A wrapped token is a cryptocurrency token whose value is tied to that of another coin. Because the original asset is placed in a wrapper, a type of digital vault that permits the wrapped version to be formed on another blockchain, it’s termed a wrapped token.
What is the point of this? Diverse blockchains, on the other hand, have different functions. They’re also unable to communicate with one another. The Bitcoin blockchain is completely unaware of what is going on with the Ethereum blockchain. Wrapped tokens, on the other hand, can create additional bridges between different blockchains.
Have you ever been frustrated by the fact that you can’t use BTC on Ethereum? Is ETH available on the Binance Smart Chain? A coin’s value cannot be moved from one blockchain to another.
Wrapped tokens are a solution around this restriction and allow non-native assets to be used on a blockchain.
What is a Wrapped Token?
A wrapped token is a cryptocurrency that has been tokenized. Its value is linked to the asset it symbolizes, and it can usually be redeemed (unwrapped) at any time. It usually refers to an asset that isn’t native to the blockchain on which it was created.
Wrapped tokens are similar to stablecoins in the sense that they derive their value from another asset. This is usually fiat currency in the case of a stablecoin. In the case of a wrapped token, it’s usually an asset that lives on another blockchain.
Because blockchains are separate systems, there is no easy method to transfer data between them. Wrapped tokens improve interoperability across blockchains by allowing the underlying tokens to flow cross-chain.
It’s worth mentioning that ordinary users don’t have to worry about the wrapping and unwrapping procedure; they may just trade wrapped tokens like any other cryptocurrency. On Binance, for example, this is the WBTC/BTC market.
How Does Wrapped Tokens Work?
Let’s look at Wrapped Bitcoin (WBTC), an Ethereum-based tokenized version of Bitcoin. WBTC is an ERC-20 token that is designed to be pegged to the value of Bitcoin at one-to-one, allowing you to use BTC on the Ethereum network.
Wrapped tokens usually need a custodian, which is an entity that retains an equivalent amount of the asset as the wrapped amount. A merchant, a multisig wallet, a DAO, or even a smart contract can serve as the custodian. In the case of WBTC, the custodian must keep 1 BTC for every 1 WBTC minted. On-chain proof of this reserve exists.
But how does the process of wrapping work? The custodian receives BTC from a merchant. After that, the custodian mints WBTC on Ethereum based on the amount of BTC sent. The merchant submits a burn request to the custodian when the WBTC has to be converted back to BTC, and the BTC is released from the reserves. The custodian can be compared to a wrapper and unwrapper. In the instance of WBTC, a DAO is in charge of adding and removing custodians and merchants.
While some members of the community refer to Tether (USDT) as a wrapped token, this isn’t the case. Tether does not maintain the precise amount of physical USD for each USDT circulating in their reserves, despite the fact that USDT commonly trades one-for-one with USD. Instead, cash and other real-world cash equivalents, assets, and loan receivables make up this reserve. The concept, though, is fairly similar. Each USDT token functions as a wrapper around a fiat USD.
Wrapped Ethereum tokens
Wrapped tokens on Ethereum are tokens that have been converted to comply with the ERC-20 standard from other blockchains. This means that assets that aren’t native to Ethereum can be used on Ethereum. Wrapping and unwrapping tokens on Ethereum costs gas, as you might anticipate.
These tokens can be implemented in a variety of ways. In our post on tokenized Bitcoin, we go over them in greater depth.
Wrapped ether is an interesting example of a wrapped coin on Ethereum (WETH). To summarize, ETH (ether) is required to pay for transactions on the Ethereum network, and ERC-20 is a technical standard for creating Ethereum tokens. Basic Attention Token (BAT) and OmiseGO (OMG), for example, are ERC-20 tokens.
However, because ETH was created prior to the ERC-20 standard, it is not compatible. Many DApps require you to convert between ether and an ERC-20 token, which causes an issue. Wrapped ether (WETH) was designed for this reason. It’s a wrapped version of ether that adheres to the ERC-20 protocol. It’s effectively an Ethereum-based tokenized version of ether!
Wrapped Tokens on Binance Smart Chain (BSC)
You can wrap Bitcoin and many other cryptos for use on the Binance Smart Chain, just as wrapped tokens on Ethereum (BSC).
The Binance Bridge enables you to wrap your crypto assets (BTC, ETH, XRP, USDT, BCH, DOT, and many others) in BEP-20 tokens for use on the Binance Smart Chain. You can trade your assets or employ them in numerous yield farming applications once you’ve brought them to BSC.
Gas is used for wrapping and unwrapping; nevertheless, you may expect substantially reduced gas expenses with BSC than with other blockchains. Our in-depth article on Binance Bridge can be found here.
Using wrapped tokens has a number of advantages.
Despite the fact that several blockchains have their own token standards (for example, Ethereum’s ERC-20 or BSC’s BEP-20), these standards cannot be used across other chains. Wrapped tokens enable the use of non-native tokens on a specific network.
Wrapped tokens can also help centralized and decentralized exchanges boost liquidity and capital efficiency. The ability to wrap idle assets and use them on a different chain can help to connect otherwise disparate liquidity sources.
Finally, transaction times and fees are a huge plus. While Bitcoin offers several wonderful features, it is not the fastest and can be costly to use at times. While that is good for what it is, it can occasionally create headaches. These problems can be solved by adopting a blockchain-based wrapper version with faster transaction times and reduced fees.
Drawbacks of using Wrapped tokens
The majority of current wrapped token implementations necessitate faith in the custodian holding the funds. Wrapped tokens can’t be utilized for actual cross-chain transactions with present technology; they usually need to go through a custodian.
However, several more decentralized alternatives for entirely trustless wrapped token minting and redemption are in the works and maybe accessible in the future.
Due to high gas prices, the minting procedure might be costly and may result in some slippage.
Summary
Wrapped tokens aid in the creation of more cross-chain connections. A wrapped token is a tokenized version of an asset that lives on a different blockchain.
This promotes bitcoin and Decentralized Finance (DeFi) ecosystem compatibility. Wrapped tokens pave the way for a world where capital is more efficient and applications may readily share liquidity.
Do you have any other concerns concerning wrapped tokens? Check out Ask Academy, our Q&A platform where the Binance community will respond to your queries.
