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Wrapped Tokens in Crypto Explained

Jon Ganor
Jon Ganor
Wrapped Tokens in Crypto Explained
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tl;dr

  • Wrapped tokens address the need for interoperability in the blockchain ecosystem, facilitating the utilization of assets on different blockchains.

  • Smart contracts or custodial entities hold the original assets and issue wrapped tokens on a target blockchain, ensuring proper reserve management.

  • Wrapped tokens maintain a pegged value to the underlying assets, offering stability and the ability to redeem them at any time.

  • Wrapped tokens adhere to established token standards like ERC-20, enabling compatibility with existing DApps and smart contracts.

  • Bridging tokens to different blockchains can be facilitated through specialized infrastructure like ChainPort.
  • The future of wrapped tokens looks promising as the crypto ecosystem expands, although alternatives like atomic swaps are also gaining popularity.

An Introduction to Wrapped Tokens

The blockchain landscape has witnessed a remarkable proliferation of diverse blockchains and tokens in recent years. According to Statista, the number of active cryptocurrencies has surpassed 8,500 in 2023. This growth has created countless unique blockchains, each with its own set of features, functionalities, and native tokens. While this diversity has fueled innovation and provided avenues for various use cases, it has also given rise to a pressing need for interoperability in the blockchain space.

Interoperability refers to the ability of different blockchains to communicate and interact with one another seamlessly. This siloed nature of blockchains restricts the full potential of dApps and limits the scope of cross-chain collaboration and value exchange.

To address this issue, the blockchain community has developed innovative solutions such as blockchain bridges. Blockchain bridges act as conduits between blockchains, enabling the transfer of assets and information across previously isolated networks. These bridges establish a secure and reliable connection that facilitates interoperability and enhances the overall functionality of the blockchain ecosystem.

Tokens that are bridged in a “lock & mint” method are sometimes called wrapped assets.

What are Wrapped Tokens in Crypto? 

Wrapped tokens, in the realm of cryptocurrency, refer to digital assets that represent underlying assets or currencies from a different blockchain. These tokens are created through a process known as tokenization, where the original assets are locked or held in reserve, and an equivalent number of tokens are minted on a different blockchain. This process enables cross-chain compatibility and facilitates the seamless transfer and utilization of assets between different blockchain networks.

The concept of wrapped tokens is primarily driven by the need for interoperability in the blockchain ecosystem. With the proliferation of diverse blockchains and the existence of isolated networks, it becomes challenging to transfer value or assets between different chains. Wrapped tokens address this challenge by acting as bridges connecting disparate blockchain networks and enabling asset movement across these ecosystems.

The tokenization process involves custodians or trusted entities that hold the original assets and issue the wrapped tokens on a target blockchain. These custodians are responsible for ensuring the proper management and security of the reserve assets, which serve as collateral for the wrapped tokens. In return, the custodians issue the equivalent number of wrapped tokens, typically on a 1:1 ratio, to the users who wish to transact or interact with the wrapped representation of the underlying assets.

Wrapped tokens are designed to maintain a pegged or fixed value to the original assets they represent. This is achieved through mechanisms such as collateralization or reserve management, where the custodians always ensure that the reserve assets back the wrapped tokens. This pegging mechanism provides stability and confidence to users, as they can redeem the wrapped tokens for the underlying assets whenever desired.

Prominent versions or wrapped tokens include WBTC or Wrapped Bitcoin on Ethereum and WETH or Wrapped ETH on certain blockchains.

How do Wrapped Tokens Work?

Wrapped tokens, a vital component of the cryptocurrency ecosystem, function as representations of underlying assets or currencies from a different blockchain. They enable the seamless transfer and utilization of assets across different blockchain networks through a tokenization process.

The process of creating wrapped tokens involves custodial entities that hold the original assets and issue equivalent tokens on a target blockchain. These custodians act as trusted intermediaries, responsible for securing and managing the reserve assets that back the wrapped tokens. Users looking to interact with these wrapped tokens can deposit their original assets with a custodian or protocol and receive an equivalent number of wrapped tokens in return.

To ensure the value stability of wrapped tokens, there are various mechanisms such as collateralization or reserve management. The reserve assets are typically maintained at a ratio that guarantees the value parity between the wrapped tokens and the underlying assets. This enables users to have confidence in the pegged value of the wrapped tokens and their ability to redeem them for the original assets at any time.

Wrapped tokens often adhere to established token standards, such as ERC-20 for Ethereum-based tokens. These standards provide compatibility with existing DApps and smart contracts on the respective blockchain. This compatibility allows users to seamlessly integrate wrapped tokens into a wide range of DeFi protocols, DEXs (Decentralized Exchanges), lending platforms, and other applications within the blockchain ecosystem.

The transfer of wrapped tokens between different blockchain networks typically involves a process of locking the wrapped tokens on one chain and minting them on the destination chain. This process is facilitated by specialized bridge infrastructure like ChainPort, ensuring secure and efficient movement across various blockchains.

Hord Wrapped Token

Earlier this month, Hord bridged tokens from BNB to Arbitrum via ChainPort’s cross-chain bridge. Behind the scenes, Hord’s wrapped tokens on BNB were burnt, and an equal number of wrapped tokens were minted on Arbitrum. 

Bridging Hord to Arbitrum unlocked many benefits for users and the Hord ecosystem. It allows Hord token holders to smoothly access the vibrant ecosystem on Arbitrum. Hord token holders can take advantage of Arbitrum’s high scalability, low transaction fees, and fast transaction finality. Moreover, Hord’s transition to Arbitrum lowered the required gas fees for ETH stakers.

Wrapped Bitcoin Token (WBTC)

Wrapped Bitcoin, or WBTC, is an initiative that bridges the gap between Bitcoin and the Ethereum ecosystem. It enables Bitcoin holders to leverage the benefits of DeFi and interact with smart contracts and DApps on the Ethereum network. 

At its core, Wrapped Bitcoin is an ERC-20 token that represents a 1:1 pegged value to Bitcoin. The process of wrapping Bitcoin involves a custodial model where users deposit their BTC to a custodian who mints an equivalent amount of WBTC. These custodians are trusted entities responsible for safeguarding the deposited BTC and issuing the corresponding WBTC tokens. The custody process is audited and transparent to ensure the verifiable backing of each WBTC token.

The beauty of Wrapped Bitcoin lies in its ability to bring Bitcoin's liquidity to the Ethereum ecosystem. WBTC enables Bitcoin holders to participate in DEXs, lending platforms, yield farming, and other DeFi applications native to Ethereum. By wrapping Bitcoin into an ERC-20 token, it becomes compatible with the Ethereum Virtual Machine and can seamlessly interact with smart contracts. 

What Makes Wrapped Tokens Unique? 

Wrapped tokens have become popular in the blockchain ecosystem due to their unique features. These tokens enable cross-chain interoperability, allowing assets from one blockchain to be represented and utilized on another blockchain. This enhances the functionality and utility of assets and promotes seamless integration between different blockchain networks. Wrapped tokens also improve liquidity by unlocking the potential of assets previously limited to their native blockchain. This expanded liquidity enhances market efficiency and provides more trading opportunities.

One key aspect that sets wrapped tokens apart is their accessibility. They make traditionally illiquid or difficult-to-access assets more readily available to a wider audience. By wrapping assets like real estate or commodities, individuals can gain exposure to these assets in a digital and easily tradeable form. This democratizes investment opportunities and removes barriers to entry for various asset classes, bringing greater inclusivity to the blockchain space.

Security and transparency are also significant advantages of wrapped tokens. The minting and burning processes of wrapped tokens are typically executed through audited smart contracts or trusted custodians, ensuring that the wrapped tokens maintain a 1:1 peg with the underlying assets. This transparency gives users confidence in the tokens' integrity and backing. 

Final Thoughts

The future of wrapped tokens is promising as the crypto ecosystem continues to expand and evolve. With the proliferation of blockchain networks and the growing diversity of digital assets, the need for interoperability and seamless asset transfer between different chains becomes increasingly crucial. Wrapped tokens provide a solution by enabling the representation of assets from one blockchain onto another, facilitating cross-chain compatibility and utilization.

As the crypto industry matures, we can expect to see a wider variety of assets being wrapped, including traditional financial instruments, real-world assets, and even intellectual property rights. This expansion will further bridge the gap between the traditional financial world and the blockchain space, unlocking new opportunities for investors and increasing assets' overall liquidity and fungibility.

While wrapped tokens currently dominate the landscape for cross-chain asset representation, it's worth noting that alternative methods, such as atomic swaps, are also gaining traction. Atomic swaps allow for direct peer-to-peer exchange of assets across different blockchains without intermediaries. While atomic swaps provide a decentralized and trustless solution, they are currently more technically complex and require support from both blockchains involved.

Both wrapped tokens and atomic swaps serve as valuable tools for achieving interoperability, and their adoption will likely continue to grow in parallel. The choice between the two methods will depend on asset type, technical feasibility, and user preferences.