodians, thus it faces a limitation as their regulation depends on the need of custodians for holding the funds; this defeats the purpose of open and decentralized blockchains.
The need for the custodian is necessary since traders do not independently use the wrapped tokens for cross-chain transactions. But the technology is evolving fast and some decentralized way will soon be available.
Is Wrapped Token a Good Investment?
As per Arcane Research, the amount of Bitcoin locked on the Ethereum blockchain has increased to 189,000 BTC in 2021. It is estimated that a record 1% of the Bitcoin circulating supply of 18.73 Million is now used through wrapped Bitcoin tokens in DeFi.
So it is regarded that wrapped token is a good investment where decentralized finance will play an important role. As per studies, in just over 1 year about $800 Million worth of Bitcoin was converted into wBTC. This gives the idea of the current capitalization of the industry.
The interoperability between different chains is a challenge for the industry. The problem develops when more blockchains are made. At that time the number of bridges has to be certain that assets on a blockchain can facilitate easy transfer to every other blockchain increases moutingly.
Summary
Wrapped tokens offer interoperability by building bridges between the blockchains so that people can transfer assets between other blockchains. The other advantages include the low fees and fast transactions.
The amount of WBTC in circulation has been steadily increasing hence the solution that allows to wrap tokens and move them to other blockchains is also increasing rapidly. Wrapped tokens are the main part of the solution for interoperability.
Nancy J. Allen is a crypto enthusiast, with a major in macroeconomics and minor in business statistics. She believes that cryptocurrencies inspire people to be their own banks, and step aside from traditional monetary exchange systems. She is also intrigued by blockchain technology and its functioning. She frequently researches, and posts content on the top altcoins, their theoretical working principles and technical price predictions.
