Tokens 101: A beginner’s guide to understanding wrapped tokens
Blockchains like Bitcoin and Ethereum act as separate distributed databases, and they aren’t built to be naturally interoperable. Therefore, as a crypto user, it understandably gets hard for one to avail of services provided by multiple blockchains, as it’s not possible to acquire native tokens for every single one of them. ‘Wrapped tokens’ are a special kind of crypto created to solve this very problem crypto users face.
As a newcomer to the crypto world, the concept of wrapped crypto might still be alien to you. That’s why in this post, we have compiled everything you need to know about wrapped tokens!
What is a wrapped cryptocurrency?
Put simply, wrapped tokens are a way to use crypto like Bitcoin or ETH on non-native blockchains. They were built as a solution to the issue of blockchain interoperability; wrapped tokens essentially act as bridges between different blockchains. Wrapped cryptocurrencies can be moved between blockchains and used similarly to native tokens.
A wrapped cryptocurrency can be explained as non-native crypto on a blockchain. These wrapped cryptos are created on top of the Ethereum blockchain, and they are pegged to certain crypto at the ratio of 1:1. A wrapped crypto would carry the same value as one unit of its underlying crypto asset.
Wrapped cryptocurrencies are created as per Ethereum’s ERC-20 token standard. The pegs to their underlying cryptos are maintained usually through smart contracts.
Wrapped cryptocurrencies are named so because they’re sort of like putting a crypto into a wrapper. They can also be thought of as a virtual vault that lets the wrapped version of a crypto be created on a non-native blockchain.
One of the best known wrapped tokens in use today would be the Wrapped Bitcoin, or WBTC. WBTC is pegged 1:1 to the price of BTC, as mentioned above. Therefore, one WBTC always equals the value of one BTC on the Ethereum blockchain.
Wrapped cryptocurrencies vs. stablecoins:
Stablecoins are cryptos that are pegged to another asset, such as USDT and USDC. They might sound similar to wrapped tokens, which are also backed by another asset. However, there is a major difference between the two.
Stablecoins can be backed by a wide range of assets, namely fiat currencies, precious metals, and of course, other cryptos. Wrapped cryptos, on the other hand, only stand for non-native crypto assets on a blockchain. Plus, what makes a wrapped token a wrapped token is not just the fact that it is pegged 1:1 to the price of another asset. The technology behind it, and the way its value is maintained are both quite unique.
How do wrapped cryptocurrencies work?
Wrapped tokens are created through the ‘minting’ process, and they are destroyed by the ‘burning’ process. We can understand the process through the example of WBTC, again.
For Wrapped Bitcoin, the underlying asset, i.e. BTC, is sent to the ‘custodian’ who keeps the BTC in a digital vault. Once the necessary amount of Bitcoin is locked away, an equivalent amount of WBTC can be minted.
The minting process is also known as the ‘wrapping’ process. This is because the underlying asset is ‘wrapped up’ in a digital vault with a smart contract, as mentioned before, and a new wrapped token is minted to be used on a non-native blockchain.
As for the ‘burning’ process, it’s the removal of a WBTC from existence. Once the request for the burning of a WBTC is issued to the ‘custodian’, the Wrapped Bitcoin in question is removed from circulation, and the equivalent amount of Bitcoin is also released from the digital vault simultaneously to be let back into circulation.
For WBTC, the act of adding or removing custodians is performed by a DAO or a decentralized autonomous organization.
Benefits of using wrapped cryptocurrencies
Wrapped tokens increase the interoperability between various blockchains, and they can help increase both the liquidity and capital efficiency for decentralized and centralized crypto exchanges alike. This way, crypto users can move their crypto assets with more ease across blockchains and avail themselves of the features and applications offered by other blockchains. Benefits of this might include quicker transactions, comparatively lower rates of fees, or yield farming options.
Wrapped tokens help you put to use your idle assets by making it possible for you to trade them on another blockchain. So, wrapped crypto also connects liquidity that would be isolated normally.
And there you have all the fundamentals of the wrapped crypto that you must know as a beginner in the crypto space!
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