You see, ever since blockchain tech was launched in 2009, the technology has evolved to give us different types of cryptocurrencies. Each with its specific use cases. You might have come across terms like altcoin, stablecoins, and etc.
We will look at how wrapped tokens work, and whether they are a good investment. Let’s get down to business. Do wrapped tokens really get wrapped? Yes, they do. Wrapped tokens get wrapped. Digitally. This sounds very confusing so let’s look at a more detailed explanation.
What are wrapped tokens & what are they used for?
A wrapped token is basically a stable coin that has its value tied to another cryptocurrency. Just like other stablecoins, a wrapped token represents another asset – a cryptocurrency. Wrapped tokens allow people to use non-native tokens on a blockchain.
For example, say you wanted to trade bitcoin on a defi protocol on Ethereum. How would you do it? Of course, you can’t use bitcoin directly as the Ethereum blockchain does not recognize bitcoin. That’s where wrapped tokens come in. You can wrap your Bitcoin into what is called Wrapped Bitcoin (WBTC), which you then use to make transactions on the Ethereum network.
Wrapped tokens are a great way to provide liquidity for defi protocols. Wrapped tokens also allow people to own and hold only a fraction of the asset.
The first wrapped token ever launched is wrapped Bitcoin (wBTC), released in January 2019. Since then, wrapped tokens have become very popular. Today, wrapped tokens have a combined market cap of 10 billion dollars.
To understand why wrapped tokens are so important, we first need to look at how they work.
How Do Wrapped Tokens Work?
For starters, wrapping a token means to store it in a vault and mint a wrapped version of the stored tokens, which you’ll then use on another blockchain. Going back to our example. Say you wanted to trade bitcoin on one of the defi protocols on Ethereum. Since Ethereum does not recognize bitcoin, you would have to create a wrapped version of the bitcoin that will work on Ethereum. You have to wrap your bitcoin. To do this, you would need to find a merchant who does the wrapping for you.
The merchant will give your tokens, e.g., bitcoin, to a custodian, who then locks the bitcoin in a vault. After locking the bitcoin, the custodian mints a wrapped version of your bitcoin and transfers it to your wallet. This wrapping process is known as minting.
You can then use the wrapped version for trades while the original tokens stay locked in the vault. You can redeem your bitcoin whenever you want.
Redeeming the wrapped tokens is done through a process called burning. The merchant will issue a burn request to the custodian, who then releases an equal amount of bitcoin from the vault. This process of burning and minting is how wrapped tokens are created and maintained. The process can be done through different mechanisms, e.g., a DAO, a smart contract, or a multisig wallet.
A DAO is a decentralized autonomous organization, and they use smart contracts to execute commands. A smart contract is simply a set of codes that is self-executing. A multi-sig wallet is a wallet that uses multiple private keys to authorize crypto transactions.
A great example of wrapped tokens is WBTC. WBTC is a wrapped version of Bitcoin that runs on the Ethereum blockchain. WBTC has its value tied to that of Bitcoin at a ratio of 1:1, which means that 1 Bitcoin is equal to 1 WBTC.
As you probably expected, wrapping and unwrapping tokens will cost a transaction fee. But hey, nothing good comes free, right? Moving on.
Another popular wrapped token is Wrapped Ether (WETH). WETH is also an Ethereum-based token. So you’re probably wondering, why was it created? You see, most defi projects, NFTs, and decentralized apps are on the Ethereum network, and most of them will ask you to use an ERC-20.
Ether is the main currency of the Ethereum network, but it is not an ERC-20 token. In fact, it was launched before the ERC-20 standard. As a result, most protocols on Ethereum do not accept Ether in their transactions. Hence the need for Wrapped Ether (WETH).
A key difference between Wrapped bitcoin and Wrapped ether is how they are run. With BTC, you have to wrap the token. Ether is the opposite. To get wrapped Ether, you simply trade regular Ether for Wrapped Ether (WETH). You can make the trade through a smart contract or through a digital wallet like MetaMask.
It is believed that wrapped Ether (WETH)will be phased out by the time Ethereum is updated and Ether becomes compliant with ERC-20 standards. Speaking of wrapping, remember we said that’s the job of merchants? Well, some common merchants include AirSwap, AAVE, and CoinList.
Top Wrapped Tokens (list 3-5 examples with descriptions)
Now, let’s take a more detailed look at the most popular wrapped tokens on the market. Of course, we can’t talk about wrapped crypto without starting with Wrapped Bitcoin.
WBTC is an ERC-20 token that has its value pegged to that of Bitcoin. ERC-20 means the token can work on the Ethereum network. Like we said earlier, Wrapped Bitcoin uses a mint and burn strategy, which is run by a DAO.
DAO simply means Decentralized autonomous organization. A DAO is simply a group of people who own and run an organization. Decisions are usually made through a voting process based on each person’s stake in the organization. People with more stake get more voting power.
WBTC has a market cap of $8 billion and is the largest wrapped token in the world. It’s also a BEP-20 token which means that you can also use it on the Binance smart chain.
Next is the wrapped version of the Binance Smart Chain Token, BNB. Wrapped BNB is a BEP-20 token. It can also be traded for other tokens or ERC-20 tokens.
Wrapped BNB has a market cap of $1.38 billion, making it one of the largest wrapped tokens.
The next wrapped token we will be looking at is renBTC. Just like WBTC, renBTC has the same goal. To bring Bitcoin to the Ethereum network. RenBTC is an ERC-20 token, but it can also be used on the Binance Smart Chain.
RenBTC uses a similar lock and mint style of operation. The only difference is that the locking and minting is done by a smart contract, unlike WBTC, which uses a DAO.
This makes renBTC more decentralized than WBTC. RenBTC has a market capitalization of over $200 million.
Another advantage of RenBTc is that its custodian, the Ren virtual machine, makes it easy to wrap its token to be used on other blockchains.
Pros and Cons of Using Wrapped Tokens
So what are the benefits of using wrapped tokens in the first place? The first value that wrapped tokens give the blockchain world is interoperability. Interoperability simply means the ability of one blockchain to communicate with another blockchain. You see, most blockchains are independent networks. This is necessary if they are to be secure enough for use in the real world. But there’s a drawback.
Many of these blockchains cannot communicate with each other. For example, you can’t just use bitcoin to make transactions on Ethereum because the Ethereum blockchain cannot communicate with bitcoin’s network. This makes it impossible to make transactions on Ethereum using Bitcoin.
This might not seem like a big issue, but it is, especially for decentralized finance protocols. Lending and staking pools need to be able to collect and share information with different blockchains regardless of the network they are native to.
This is where wrapped tokens come in. Wrapped tokens make it easy for networks to share information with each other. This allows the trade of non-native assets on a blockchain. I.e., this is what allows you to trade bitcoin on the Ethereum blockchain via wrapped tokens.
Another benefit of wrapped tokens is liquidity. Liquidity simply means how easy it is to buy and sell assets on the market. Wrapped tokens increase liquidity on a blockchain thanks to the fact that they allow you to trade non-native assets on a network.
For example, a defi exchange based on the Binance smart chain can still get liquidity thanks to holding wrapped Ethereum tokens (WETH) or Wrapped Bitcoin (WBTC).
Next up is the benefit of reduced transaction costs. As many of you know, the more congested a blockchain network becomes, the higher it will charge in gas fees. Gas fees simply mean fees charged for making transactions on the network.
Ethereum, the most used blockchain network on earth, has the highest gas fees. These high costs can be very discouraging to crypto projects that don’t have high capital. As a result, many of them need an alternative that would give them the benefits of a solid network like Ethereum and the benefit of low transaction costs.
What many of these protocols did was to have their main project native to Ethereum while they launched wrapped versions of their tokens on other blockchains like the Binance Smart chain (BNB).
Lastly, another benefit of wrapped tokens is reduced transaction speed. Some blockchains are faster than others, and so transactions may be delayed on slower networks. Having wrapped tokens can help you leverage the speed of a network without owning the native token of that network.
For example, Bitcoin is older and not as fast as Ethereum. As a result, sending BTC on the bitcoin blockchain takes longer than sending WBTC on Ethereum. So now that we’ve looked at the upsides, you’re probably wondering, are there any downsides? Well, quite a few.
Firstly, there is the issue of centralization. One of the things that made crypto stand out is the idea of decentralization. A situation where an asset will be owned and maintained by a group of people rather than a central entity. Sadly, many blockchains have not been able to achieve this dream of decentralization.
Wrapped tokens make centralization necessary as the person has to trust the custodian in charge of the mint and burn process. The second issue has to do with relying on the custodian. If the custodian makes a serious error, it will have severe consequences on the mint and burn process. Lastly is the issue of costs. Sometimes, the costs of minting and wrapping tokens might be more than the benefits you get from the wrapped tokens. So keep that in mind when dealing with wrapped tokens.
Should I Invest in Wrapped Tokens?
So all this talk leaves us with one question? Should you invest in wrapped tokens? The answer is it depends.
Wrapped tokens represent another token, so their price should match the token they represent. Wrapped Bitcoin, for example, has its price tied to Bitcoin, so Bitcoin’s current price is almost the same as that of Wrapped Bitcoin.
Wrapped tokens should perform so long the asset they represent is performing well. Right now, one will be correct to say that tokens are performing very well. Especially the big two – Wrapped Bitcoin (WBTC) and Wrapped Ether (WETH).
Wrapped tokens are even set to grow in popularity as the demand for decentralized finance services grows. As we discussed earlier, tokens are a great way to provide liquidity to a blockchain or a defi protocol. Plus, with quicker transaction times and cheaper fees, more people will look to wrapped tokens as an alternative to slower networks like bitcoin and Ethereum.