Cryptonomics: Wrapped Tokens Explained

Wrapped tokens are tokenized versions of a cryptocurrency hosted on another blockchain representing the real-time underlying asset’s value.

By
Ace
on
January 25, 2021
Category:
Cryptonomics

Cryptonomics: Wrapped Tokens Explained

Wrapped tokens are becoming increasingly popular in cryptocurrency markets; it’s developed across various blockchain networks for varying reasons that serve important aspects like transaction speed, interoperability and gas fees. A wrapped token is an asset hosted on a blockchain with a worth identical to another underlying asset, not native to the host blockchain. It’s wrapped because the original asset is put in a vault (collateralized) representing its original value and price. Therefore wrapped tokens solve interoperability issues, supporting totally different blockchains with different use-cases. In most cases, different blockchains can't communicate with one another; wrapped tokens solve this unique problem.


Introduction to Wrapped Tokens

Interoperability across chains wasn’t integrated into the original idea of blockchain protocols; however, as technology grew, the need for cross-chain solutions arose. Interoperability grants users accessibility, transaction benefits, and speed. The idea of having wrapped BTC on Ethereum based protocols is quite a fascinating one made possible by the wrapped mechanism. Previous to using wrapped tokens, there was no possible way to replicate BTC on the Ethereum Network and other blockchains.


What is a Wrapped Token?

Wrapped tokens are tokenized versions of a cryptocurrency on another blockchain representing the real-time underlying asset’s value. Such wrapped versions of a token do not originally live in that protocol, and as such, they can be unwrapped. They are pegged 1-to-1 with the underlying asset it represents, i.e., at every given time wrapped BTC(WBTC) is equal to 1 BTC, of course, value and price changes with the market’s overall fluctuations.


Types of Wrapped Tokens

Stablecoins were somewhat the first wrapped tokens created through collateralizing crypto with prominent fiat currencies. This achieved a stable peg to fiat currencies created simple fiat-crypto on-ramps. Some of the most prominent stable coins can still be exchanged, such as USDT, USDC, TUSD, DAI, etc.; there are also Yen, Euro, Yuan, and countless other Fiat currency wrapped cryptos. Some may argue that stablecoins are not truly "wrapped" as coins such as USDT are backed by multiple fourms of capital such as cash, loans, and other assets. For the purposes of this article we will classify stable coins as a form of wrapped tokens.

Currently, Ethereum is the biggest De-Fi blockchain with the largest number of wrapped tokens. On Ethereum, underlying assets are pegged under the ERC-20 token standard, but we are beginning to see similar wrapped assets on the BSC, conforming to BEP-20 token standards. Wrapped privacy coins, e.g., Zcash, Monero, etc., are becoming commonplace as well as cross-chain technology continues to expand.


Mechanics of Wrapped Tokens

Imagine being a De-Fi enthusiast already familiar with DEX platforms, mostly Ethereum built, outside the fact that most Defi coin and application are Ethereum standard. You want to cash out with Bitcoin, but there is a problem, there is no known bridge or link that could affect a cross-chain communication between these two distinct blockchain types; wrapped BTC help to solve this problem and provide ample amounts of liquidity in doing so. With wrapped tokens, cross-chain communication between blockchains that naturally cannot occur is made possible. Wrapped tokens are custodian tokens – an entity that holds an equivalent amount of the asset as the wrapped amount. This custodian can be a merchant, a multi-sig wallet, a DAO (Decentralized autonomous organization), or even a smart contract. For example, in WBTC’s case, the custodian must hold 1 BTC for each 1 WBTC minted. Proof of this reserve exists on-chain. As previously mentioned, this is where stable-coins dont exactly fit into the category of wrapped tokens, as custody is not always held 1-1.


What Are the Benefits of Wrapped Tokens? 

Users have the enabled possibility of exploring options across various blockchains, allowing for a wide range of multiple chains and cross-chain experience. Wrapping tokens also improves liquidity and market exposure for the respective projects. It allows users of previously unsupported chains to adopt wrapped versions of the original tokens and utilize them on the new chain.


Wrapped Tokens on Ethereum

Ethereum is the most popular blockchain where tokens get wrapped due to its strategic position as the infrastructure blockchain for De-Fi applications. Wrapped tokens are tokens made to be compliant with the ERC-20 standard of Ethereum blockchain, which means you can use assets not native to the Ethereum blockchain within the environment. Notable projects have their wrapped version already deployed, ZCash, NEM, BTC, and even ETH, with Wrapped ETH(WETH), a compatible version of ETH on the ERC-20 standard.


Wrapped Tokens on Binance Smart Chain

Following closely on the heels of Ethereum in deploying standard wrapped version of tokens is the Binance Smart Chain (BSC); just like Ethereum, projects can wrap their tokens using the Binance Bridge that allows you to wrap tokens in the form of BEP-20 tokens, which comes with significantly reduced fees compared to the ERC-20 standard.


The Weakness of Wrapped Tokens

Trust is the biggest factor that users have to deal with in interacting with a custodian entity; a wrapped coin/token will require trust in the custodian holding the coin. They aren’t entirely cross-chain as per the current development; they must go through a custodian. The token deployment can be a high cost due to high gas fees occurring in these blockchains like BTC and ETH; high slippage in price is expected in the cause of minting.


Concluding Thoughts

Unlike most known stable coins, Wrapped coins have proven to be more transparent, and an independent security audit has proved WBTC’s total holding by Bitgo. However, the cost of minting and burning is still on the rise; with future technology, we should see many improvements in this area of development.

Wrapped tokens are responsible for the growth of De-Fi, as projects can now deploy tokens not originally native on the host chain. Incredible developments like this are expected to drive innovation to a whole new level as De-Fi innovation continues to spur. 


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Ace

Ace finds himself as a blockchain enthusiast who is focused on growing with the entire crypto sector. He is an energetic and passionate writer who believes that all things are achievable.