TL;DR

Wrapped tokens are cryptocurrency tokens that are pegged to the value of another cryptocurrency. The term used is wrapped token because the original asset is put in a wrapper, which is a kind of digital vault that allows a wrapped version to be created on another blockchain.

What is the point? Different blockchains offer different functionalities as well. Additionally, blockchains cannot communicate with each other. The Bitcoin blockchain is not aware of what is happening on the Ethereum blockchain. However, there will be bridges between various blockchains with wrapped tokens.

Introduction

Have you ever been annoyed that you can't use BTC on Ethereum? Or ETH on Binance Smart Chain? Coins on a particular blockchain cannot simply be transferred to another blockchain.

Wrapped tokens are a way to overcome this limitation and use foreign assets on a blockchain.

What are wrapped tokens?

Wrapped tokens are tokenized versions of other cryptocurrencies. The value is pegged to the asset represented and can generally be exchanged (unwrapped) at any time. Additionally, these tokens typically represent assets that are not inherently native to the blockchain on which they are issued.

Wrapped tokens can be thought of like  stablecoins that derive their value from other assets. In the case of stablecoins, the asset is usually a fiat currency. In the case of wrapped tokens, the assets usually come from another blockchain.

Because blockchain is a special system, there is not yet a perfect way to move information between each other. Wrapped tokens improve interoperability between different blockchains – in essence, the base token is cross-chain capable.

Please note that if you are a regular user, you don't need to worry about the wrapping and unwrapping process. You simply trade these wrapped tokens like any other cryptocurrency. For example, the WBTC/BTC market on Binance.

How do wrapped tokens work?

Let's use Wrapped Bitcoin (WBTC) as an example, which is a tokenized version of Bitcoin on Ethereum. WBTC is an ERC-20 token that is supposed to have a one-to-one peg to the value of Bitcoin allowing you to use BTC effectively on the Ethereum network.

Generally, wrapped tokens require a custodian – an entity that holds an amount of assets equal to the amount wrapped. These custodians can be merchants,  multisig wallets, DAOs, or even smart contracts. So, in the case of WBTC, the custodian must own 1 BTC for every 1 WBTC minted. This proof of reserve exists on-chain. 

However, how does the wrapping process work? The merchant will send the BTC to the custodian for printing. Then, the custodian will print WBTC in Ethereum according to the amount of BTC sent. When WBTC needs to be exchanged back into BTC, the merchant will make a burn request to the custodian and BTC will be released from the reserve. Custodians can be thought of as wrappers and unwrappers. In the case of WBTC, the addition and removal of custodians and merchants is done by the DAO.

Although some people in the community consider Tether (USDT) to be a wrapped token, that is not the case. Generally, USDT is traded one-to-one with USD, but Tether does not hold an exact physical amount of USD for each USDT in circulation in their reserves. These reserves are actually formed from cash and cash equivalents, assets and receivables from other loans in the real world. However, the concept is very similar. Each USDT token acts as a kind of wrapped token of USD fiat.

Wrapped token di Ethereum

Wrapped tokens on Ethereum are tokens from other blockchains that are created to comply with the ERC-20 standard. This means that you can use non-Ethereum assets on Ethereum. Of course, the process of wrapping and unwrapping tokens on Ethereum requires gas.

Implementations of these tokens can be very different. We wrote about this in more detail in our Bitcoin tokenized article. 

Another interesting example of a wrapped token on Ethereum is wrapped ether (WETH). In short – ETH (ether) is required 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 conform to that standard. This is a problem, as most DApps require you to convert between ether and ERC-20 tokens. This is the reason why wrapped ether (WETH) was created. This token is a packaged version of ether that complies with the ERC-20 standard. Basically, WETH is a tokenized version of ether on Ethereum!

Wrapped token di Binance Smart Chain (BSC)

Just like wrapped tokens on Ethereum, you can wrap Bitcoin and most other cryptos for use on the Binance Smart Chain (BSC).

 Binance Bridge allows you to wrap your crypto assets (BTC, ETH, XRP, USDT, BCH, DOT, and more) for use on the Binance Smart Chain in the form of BEP-20 tokens. Once you have your BSC assets with you, you can trade or use them in various yield farming applications.

The wrapping and unwrapping process requires gas. However, with BSC, gas fees will be significantly lower than other blockchains. You can read more about Binance Bridge in our detailed article.

Benefits of using wrapped tokens

Although most blockchains have their own token standards (ERC-20 for Ethereum or BEP-20 for BSC), these standards cannot be used across multiple chains at once. Wrapped tokens allow foreign tokens to be used on a particular blockchain.

In addition, wrapped tokens can increase capital efficiency and liquidity, both for centralized and decentralized exchanges. The ability to wrap idle assets and use them on other chains creates a stronger connection between initially isolated liquidity.

Finally, the main benefits are related to transaction times and fees. While Bitcoin has some amazing properties, they are not the fastest and can sometimes be expensive to use. This problem can be mitigated by using a bundled version on a blockchain with faster transaction times and lower fees.

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Limitations of using wrapped tokens

Most wrapped token implementations currently require trust in a custodian who owns the funds. For currently available technology, wrapped tokens cannot be used for true cross-chain transactions – these tokens usually have to go through a custodian. 

However, some more decentralized options are in the works and may be available in the future for printing and exchanging wrapped tokens without a trust entity entirely.

The printing process can also be expensive due to high gas costs and can result in discrepancies.

Closing

Wrapped tokens help create stronger bridges between different blockchains. Wrapped tokens are a tokenized form of an asset that originates from another blockchain.

This helps interoperability in cryptocurrencies and the Decentralized Finance (DeFi) ecosystem. Wrapped tokens open up opportunities for capital to be more efficient and applications to share liquidity with each other easily.

Do you have further questions regarding wrapped tokens? Visit our question and answer platform, Ask Academy, where the Binance community will answer your questions.