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Wrapped Crypto Tokens: What Are They And How Do They Work?

Steve Kornacki

BySteve Kornacki

Oct 6, 2023

Wrapped Token Explained

A wrapped token represents a distinct digital asset supported by an alternative coin or resource native to a specific blockchain or network. What distinguishes wrapped tokens from others is that they have cross-chain adaptability and are suitable for decentralized finance (DeFi) applications.

These assets enable users to leverage various functionalities and amenities across multiple blockchain protocols. Thus, assets are seamlessly transferred from one platform to another.

Wrapped tokens can also comprise diverse assets, depending on the wrapping process’s specific use case and intricacies. Apart from cryptocurrencies, they can also consist of stablecoins and, in some instances, nonfungible tokens (NFTs).

Wrapped Bitcoin (wBTC), a prominent digital currency within the Ethereum network, is an example. wBTC acts as a Bitcoin (BTC) channel that allows users to interact with the DeFi ecosystem and decentralized exchanges (DEXs) built on the Ethereum ecosystem while maintaining BTC’s fundamental value and attributes.

The Workings Of Wrapped Tokens  

Wrapped crypto tokens work in several ways. The two most common are tokenized asset locking and wrapped token issuance.

Tokenized Asset Locking

In the blockchain industry, asset locking entails securing a predetermined amount of the native cryptocurrency of a particular blockchain, like Ethereum. The locked value is then entrusted to a smart contract, acting as a digital vault and managed by a DAO (a decentralized autonomous organization) or a designated entity that can be trusted.

The end goal of this process is to create a wrapped token. This token class is a digitized version of the initially locked native coin. As a result, the collateralized assets held within the smart contract secure its value.

Wrapped Token Issuance

The corresponding volume of wrapped tokens is developed once the native crypto asset is successfully locked within the smart contract. This issuance occurs on a separate blockchain, connecting two digital ecosystems.

For instance, a wrapped version of BTC, denoted as wBTC, is minted on the Ethereum blockchain.

Categories Of Wrapped Tokens

Wrapped tokens are innovatively designed to integrate seamlessly with specific blockchain configurations, revolutionizing how several assets converge within a unified ecosystem.

Accordingly, Wrapped Bitcoin, a distinct class of wrapped tokens, is an example of this variety of assets. This token variety allows Bitcoin owners to leverage their investments across the vast Ethereum’s decentralized applications and DeFi platforms.

Wrapped Ether (wETH), like Wrapped Bitcoin, helps increase the Ethereum network’s efficiency. It facilitates seamless trading, smart contract interactions, and streamlining of the ecosystem.

Similarly, the wrapped counterparts of stablecoins, such as Dai (DAI), Tether (USDT), and USD Coin (USDC), help revolutionize stablecoin interoperability.

Benefits Of Wrapped Tokens

Wrapped tokens have immense and diverse values. They serve as on-chain bridges by seamlessly connecting assets from various blockchains under a single ecosystem.

Thus, there is an increase in users’ access to a broad range of support and liquidity surge. Furthermore, wrapped tokens make it easier to integrate assets with various functionalities.

wBTC, for example, enables Bitcoin to be integrated into Ethereum’s DeFi projects. They also help standardize and streamline asset interactions, which improves their use cases.

These assets also empower users by giving them more control over their funds and further promoting decentralization. By improving the utility, accessibility, and adaptability of digital assets across various blockchain networks, wrapped tokens nurture a more integrated and dynamic crypto economy.

Limitations Of Wrapped Tokens

Wrapped tokens have some drawbacks despite their numerous advantages. For instance, they depend on custodians to hold the original assets, raising concerns about centralization and the counterparty risk associated with this method.

If the custodian encounters problems, the value and utility of the wrapped token may decline. Furthermore, the complexities and potential costs of wrapping and unwrapping tokens may deter some users from adopting wrapped tokens.

Nevertheless, wrapped tokens will continue to bring different blockchain ecosystems together and increase the utility of the underlying digital assets.

Steve Kornacki

Steve Kornacki

Steve Kornacki, a respected author at Big Trends Signals, uses his deep online trading acumen to create comprehensive guides and balanced reviews, empowering traders in their digital pursuits.

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