In brief
Wrapped tokens are cryptocurrency tokens that are pegged to the value of another cryptocurrency. The name wrapped token comes from the fact that the original asset is placed in a wrapper, a type of digital vault that allows the creation of a wrapped version on another blockchain.
What is the problem here? Different blockchains provide different functionalities. And blockchains cannot talk to each other. The Bitcoin blockchain does not know what is going on on the Ethereum blockchain. However, wrapped tokens can help create a bridge between different blockchains.
Introduce
Have you ever felt frustrated when you couldn't use BTC on Ethereum? Or ETH on Binance Smart Chain? Transferring coins that exist on a certain blockchain to another blockchain is not easy.
Wrapped tokens are a way to overcome this limitation and use non-native assets on the blockchain.
What is wrapped token?
Wrapped token is a tokenized version of another cryptocurrency. Wrapped tokens are anchored to the value of the asset they represent and can generally be exchanged for that (unwrapped) asset at any time. Wrapped tokens typically represent an asset that does not exist on the blockchain on which it is issued.
You can think of a wrapped token as a stablecoin because it derives its value from another asset. In the case of stablecoins, that is usually fiat currency. In the case of wrapped tokens, it is typically an asset that inherently exists on another blockchain.
Because blockchains are separate systems, there is no efficient way to move information between blockchains. Wrapped tokens increase interoperability between different blockchains – essentially, the underlying token can move cross-chain.
It's worth noting that if you're a regular user, you don't have to worry about the wrap and unwrap process; You simply trade these wrapped tokens like any other cryptocurrency. For example, here is the WBTC/BTC market on Binance.
How does wrapped token work?
We will take Wrapped Bitcoin (WBTC), the tokenized version of Bitcoin on Ethereum, as an example. WBTC is an ERC-20 token pegged to Bitcoin at a 1:1 ratio, allowing you to effectively use BTC on the Ethereum network.
Wrapped tokens typically require a custodian – an entity that holds an equivalent amount of assets in the form of the wrapped currency. This custodian can be a merchant, a multi-signature wallet, a DAO, or even a smart contract. In the case of WBTC, the custodian needs to hold 1 BTC for every 1 WBTC minted. Proof of this reserve exists on-chain.
But how does the encapsulation process work? A trader sends BTC to be minted by a custodian. The custodian will then mint WBTC on Ethereum according to the amount of BTC deposited. When needing to exchange WBTC for BTC, the merchant will send a burn request to the custodian and the BTC will be released from the reserve. You can think of the supervisor as wrapper and unwrapper. In the case of WBTC, adding and removing custodians and merchants is done by the DAO.
While some in the community may consider Tether (USDT) to be a wrapped token, this is incorrect. While USDT typically trades at a 1:1 ratio with USD, Tether does not keep an exact amount of USD for each USDT in circulation in its reserves. Instead, this reserve includes real-world cash and cash equivalents, assets, and loan receivables. However, the idea is similar. Each USDT token acts as a wrapped version of the fiat currency USD.
Wrapped token trên Ethereum
Wrapped tokens on Ethereum are tokens from other blockchains created to comply with the ERC-20 standard. This means you can use non-Ethereum native assets on Ethereum. Wrapping and unwrapping tokens on Ethereum will cost gas.
The deployment process for these tokens can vary widely. We discussed this topic in more detail in our Tokenized Bitcoin article.
An interesting example of a wrapped token on Ethereum is wrapped ether (WETH). Quick summary – users must have ETH (ether) to pay for transactions on the Ethereum network, while ERC-20 is the technical standard for issuing tokens on Ethereum. For example, Basic Attention Token (BAT) and OmiseGO (OMG) are ERC-20 tokens.
However, because ETH was developed before the ERC-20 standard, it does not comply with this standard. This creates problems, as many DApps require you to convert between ether and an ERC-20 token. This is why wrapped ether (WETH) was born. It is a wrapped version of ether that complies with the ERC-20 standard. It's basically a tokenized version of ether on Ethereum!
Wrapped token trên Binance Smart Chain (BSC)
Just like wrapped tokens on Ethereum, you can wrap Bitcoin and many other cryptocurrencies for use on Binance Smart Chain (BSC).
Binance Bridge allows you to wrap crypto assets (BTC, ETH, XRP, USDT, BCH, DOT, etc.) for use on Binance Smart Chain as BEP-20 tokens. After posting assets to BSC, you can trade or use these assets in many yield farming applications.
However, the gas fees to wrap and unwrap on BSC are significantly lower than on other blockchains. You can read more about Binance Bridge in our detailed article.
Benefits of using wrapped tokens
Although many blockchains have their own token standards (Ethereum's ERC-20 or BSC's BEP-20), these standards cannot be used across chains. Wrapped tokens allow users to use tokens that are not native tokens on a given blockchain.
In addition, wrapped tokens can help increase liquidity and capital efficiency for both centralized and decentralized exchanges. The ability to wrap idle assets and use them on another chain can strengthen connectivity between isolated liquidity sources.
Finally, a huge benefit to using wrapped tokens is time and fees. While Bitcoin has some attractive attributes, it is not the fastest and is sometimes costly. While everything with Bitcoin seems fine right now, some problems can arise from time to time. These problems can be alleviated by using a wrapped version on the blockchain with faster transaction times and lower fees.
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Limitations of using wrapped tokens
Most current wrapped token implementations require trust in the custodian holding the funds. With current technology, users cannot use wrapped tokens for true cross-chain transactions – which usually have to go through a custodian.
However, a number of more decentralized options are in the works and may launch in the future to make minting and redeeming wrapped tokens completely trustless.
The casting process can also be relatively expensive due to high gas fees and possible price inflation.
summary
Wrapped tokens help create more bridges between different blockchains. Wrapped token is a tokenized form of an asset that exists on another blockchain.
This helps increase interoperability within the cryptocurrency and Decentralized Finance (DeFi) ecosystem. Wrapped tokens support more efficient use of capital and help applications easily share liquidity with each other.