What Are Wrapped Tokens And How Do They Work? (2024)

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The wrapped token market has witnessed substantial growth in the last three years, with Wrapped Bitcoin (wBTC) alone worth a significant $10.58 billion – a sum worth the budget of three small African countries put together.

At time of writing, wBTC had seen a price increase of 1.7% in a single day, with its price hovering around $68,443.00. This shows that more people are wrapping their digital assets to use them in new ways in the DeFi space. Combined, themarket capfor wrapped tokens today stands at $12.1 Billion.

As the market cap indicates, wrapped tokens like wBTC are gaining traction. Consequently, crypto thought leaders have expressed enthusiasm for the potential of wrapped tokens to revolutionise the DeFi landscape.

Binance, for instance, highlighted the cross-chain functionality that wrapping brings to tokens, allowing for a token pegged to the value of the original asset.

But what exactly are wrapped tokens, and how do they work?

Wrapped Tokens: What They Are And How They Work?

Wrapped tokens are like digital vouchers representing another asset from a different blockchain. They’re crucial for allowing different blockchain networks to “talk” to each other, like how an interpreter helps people who speak different languages communicate. They could be cryptocurrencies, stablecoins, or NFTs.

Put simply, wrapped Bitcoin (wBTC) – which is the first and most prominent wrapped token – is like a copy of Bitcoin that is tradable on Ethereum’s Blockchain (ECR-20). So, for every wBTC, there’s a real Bitcoin saved somewhere safe (pegged at a 1:1 ratio) through a network of automatically monitored merchants and custodians.

Source:Gate.io

This setup makes sure that wBTC always has the same value as Bitcoin. It’s like having a voucher that you can swap for a real item at any time. This way, people can use Bitcoin on Ethereum’s network, which normally wouldn’t accept it, without needing anyone to oversee the process.

The Need For Wrapped Tokens In The Crypto Ecosystem

Interoperability is the answer.

Imagine you have a ticket for a bus, but you need to take a train. You can’t use the same ticket, right?

Wrapped tokens solve this by “wrapping” a token (like a bus ticket) into a new form (a train ticket) so it can be used on another blockchain, increasing the places where you can use your digital assets and helping everyone join the DeFi movement.

In other words, these tokens act as a bridge, allowing assets from one blockchain to be used on another. This not only makes blockchains more versatile but also increases liquidity, with which assets can be traded easily. This is especially important in Decentralised Finance (DeFi), where wrapped tokens help create a more fluid and dynamic financial environment.

Yet, wrapped tokens didn’t just appear out of nowhere; certain entities created them to solve a specific problem at some point in the history of cryptocurrency.

The Creation of Wrapped Tokens

The first significant wrapped token was wrapped Bitcoin (wBTC), an ERC-20 version of Bitcoin, created by BitGo, Kyber, and Ren in 2019.

What these innovators hoped to achieve was the need for assets to traverse the blockchain divide, and they acted to bridge the gap. As key players and organisations, they set the stage for a more interconnected blockchain world.

After this, over the years, the crypto space has witnessed the birth of more wrapped tokens, like wETH (wrapped ETHER), wBNB (wrapped BNB), wSOL (wrapped Solana), and many others.

The Genesis of these Versed Tokens

The concept of wrapped tokens took shape around October 2018, with wBTC launching on January 31, 2019, from a collaboration between Kyber Network and BitGo. This marked a pivotal moment in blockchain history, as it allowed Bitcoin holders to ‘wrap’ their coins and use them in Ethereum’s vibrant DeFi ecosystem.

Wrapped Tokens vs Regular Tokens

Wrapped and normal tokens are clearly distinct from each other – especially in terms of interoperaberability.

• Blockchain Compatibility:

Wrapped tokens can be used on multiple blockchains. They’re like a passport that lets a token travel and be accepted in different crypto countries.

Regular tokens usually stick to their own blockchain. It’s like having money that can only be spent in the country where it was made.

• Purpose:

Wrapped tokens are ceated to represent another asset on a different blockchain, allowing that asset to be used in new ways.

Regular tokens serve various purposes on their native blockchain, like voting, paying fees, or buying services.

• Creation Process:

Wrapped tokens are made through a process called “wrapping,” which involves locking up the original asset and issuing a new token on a different blockchain.

Regular tokens are directly issued on their native blockchain without needing to be wrapped.

• Market Participation:

Wrapped tokens enable participation in decentralised finance (DeFi) on blockchains where the original asset couldn’t normally operate.

With regular tokens, participation is limited to their native blockchain ecosystem.

• Security and Trust:

Wrapped tokens require trust in the custodian or smart contract that holds the original asset.

With regular tokens, security and trust are based on the underlying blockchain’s protocol.

Controversies and Challenges

Wrapped tokens aren’t without their drama. They’ve faced criticism for potential security holes and for giving too much control to the few custodians who hold the keys to the wrapping process. These risks must be carefully managed to maintain the integrity of wrapped tokens.

Wrapped tokens are poised to play a transformative role in the future of blockchain technology and DeFi. They offer a glimpse into a world where the barriers between different cryptocurrencies are dissolved, paving the way for a more fluid and interconnected digital economy.

As we look to the future, these digital chameleons will likely play a pivotal role in the evolution of blockchain technology and finance.

Author:Ayanfe Fakunle

The editorial team at #DisruptionBanking has taken all precautions to ensure that no persons or organisations have been adversely affected or offered any sort of financial advice in this article. This article is most definitely not financial advice.

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