Wrapped Token

Wrapped tokens enhance interoperability between distinct blockchain networks, enabling assets from one chain to be utilized within the ecosystem of another. This process involves "wrapping" the original asset, where the asset is held in custody by a trusted entity, and an equivalent amount of the wrapped token is minted on the target blockchain. This mechanism allows users to engage in decentralized finance (DeFi) activities, such as lending, borrowing, and trading, on platforms that the original asset couldn't natively access.

💡 How Wrapped Tokens Work:

1. Custody of Original Asset – The original asset is locked in a secure digital vault managed by a custodian.
2. Minting Wrapped Token – An equivalent amount of the wrapped token is created on the target blockchain, representing the original asset.
3. Utilization on New Blockchain – Users can transact with the wrapped token on the new blockchain, participating in various applications and services.
4. Redeeming Original Asset – To retrieve the original asset, the wrapped token is burned, and the custodian releases the corresponding amount of the original asset.

🔄 Wrapped Tokens vs. Native Tokens:

• Wrapped Tokens enable cross-chain functionality, allowing assets to operate on non-native blockchains.
• Native Tokens are confined to their original blockchain and cannot directly interact with other networks.

🏛 Example 1: Wrapped Bitcoin (WBTC)

Wrapped Bitcoin is an ERC-20 token on the Ethereum blockchain that represents Bitcoin (BTC) at a 1:1 ratio. It allows BTC holders to engage with Ethereum's DeFi ecosystem, utilizing their Bitcoin for activities like lending, borrowing, and trading on decentralized platforms.

🏛 Example 2: Wrapped Ether (WETH)

Ether (ETH) is the native cryptocurrency of the Ethereum blockchain but isn't compliant with the ERC-20 token standard used by many Ethereum-based applications. Wrapped Ether (WETH) is an ERC-20 compliant version of ETH, enabling seamless interaction with smart contracts and decentralized applications (dApps) that require ERC-20 tokens.

📚 References

1. Ledger Academy - What Is Wrapped Crypto?

2. Coinbase - What is wrapped crypto?

3. Cointelegraph - A beginner's guide to understanding wrapped tokens and wrapped Bitcoin

⚠️ Controversies & Misconceptions

• "Wrapped tokens are always decentralized." – The wrapping process often involves custodians, which can introduce centralization and require trust in the entity managing the original asset.
• "Wrapping and unwrapping tokens is free." – The process may incur fees, and users should be aware of potential costs associated with minting or redeeming wrapped tokens.

🚀 Conclusion

Wrapped tokens play a pivotal role in enhancing blockchain interoperability, allowing assets to traverse across different networks and participate in a broader range of applications. While they offer increased utility and liquidity, users should consider the associated custodial risks and potential fees when engaging with wrapped tokens.

Related Terms

• ERC-20

  ERC-20 is a widely used token standard on the Ethereum blockchain for fungible tokens. It defines a set of rules that enable seamless interaction between tokens and Ethereum-based applications.

• DApp (Decentralized Application)

  A decentralized application (DApp) is an application that runs on a blockchain or peer-to-peer network without a central authority. DApps leverage smart contracts to facilitate trustless operations and decentralized governance.

• Governance Token

  A governance token is a cryptocurrency that grants holders voting power in a decentralized finance (DeFi) protocol. These tokens enable users to influence key decisions, including protocol upgrades, fee structures, and treasury allocations.

• LP Token

  An LP (Liquidity Provider) token is a digital asset received by users who contribute liquidity to a decentralized finance (DeFi) protocol. These tokens represent the user's share of a liquidity pool and can be redeemed for the original assets plus any accrued fees.

• Stablecoin

  A stablecoin is a type of cryptocurrency designed to maintain a stable value by pegging its worth to a reserve of assets, such as fiat currencies like the U.S. dollar, commodities like gold, or a basket of assets. This stability allows stablecoins to be widely used for transactions, trading, and decentralized finance (DeFi) applications.