wrapped crypto tokens

Wrapped Tokens Explained

What are Wrapped Tokens?

Wrapped tokens represent assets enabling the seamless transfer of value from one blockchain to another. Among the most renowned wrapped tokens is Wrapped Bitcoin (WBTC), designed to mirror the value of Bitcoin (BTC) on a 1:1 basis, ensuring one WBTC is always equivalent to one BTC. However, unlike BTC, WBTC exists as ERC-20 or TRC-20 tokens, facilitating its utilization and exchange across Ethereum and Tron blockchains.

In essence, wrapped tokens share similarities with stablecoins like USDT, which are tethered to the value of the U.S. dollar. Similar to WBTC’s pegging to BTC, one USDT maintains a fixed value relative to $1.

However, what defines a wrapped token isn’t solely its 1:1 pegging to another asset; rather, it’s the underlying technology and mechanisms securing and preserving its value.

Wrapped Token Mechanics

The mechanics of wrapped crypto tokens can be broken down into three primary functions:

Asset Locking

Wrapped tokens are brought into existence and removed from circulation through a method known as “minting” and “burning.” When minting a wrapped token like WBTC, the underlying asset, such as BTC, is transferred to a custodian – in many cases as Decentralized Autonomous Organization (DAO), multi-sig wallet, or merchant, responsible for safeguarding it in a digital vault. Subsequently, once the BTC is securely stored as de facto collateral, an equivalent amount of WBTC is generated.

This procedure can also be interpreted as “locking” or “wrapping.” The underlying asset is metaphorically “wrapped up” within a digital vault via a smart contract, thereby facilitating the creation of a newly wrapped asset for utilization on a different blockchain.

Issuance

Once the primary cryptocurrency is secured, a proportional quantity of wrapped tokens is generated or introduced on an alternative blockchain (for instance, a wrapped rendition of Bitcoin, such as WBTC, is launched on the Ethereum blockchain). Within the realm of the secondary blockchain, these wrapped tokens act as representations of ownership of the locked native coin, enabling unrestricted trading.

Burning

In a parallel manner to minting wrapped tokens being akin to “wrapping” the underlying asset to produce a token of equal worth for utilization on another blockchain, burning wrapped tokens can be likened to “unwrapping” the underlying asset.

This cycle of minting and burning, or wrapping and unwrapping, ensures that all wrapped tokens, ranging from WBTC to renDOGE (a wrapped variant of Dogecoin), possess collateral in the form of an equivalent amount of their foundational currency. For every 100 renDOGE minted, 100 DOGE are reserved to uphold the value of the wrapped token.

Leading Wrapped Tokens

Wrapped tokens are engineered to seamlessly integrate with specific blockchain configurations, thereby facilitating the interoperability of numerous assets within a unified ecosystem.

A prime illustration of this concept is Wrapped Bitcoin, one among various types of wrapped tokens, which empowers BTC holders to leverage their assets within Ethereum’s decentralized applications and DeFi platforms.

  • WBTC is a project aimed at encapsulating Bitcoin for utilization on the Ethereum blockchain, managed by the WBTC DAO and initiated collaboratively by Kyber, Ren, and BitGo.

Similarly, the Ethereum network benefits from increased efficiency with the presence of Wrapped Ether (wETH), streamlining trading activities and smart contract interactions. Moreover, the interoperability of stablecoins across multiple blockchain ecosystems is greatly enhanced through wrapped equivalents such as Tether (USDT), USD Coin (USDC), and Dai (DAI).

  • WETH, short for Wrapped ETH, was established by a consortium of projects under 0x labs and represents an ERC-20 variant of Ethereum, serving as a tradable asset on various DeFi protocols; and
  • renDOGE is a wrapped iteration of Dogecoin, attainable through the RenBridge on the RenVM protocol, enabling the minting of Dogecoin equivalents for use across blockchain networks.

Furthermore, certain blockchains host their own wrapped tokens, like BNB Smart Chain (BSC) and Polygon, fostering cross-chain compatibility and enabling diverse decentralized applications.

  • Assets within the BSC network exist as BEP-20 tokens, mirroring the functionality of ERC-20 tokens on the Ethereum network. Transitioning your cryptocurrency assets into their corresponding wrapped versions supported on the Binance Smart Chain enables seamless participation in liquidity mining activities.

Advantages of Wrapped Tokens

Wrapped tokens serve various purposes, with their primary function being the provision of tokens that aren’t native to a particular blockchain. Typically, a cryptocurrency asset native to the Ethereum network cannot be utilized on another blockchain. However, wrapped tokens bridge this gap by representing a tokenized version of the asset on that blockchain.

Introducing a wrapped token for a cryptocurrency asset struggling on a specific blockchain can invigorate its activity. By enabling accessibility on an alternative blockchain through a wrapped token, liquidity for the asset can surge, establishing a connection between its original liquidity and the newfound liquidity.

Binance Smart Chain is renowned for its lower gas fees compared to other blockchains. Consequently, employing a wrapped token of an asset on a different network like BSC can lead to cost savings. Additionally, since transaction processing speeds vary among different blockchains, representing the asset as a wrapped token on a faster blockchain can expedite transaction times.

Moreover, wrapped tokens foster decentralization by empowering users with greater control over their assets. Through these tokens, the utility, accessibility, and flexibility of digital assets are markedly enhanced across diverse blockchain networks, fostering a more interconnected and vibrant crypto economy.

Limitations of Wrapped Tokens

The primary drawback of a wrapped token lies in the reliance on the custodian responsible for holding the equivalent amount of the crypto asset. That is, there is a latent trust issue concerning the validity of the custodian holding the underlying custodial crypto asset. The need to go through a custodian before minting the wrapped tokens introduces an indirect aspect to the process.

However, efforts are underway to address these limitations by exploring more decentralized approaches, potentially mitigating this concern in the future. Additionally, another limitation arises from the fees incurred during the minting and burning of wrapped tokens, which can be substantial in certain scenarios.

Conclusion

Wrapped tokens are quickly becoming an integral part of the crypto ecosystem by offering a solution for competing blockchain’s lack of interoperability. Moreover, for a token issuer or new blockchain, the creation of a wrapped crypto token can solve trading liquidity challenges

If you have questions regarding the creation of a wrapped crypto token, be sure to reach out

You can also book a free consultation here.

About Adam Tracy

Adam Tracy is a payments expert and entrepreneur who specializes in payment systems, blockchain technology, digital currencies, and other emerging technologies. He is the founder of Blockrunner, LLC that provides consulting services to clients in the blockchain, payments and cryptocurrency arenas.

Tracy has been involved in the payments industry as an attorney, consultant and entrepreneur since 2005, while he was become an expert in blockchain and cryptocurrency since its advent in 2013. Tracy has worked with a wide range of clients, including startups, established businesses, and investor – both in the United States and worldwide. He has advised clients on a wide range of compliance, legal and operational issues related to payment transfer systems, crypto token generation and architecture, cryptocurrency exchanges, regulatory licensing, smart contracts, and other blockchain applications.

In addition to his consulting work, Tracy has founded several companies in the payments, blockchain and cryptocurrency space, including a digital asset hedge fund, licensed electronic money institution and a blockchain-based tokenization platform. He is also a proponent of decentralized finance (DeFi) and has been involved in various DeFi projects.

Tracy is also a frequent speaker and writer on blockchain and cryptocurrency topics. He has been featured in a wide range of publications, including Forbes, Hollywood Reporters, CNBC, Reuters, CoinDesk, and Bitcoin.com.

Find Adam: https://linktr.ee/adamtracy

Blockrunner, LLC., is a financial services match-making marketplace and consulting company. We are not a bank, FI/NBFI, Payment Service Provider, deposit taking institution, trust, or money services business of any kind. We are not regulated by any financial regulator. Banking, Payment, Processing, and Licensing services are provided by our participating members. This website is for informational purposes only and does not constitute legal advice. If you need legal advice, please consult a licensed attorney in your jurisdiction.

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