What is a Wrapped Token? The Ins and Outs in Plain English

The lack of interoperability between various blockchains and their corresponding assets is one of the main problems facing the blockchain and cryptocurrency industries.

This indicates that a cryptocurrency based on chain X cannot be used on chain Y directly. By design, blockchains are unable to handle such cross-chain digital assets.

Supporting assets cross-chain has become essential for cryptocurrencies and decentralized finance (DeFi), with coins and tokens existing across numerous other blockchains but decentralized finance (DeFi) primarily on Ethereum.

Wrapped crypto tokens can be useful in this situation. This system makes things easy to transfer assets between blockchains and utilize them throughout the cryptocurrency ecosystem.

In other words, wrapped tokens enable frictionless exchange and communication between networks like Bitcoin and Ethereum. The Wrapped Bitcoin (WBTC) token is one of the most well-known wrapped tokens. This will be covered in more detail later in the article.

So, you get a bit idea about wrapped tokens that use assets to move them between blockchains and use them throughout the crypto ecosystem.

But there’s more to talk about. In this post, we’ll examine wrapped tokens in-depth, dissecting their function, mechanics, use cases, well-known applications, obstacles, and potential. Whether you’re unfamiliar with the idea or trying to gain a better understanding, we can help.

What are Wrapped Tokens?

Wrapped tokens are electronic assets that are a representation of other assets, such as cryptocurrency or conventional assets like gold or real estate, as was briefly explained above. They are produced by “wrapping” the underlying asset into a blockchain-based representation, which is then used for decentralized finance (DeFi) applications and may be purchased, sold, and exchanged on digital asset exchanges.

To put it simply, wrapping a token involves exchanging one token for another in an equal amount via a smart contract, or blockchain code that can receive and send payments. Imagine it as a $1 bill being exchanged for four quarters. Although they both have the same value, quarters can be used in pinball machines whereas dollar bills cannot.

You should be familiar with wrapped tokens’ origins and purposes in order to appreciate their worth. Before the ERC-20 standard was designed, Ether (ETH), the first wrapped token, was intended to improve interoperability. 

It was crucial that there be a means to connect ETH and these assets given the emergence of multiple altcoins that were created utilizing the ERC-20 standard. Wrapped Ether (wETH) is the result of this.

Is this seem more complex? So, let’s go into more detail by understanding their benefits first.  

The Benefits of Wrapped Tokens

Wrapped tokens offer several significant benefits to the blockchain ecosystem, users, and the broader decentralized finance (DeFi) space. Let’s delve into the advantages that make wrapped tokens a valuable addition to the world of cryptocurrencies:

1. Enhanced Interoperability: Wrapped tokens act as bridges between different blockchain networks, enabling seamless transfer and utilization of assets across disparate platforms. This enhanced interoperability opens up a world of possibilities, allowing users to access a wider range of applications, services, and decentralized finance protocols.

• Users can utilize wrapped tokens representing assets from one blockchain within the ecosystem of another blockchain, thus leveraging the benefits of both networks simultaneously.

• For example, by wrapping Bitcoin into WBTC (Wrapped Bitcoin), users can access DeFi protocols and decentralized exchanges on the Ethereum network, enjoying the liquidity and functionality of Ethereum while retaining exposure to Bitcoin’s value.

2. Liquidity Expansion: Wrapped tokens increase the liquidity of assets by making them accessible on different blockchains. This expanded liquidity unlocks new opportunities for trading, lending, borrowing, and other financial activities.

• Previously illiquid assets, such as non-fungible tokens (NFTs) or assets from less liquid blockchains, can be wrapped and made available for trading on more liquid platforms.

• Increased liquidity reduces price slippage and enables users to execute transactions with minimal impact on asset prices.

3. Access to DeFi Services: Wrapped tokens play a crucial role in the rapidly evolving DeFi ecosystem. By representing assets from different blockchains, they allow users to tap into a wide array of DeFi services and applications.

• Users can utilize wrapped tokens as collateral for borrowing or lending in DeFi lending protocols, earning interest on their holdings, or accessing liquidity without the need to sell their underlying assets.

• Wrapped tokens also enable participation in decentralized exchanges, yield farming, liquidity provision, and other DeFi activities across various blockchain networks.

4. Easier Cross-Chain Transactions: Wrapped tokens simplify cross-chain transactions, making it easier to transfer assets between different blockchains without the need for complex swaps or multiple exchanges.

• Users can convert their assets into wrapped tokens on one blockchain, transfer them to another blockchain, and convert them back into the original assets, reducing the time and effort required for cross-chain transactions.

• This streamlined process improves efficiency, minimizes transaction costs, and promotes seamless asset transfer across different blockchain networks.

5. Expanded Asset Support: Wrapped tokens pave the way for the representation of a broader range of assets within the blockchain ecosystem.

• Real-world assets, such as traditional currencies, commodities, and even stocks, can be tokenized and represented as wrapped tokens. This opens up avenues for blockchain-based asset management and decentralized trading of traditional financial instruments.

• Intellectual property rights, such as music royalties or patent ownership, can also be represented as wrapped tokens, enabling more efficient and transparent management and monetization.

6. Regulatory Compliance: Wrapped tokens can potentially address regulatory compliance concerns by providing more transparency and traceability in asset transactions.

• Regulatory challenges often arise when traditional financial systems interact with blockchain networks. Wrapped tokens, with their clear representation and traceability, can facilitate the integration of traditional financial systems with blockchain technology in a compliant manner.

• Compliance measures, such as Know Your Customer (KYC) and Anti-Money Laundering (AML) requirements, can be implemented at the level of custodians or decentralized platforms that deal with wrapped tokens, ensuring regulatory adherence.

Understanding the Mechanics of Wrapped Tokens

As of now, you are aware that a wrapped token is an exact replica of a cryptocurrency running on a different blockchain. Alternatively, it may occasionally be a representation of an asset that is built on the same chain but uses a different token standard. 

But exactly how do we “wrap” these tokens? or how wrapped tokens’ real mechanics operate? 

But first, let’s get into the specifics of the components of wrapped tokens. 

What are the Major Components of Wrapped Tokens?

Wrapped tokens are composed of several key components that work together to enable the representation and transfer of assets across different blockchain networks. Let’s explore the major components that makeup wrapped tokens:

1. Original Asset: The original asset is the underlying digital or physical asset that is being represented by the wrapped token. It could be a cryptocurrency like Bitcoin or Ethereum, a stablecoin, or even a traditional asset like gold or real estate. These original assets hold value and represent ownership or entitlement to a specific asset outside of the blockchain ecosystem.

2. Custodian: The custodian is the entity responsible for holding the original assets and issuing the corresponding wrapped tokens. Custodians play a critical role in ensuring the integrity and security of the assets.

Custodians are typically trusted third parties, such as regulated financial institutions or specialized custodial services, that hold the original assets in secure storage.

They are responsible for the creation, redemption, and maintenance of the wrapped tokens, ensuring that there is a 1:1 peg between the wrapped tokens and the original assets.

3. Smart Contracts: Smart contracts are self-executing contracts with predefined rules and conditions encoded on the blockchain, wrapping and unwrapping the original assets, ensuring transparency, and enabling the secure transfer of wrapped tokens. 

They govern the interactions between users, custodians, and the blockchain network, facilitating the seamless conversion and transfer of wrapped tokens.

4. Token Standards: Token standards provide a set of rules and protocols for the creation and functioning of wrapped tokens. They ensure interoperability and compatibility across different blockchain networks.

For example, the ERC-20 standard is widely used for creating wrapped tokens on the Ethereum blockchain. It defines a common set of functions and interfaces that allow wrapped tokens to be easily integrated into various decentralized applications and exchanges.

Other blockchain networks may have their own token standards, such as BEP-20 on the Binance Smart Chain or SPL tokens on the Solana blockchain.

5. Oracle Systems: Oracle systems provide external data to the smart contracts, allowing the wrapped token to reflect the real-time value and status of the original asset. 

Oracles retrieve data from off-chain sources, such as price feeds or custody reports, and feed it into the smart contracts that govern the wrapped tokens. 

This ensures that the value of the wrapped token accurately represents the value of the original asset and enables real-time tracking of assets.

6. Blockchain Network: The blockchain network serves as the underlying infrastructure that hosts and validates the transactions involving wrapped tokens. Different blockchain networks, such as Ethereum, Binance Smart Chain, or Solana, can support the creation and use of wrapped tokens.

The blockchain network provides the necessary security, immutability, and consensus mechanisms required for the creation and secure transfer of wrapped tokens.

It also enables the execution of smart contracts and ensures the transparency and audibility of transactions involving wrapped tokens.

How Wrapped Tokens Work?

The mechanism of wrapped token works in a precise way from selecting the asset, to wrapping it and then utilizing the final digital system. Here is a very basic way that a wrapped token works in the actual world. 

1. Selection of Asset and Custodian: The process begins with the selection of an asset that will be represented by the wrapped token. This asset could be a cryptocurrency like Bitcoin or Ethereum, a stablecoin, or even a traditional asset like gold. A trusted custodian is then chosen to hold the original asset and issue the wrapped tokens.

2. Depositing the Original Asset: The asset holder sends the original asset to the custodian’s secure storage. The custodian verifies the deposit and issues a corresponding amount of wrapped tokens, maintaining a 1:1 peg with the original asset.

3. Creation of Smart Contracts: Smart contracts are created on the blockchain network that will host the wrapped tokens. These smart contracts define the rules and functionalities for wrapping and unwrapping the tokens, as well as governing their transfer and usage.

4. Wrapping the Original Asset: The custodian initiates the wrapping process by locking the original asset in the custodial account. This process is usually overseen and audited to ensure transparency and adherence to the 1:1 peg.

5. Minting of Wrapped Tokens: Once the original asset is locked, the custodian mints an equivalent amount of wrapped tokens. These tokens are then transferred to the user’s wallet, representing the ownership or entitlement to the original asset.

6. Transferring and Utilizing Wrapped Tokens: Users can now freely transfer their wrapped tokens to other wallets or utilize them in various decentralized applications, decentralized exchanges, or lending platforms. The wrapped tokens can be used within the blockchain network that supports the wrapped token standard.

7. Redeeming Wrapped Tokens: If a user wants to retrieve the original asset, they can initiate the redemption process. The user sends the wrapped tokens back to the custodian’s designated address and provides the necessary information for redemption.

8. Unwrapping and Asset Retrieval: The custodian receives the wrapped tokens, verifies the authenticity, and initiates the unwrapping process. The custodian burns the wrapped tokens and releases the equivalent amount of the original asset to the user’s specified address.

9. Interoperability across Blockchains: Wrapped tokens can be transferred across different blockchain networks that support the same token standard. For example, wrapped tokens created on the Ethereum blockchain can be transferred to the Binance Smart Chain or other compatible networks, allowing users to access different ecosystems while maintaining the representation of the original asset.

By following these steps, wrapped tokens facilitate the movement of assets across different blockchain networks, enabling enhanced interoperability, liquidity, and access to decentralized finance services. The process relies on trusted custodians, secure smart contracts, and the underlying infrastructure of blockchain networks to ensure seamless conversion and transfer of assets in a transparent and auditable manner.

Popular Wrapped Tokens in the Market

Wrapped tokens have gained significant popularity in the blockchain space, with several notable projects offering wrapped versions of major cryptocurrencies. Let’s explore three of the most popular wrapped tokens in the market:

Wrapped Bitcoin (WBTC)

Wrapped Bitcoin (WBTC) is one of the most prominent wrapped tokens, designed to bring Bitcoin’s liquidity and value to the Ethereum ecosystem. Here are key details about WBTC:

• Token Symbol: WBTC
• Blockchain Network: Ethereum
• Token Standard: ERC-20
• Token Supply: WBTC is minted by depositing Bitcoin with approved custodians who then issue an equivalent amount of WBTC.
• Liquidity and DeFi: WBTC is widely used in various decentralized finance (DeFi) applications, including lending platforms, decentralized exchanges, and yield farming protocols.
• Enhanced Interoperability: By wrapping Bitcoin as WBTC, users can leverage the extensive Ethereum DeFi ecosystem while still maintaining exposure to the value of Bitcoin.

Wrapped Ethereum (WETH)

Wrapped Ethereum (WETH) is an ERC-20 token that represents Ether (ETH), the native cryptocurrency of the Ethereum blockchain. Here are key details about WETH:

• Token Symbol: WETH
• Blockchain Network: Ethereum
• Token Standard: ERC-20
• Token Supply: WETH is created by depositing ETH into a smart contract, which then mints an equivalent amount of WETH.
• Liquidity and DeFi: WETH serves as a fundamental token in the Ethereum DeFi ecosystem, facilitating liquidity provision, lending, decentralized exchanges, and other DeFi activities.
• Gas Fee Optimization: WETH allows users to wrap their ETH, making it more compatible with certain DeFi protocols and saving on gas fees for transactions.

Other Prominent Wrapped Tokens

In addition to WBTC and WETH, several other prominent wrapped tokens have emerged, each representing different assets and serving specific purposes within their respective blockchain ecosystems. For example: 

1. Wrapped Litecoin (WLTC): WLTC is an ERC-20 token that represents Litecoin (LTC) on the Ethereum network. It brings the liquidity and utility of Litecoin to the Ethereum ecosystem, enabling users to leverage it in various DeFi applications.

2. Wrapped Filecoin (WFIL): WFIL is an ERC-20 token that represents Filecoin (FIL), a decentralized storage and data retrieval network. WFIL allows Filecoin holders to access DeFi services on the Ethereum blockchain while maintaining their FIL holdings.

3. Wrapped Polkadot (WPOLK): WPOLK is an ERC-20 token that represents Polkadot (DOT), a multi-chain platform that enables interoperability between different blockchains. WPOLK brings the value of DOT to the Ethereum ecosystem, allowing users to participate in Ethereum-based DeFi services.

4. Wrapped Cardano (WCARD): WCARD is an ERC-20 token that represents Cardano (ADA), a blockchain platform known for its focus on security, scalability, and sustainability. WCARD enables Cardano holders to access DeFi applications and services on the Ethereum network.

What are the opportunities for Wrapped Token Development?

The development of wrapped tokens extends beyond the realm of cryptocurrencies and blockchain platforms. The versatility and interoperability of wrapped tokens offer opportunities for their implementation in various sectors. Let’s explore some of the sectors where the wrapped token system can be developed:

1. Real Estate: Wrapped tokens can revolutionize the real estate sector by tokenizing properties and enabling fractional ownership. Investors can hold shares of real estate assets in the form of wrapped tokens, providing liquidity, ease of transfer, and the ability to trade fractions of properties.

2. Art and Collectibles: The art and collectibles market can benefit from wrapped tokens by tokenizing valuable assets such as artwork, rare collectibles, or luxury goods. Wrapped tokens enable fractional ownership, transparent provenance, and enhanced liquidity in the art market, opening up new investment opportunities for art enthusiasts.

3. Commodities: Commodities like gold, silver, or oil can be tokenized using wrapped tokens, enabling seamless trading and investment in these physical assets. Wrapped tokens represent ownership of the underlying commodities, allowing users to easily buy, sell, and trade these assets on blockchain platforms.

4. Supply Chain: Wrapped tokens can improve supply chain management by tokenizing goods, tracking their movement, and ensuring transparency and authenticity. This enables efficient traceability, reducing fraud and counterfeiting risks while enhancing trust and visibility throughout the supply chain.

5. Gaming and Virtual Assets: The gaming industry can leverage wrapped tokens to tokenize in-game assets, virtual currencies, and non-fungible tokens (NFTs). This allows players to own and trade their virtual assets securely, both within and across different gaming platforms, enhancing the overall gaming experience and providing new revenue streams for gamers.

6. Finance and Investment: Wrapped tokens have significant applications in traditional finance, enabling the tokenization of traditional financial assets such as stocks, bonds, and derivatives. By wrapping these assets, they can be seamlessly traded on blockchain platforms, increasing accessibility and liquidity while reducing intermediaries and transaction costs.

7. Cross-Border Payments: Wrapped tokens can streamline cross-border payments by digitizing fiat currencies and representing them as tokens. This facilitates faster, more cost-effective international transactions, eliminating the need for traditional intermediaries and reducing settlement times.

8. Identity and Credentials: Wrapped tokens can play a role in digital identity solutions, enabling secure and decentralized identity verification and management. Individuals can possess their personal data in the form of wrapped tokens, granting them control over their identity information while ensuring privacy and reducing reliance on centralized identity systems.

Challenges and Risks Associated with Wrapped Tokens

Wrapped tokens offer various advantages and use cases, but they also come with certain challenges and risks that users need to be aware of. Let’s delve into three key sub-sections that highlight the potential risks and concerns associated with wrapped tokens:

Counterparty Risks and Trustworthiness: 

Most of the time, wrapped tokens require a custodian to hold the underlying assets that are being wrapped. Users are exposed to counterparty risks, as they must trust the custodian to maintain the reserved assets securely and issue the wrapped tokens in a reliable and transparent manner.

It’s essential to assess the reputation, security measures, and track record of the custodial service to ensure their trustworthiness and mitigate the risk of potential mismanagement or loss of assets.

Centralization Concerns and Regulatory Challenges: 

Wrapped tokens mainly count on centralized custodians to manage the underlying assets and issue the wrapped tokens. This introduces a level of centralization and reliance on a third-party entity.

Centralization poses risks, such as single points of failure, potential censorship, or even custodial mismanagement. Users should carefully consider the trade-off between convenience and the decentralization ethos of blockchain technology.

In some cases, wrapped tokens may be subject to censorship or blacklisting due to their association with specific assets or activities.

Users should be aware that certain wrapped tokens could face restrictions or limitations imposed by regulatory authorities or industry participants. This may impact the fungibility and transferability of the wrapped tokens.

Potential Security Vulnerabilities: 

Wrapped tokens often rely on smart contracts to facilitate the wrapping and unwrapping process. Smart contracts are subject to potential vulnerabilities, including coding errors, security flaws, and hacking risks.

Also, the popularity of wrapped tokens makes them potential targets for phishing attacks and scams. Malicious actors may create fraudulent websites or apps to trick users into divulging their private keys or sending funds to unauthorized addresses.

Users should exercise caution, ensure they are interacting with legitimate platforms, and follow best security practices to protect their assets from phishing attempts and scams.

So, What does the Future Hold for Wrapped Tokens?

As the blockchain and cryptocurrency ecosystem continues to evolve, the future of wrapped tokens appears promising. Let’s explore some of the potential developments and trends that lie ahead:

Wrapped Tokens in the Metaverse

The concept of the metaverse, a virtual world where users can interact, trade, and create digital assets, has gained significant attention. Wrapped tokens are expected to play a crucial role in the metaverse by enabling the seamless integration of real-world assets and their representation as digital tokens. 

This opens up opportunities for virtual ownership, trading, and monetization of assets within the metaverse, bridging the gap between physical and digital realms.

Integration of Wrapped Tokens with Traditional Finance

The integration of wrapped tokens with traditional finance is expected to grow in the future. As the regulatory landscape becomes clearer and traditional financial institutions embrace blockchain technology, we can anticipate greater collaboration between the traditional finance sector and the world of wrapped tokens. 

This integration could lead to the tokenization of traditional financial assets, such as stocks, bonds, and real estate, making them more accessible, liquid, and efficient.

Evolution and Innovation in the Wrapped Token Space

The wrapped token space is poised for continued evolution and innovation. We can expect the development of more advanced wrapping protocols and standards, making the process of wrapping assets more secure, efficient, and user-friendly. 

Additionally, the interoperability between different blockchain networks and the expansion of cross-chain solutions will enhance the seamless transfer of wrapped tokens and assets across multiple platforms.

Furthermore, the emergence of decentralized finance (DeFi) has already revolutionized the financial landscape. In the future, we can anticipate further advancements in DeFi protocols that leverage the capabilities of wrapped tokens. 

This includes innovative lending and borrowing platforms, decentralized exchanges, and yield farming opportunities that provide enhanced liquidity, increased financial inclusivity, and new avenues for wealth generation.

Moreover, as blockchain technology matures and scalability solutions improve, the transaction costs and speed associated with wrapped tokens are likely to become more favorable. This will contribute to a broader adoption of wrapped tokens and make them more accessible to a wider range of users, including individuals, businesses, and institutions.

Wrapping it Up

Wrapped token development has shown some potential, but widespread usage is still years away. The demand for interoperability and wrapped tokens will certainly increase as more people come to trust and investigate decentralized finance. It’s because wrapped tokens create a world where sharing liquidity between applications is simple, and money is more effectively used. Bridges and wrapped tokens are expected to remain a key component of the interoperability solution for the foreseeable future, if not longer.

In the end, it will be intriguing to observe how wrapped tokens influence the crypto industry’s future and how they could even change how we perceive cryptocurrencies in general. 

Leverage the power of blockchain and explore the potential of wrapped tokens with Webisoft, one of the leading blockchain development solutions. So, schedule a free appointment to connect with our blockchain and DeFi specialists! 

FAQs

1. How do you unwrap a wrapped token? 

Unwrapping a wrapped token involves the process of redeeming the wrapped token for the original asset it represents. Users can initiate the unwrapping process by sending the wrapped tokens to a designated smart contract, which verifies the ownership and releases the equivalent amount of the underlying asset.

2: What is the difference between a token and a wrapped token? 

The main difference between a token and a wrapped token lies in their underlying blockchain networks. A token typically refers to a native asset issued on a specific blockchain, while a wrapped token represents an asset from a different blockchain, allowing it to be used on a different network through the process of wrapping and unwrapping.

3: Who controls WBTC? 

It is managed by a consortium called the WBTC DAO (Decentralized Autonomous Organization), which consists of custodians, merchants, and users who participate in the minting and burning process of WBTC. The WBTC DAO ensures the transparency and security of the wrapped token.