Now, in 2023, the web space is filled with a huge amount of various crypto assets that are used by different blockchains. To make operations between them more convenient, without being distracted by additional swaps, programmers developed a solution – wrapped tokens. What are those and why do we need them? Let's find out in this article.
What are wrapped tokens?
Was it even possible to imagine just a few years ago that Bitcoin (BTC) could be used for payments on the Ethereum platform? Probably not, because it had its own blockchain. There was a strict demarcation that established clear boundaries between crypto platforms. But not so long ago, these boundaries began to slowly disappear thanks to new technology.
A wrapped token is a copy of a digital asset with its original value that has been transferred to another blockchain. Like WBTC (Wrapped Bitcoin), which exists on the Ethereum blockchain, but its value is linked to Bitcoin.
At the end of January 2019, the WBTC token was created by the joint efforts of the three organizations: Kyber Network, BitGo and Ren. According to the developers, it combines the power of Bitcoin and the flexibility of Ethereum. This is an ERC20 token backed by BTC. Basically, WBTC standardizes Bitcoin for the Ethereum network by creating new smart contracts.
Why do we need wrapped tokens?
The DeFi application market was the first to feel the need of using a crypto asset from one blockchain in another. Most cryptocurrency transactions took place on centralized exchanges (CEX) with the participation of Bitcoin. Wrapped tokens solved this problem. They can perform a number of the following functions:
- support the work of decentralized exchanges;
- be used as a loan collateral on a third-party platform;
- unload the work of crypto exchanges and crypto wallets – they no longer need to develop separate nodes for swaps and transfers.
However, wrapped tokens have several risk points:
- like cross-chain bridges, they rely on smart contracts, so they are vulnerable to hacks;
- there is a risk of centralization, since all data about private keys is collected in one place for further operations.
How do wrapped tokens work?
Let’s take, for example, WBTC. These tokens are created according to a specific scheme:
- The crypto asset is placed in a special storage – custodial wallet. It will hold an amount of an asset which is equivalent to the one it will be swapped to.
- Based on how many crypto assets have entered the custodial, the system issues WBTC tokens on Ethereum.
- In order to convert back and return BTC, the user must send a request to the custodian to burn WBTC.
Examples of wrapped tokens
Many users mistake wrapped tokens for stablecoins because both these assets are linked to something. But in the case of stablecoins, they are pegged to fiat, and wrapped tokens are tied to crypto.
A lot has already been said about WBTC above, so let's see what other wrapped tokens are out there:
- Wrapped Ethereum (WETH)
Used for issuance on third-party platforms such as Polygon, Binance Smart Chain, Solana, Near, Avalanche, and Fantom, and traded on the OpenSea NFT platform.
- Wrapped tokens on the Solana blockchain
On the Solana network, the transfer of cryptocurrencies requires the help of cross-chain bridges. They automatically create smart contracts and seamlessly transfer funds from one system to another. The most popular cross-chain bridge on this network is Wormhole. It connects Solana (SOL) to Ethereum (ETH), Avalanche (AVAX), Oasis (ROSE), Binance Smart Chain and Polygon (MATIC).
- Wrapped tokens on the Avalanche blockchain
Local developers have released the official cross-chain bridge Avalanche Bridge, connecting Avalanche and Ethereum. It can be used to wrap ERC-20 standard tokens (for example, USDC, USDT, BUSD).
Conclusion
In general, wrapped tokens are a useful invention of the cryptosystem. They brought more freedom to the network, reduced the load on the network, and created stable links between blockchains. All this allows cryptosystems to interact with each other and to develop further together.
If you want to learn more interesting facts about crypto then check out our blog! You might like our articles “Technologies That Will Shape the Future of WEB3” and “Why Would Anyone Need To Wrap A Token?”.
