Posted: 14.07.2021 | 05:24
What are Wrapped Tokens?
Wrapped token is a tokenized version of another cryptocurrency. It is fixed to the value of the asset it represents and can usually be used for it at any point. It usually represents an entity that does not live natively on the blockchain in which it is published.
Wrapped token can be considered similar to stablecoin as it derives its value from another asset. In the case of stablecoin it is indexed to a fiat currency. The value of Wrapped tokens is indexed to an asset issued on another blockchain.
Because blockchains are different systems, there is no good way to move information between them. Wrapped tokens increase interoperability between different blockchains.
How Wrapped Tokens Work?
As an example, Wrapped Bitcoin (WBTC), which is the tokenized version of Bitcoin on Ethereum, can be explained. WBTC is an ERC-20 token that must be pegged to the Bitcoin value one-to-one, allowing you to use BTC effectively on the Ethereum network.
Wrapped tokens are usually held by an escrow officer. A custodian is a unit that holds the indexed amount of the asset. This custodian can be a vendor, multi-signature wallet, DAO, or smart contract. In the WBTC example, the custodian is required to hold 1 BTC for every 1 WBTC issued. The proof of this reserve is on the chain.
So how does the wrapped process work?
A seller sends a wrapped token creation BTC to the escrow. The custodian then issues WBTC on Ethereum as much as the amount of BTC sent. When WBTC needs to be converted back to BTC, the seller requests a burn from the custodian and the BTCs in the reserve are released. . You can think of the escrow as the unit that performs the wrapping and undoes it. In the WBTC example, adding and removing custodians and vendors is handled by a DAO.
While some in the community refer to Tether (USDT) as a wrapped token, this is not exactly the case. While USDT usually trades with USD one-to-one, Tether does not hold the exact amount of physical USD for every USDT circulating in its reserves. Instead, that reserve consists of cash and other real-world cash equivalents, assets, and receivables on loans. But the idea is very similar, every USDT token acts as a kind of wrapped version of fiat USD.
Benefits of Using Wrapped Tokens
Although many blockchains have their own token standards (ERC-20 for Ethereum or BEP-20 for BSC), these standards cannot be used in a single blockchain. Wrapped tokens allow non-native tokens to be used on a particular blockchain.
In addition, wrapped tokens can increase liquidity and capital efficiency for both centralized and decentralized exchanges.
Finally, a big advantage is processing times and fees. While Bitcoin has some great features, it is not one of the fastest blockchains and can sometimes be expensive to use. Therefore, there may be some difficulties during the process. Using wrapped versions on a blockchain with faster transaction times and lower transaction fees allows avoiding these frustrations.