What Are Wrapped Crypto Tokens?

The crypto industry is full of variety, and the truth is that ‘cryptocurrency’ is an umbrella term that encompasses many types of digital assets. These include stablecoins, meme coins, and, of course, wrapped crypto tokens.

If you’ve been following the crypto scene, then you’ve probably heard of wrapped tokens at some point. They’ve been prominent in the space for several years now and seem to only become more popular. Anyone who invests in crypto should be aware of what they are, how they work, and how they can benefit you.

In this guide, we’ll be taking a deep dive into wrapped crypto tokens.

What Is Wrapped Crypto?

As we know, cryptos are based on blockchains and oftentimes, particular tokens can only be used on their native blockchains. This poses a challenge for users who might want to take advantage of a specific token’s value but use a different blockchain.

This is where wrapped cryptos come in. As the name implies, wrapped cryptos are tokens that are ‘wrapped’, or pegged to the value of another crypto while being used on a different blockchain. By doing this, not only are the different cryptos connected but their respective blockchains are as well.

Wrapped cryptos are also not only pegged to other digital assets but also to physical assets. These include real estate, art, gold, etc. Wrapped cryptos allow for these assets to be essentially tokenized and easily traded.

The desire to leverage both cryptos and real-life assets has seen wrapped cryptos become much more prominent in the industry. As such, it is not uncommon to see wrapped versions of major cryptos like Bitcoin (BTC) and Ethereum (ETH), as well as wrapped stocks of companies like Apple Inc (NYSE: AAPL) and Tesla Inc (NYSE: TSLA).

As wrapped cryptos represent such a unique development and investment opportunity, investors should be aware of them.

How Wrapped Tokens Work

Now that we know what wrapped tokens are, we need to understand just how they work. First, we need the token whose value we want to leverage. For example, let’s take Bitcoin. You also need the new network that the wrapped version will be used on. So, the wrapped version of Bitcoin would be wBTC.

But how would wBTC come into existence? For this, we would need a custodian. People deal with these wrapped tokens under the belief that there is a stash of the pegged asset somewhere. It is similar to how the issuers of a dollar-pegged stablecoin are assumed to have USD put away somewhere. In this case, we call the person who holds the initial asset a custodian.

The custodian could be a person or even a smart contract that executes certain functions. When a merchant or investor wants wBTC, they send BTC to a custodian who then mints wBTC according to the amount they receive, e.g. 10 BTC becomes 10 wBTC. These wrapped tokens are designed to function on certain chains besides the Bitcoin network.

When the transactions are completed and the investor wants their Bitcoin back, the custodian burns the wBTC and returns the initial deposit.

Wrapped Bitcoin

Wrapped Bitcoin is perhaps one of the most popular wrapped cryptos and its existence was born out of necessity. As we all know, Bitcoin is the most valuable token in the world and crypto investors have worked for years to make money off it. But by 2019, the decentralized finance (DeFi) space was on the rise and this meant that many tokens could be monetized through lending, yield farming, and much more.

The only problem is that Bitcoin cannot be used on DeFi protocol, which proved a problem. On the other hand, Ethereum-based assets could be used on DeFi protocols as Ethereum was basically the backbone of the industry. With this in mind, developers sought a way to combine the liquidity of Bitcoin with the DeFi-compatibility of the Ethereum blockchain.

In 2019, the first wrapped Bitcoin (wBTC) was launched as a joint initiative with  BitGo, Kyber Network liquidity protocol, and others. This initiative included three different players: the custodians who minted the wrapped tokens, merchants who went BTC to the custodians, and a 17-member DAO that approved the addition or removal of a merchant or custodian from the ecosystem.

Wrapped Bitcoin has proven to be a hit so far and now, many other initiatives with the same concept have launched.

Wrapped Ethereum

Considering the fact that the Ethereum blockchain serves as the foundation of many DeFi protocols, it might seem surprising that its native token would need to be wrapped at all. To understand why this is so, we need to go back in time a little. Ethereum token was developed in back 2013. Years later, in 2017, the developers of the blockchain developed ERC-20, a standard for fungible tokens to allow them to be used in the same ecosystems,

So, if an application is built using the ERC-20 standard, all tokens developed according to this standard can be used on it. There was just one problem: ETH, the native token of Ethereum, had been developed before ERC-20 and so it didn’t conform to it. This represented a major problem as it meant that ETH, the second-most valuable token in the industry, was shut out of many decentralised applications (dApps).

This is where wrapped Ethereum (wETH) comes in. Pegged at a 1:1 ratio to the value of Ether itself, it can be used on a plethora of applications that Ether might not be.

Benefits of Using Wrapped Tokens

Wrapped cryptos have become one of the most popular types of cryptos because they offer the following benefits:

• Cross-chain operability. One of the major limitations that the blockchain space faces is the lack of interoperability across networks. But with wrapped tokens, cryptos can be used outside of their native environment and this is a great convenience for crypto lovers.
• Liquidity transfer. As we can see from the example of wrapped Bitcoin, wrapping tokens allows for the liquidity of one token to be transferred to the blockchain of a different network. by using wrapped cryptos, liquidity issues within various ecosystems can be addressed without having to move digital assets around.
• Benefits transfer. Different tokens have different selling points and wrapping them allows a transfer of these benefits. For example, Bitcoin offers great monetary value to investors but is lacking in speed. By wrapping it and migrating to a network like Ethereum, this speed can be enjoyed.
• Access to various applications. A crypto user who favours Bitcoin or Ether would be shut out from applications based on the ERC–20 standard if not for token wrapping. This highlights a major benefit of wrapping, which is that there is greater access to valuable applications.

Limitations of Wrapped Tokens

Despite all the benefits mentioned above, you shouldn’t fall into the trap of thinking that wrapped tokens are a catch-all solution for all of the industry’s problems. In fact, they have a few limitations some of which are as follows:

• Unwrappable tokens. Not every single token can be wrapped for use in every single network and this means that the issues wrapping tries to address are not fully resolved.
• Centralization. Wrapping involves crypto users giving up control of their tokens for a period to a custodian and this centralized process brings up issues of trust and security.
• Complexity. Let’s face it, sending your tokens to a custodian and then receiving wrapped tokens and then doing the same process in reverse seems rather tedious and not every user will be interested.
• Values and fees. Because the crypto space is volatile, custodians might not be able to maintain an exact 1:1 value between the wrapped asset and the original one. On top of this, users still need to pay a fee to have their assets wrapped.

Closing Thoughts

While the blockchain and crypto space is certainly innovative, it is far from perfect. Several issues have been addressed for years now, one of which is the lack of interoperability between many major ecosystems. Wrapped tokens have been a massive step forward in combating this.

By allowing tokens to essentially be used outside of the native ecosystems, various blockchains are further connected, benefits like liquidity are transferrable, and consumers have access to a wider range of applications. However, this comes with its own set of issues such as the emphasis on centralization via custodians and the fact that wrapping does not fully address the issues of limited interoperability within the industry.

While the limitations of wrapped cryptos still need to be resolved, they continue, nevertheless, to be a valuable tool for crypto users.