Wrapped tokens have emerged as a significant advancement, that bridge different blockchain ecosystems and enhance the functionality of decentralized finance (DeFi).
Wrapped tokens are virtual assets that are associated with another cryptocurrency on a different blockchain. Essentially, a wrapped token is a tokenized version of another cryptocurrency that functions on a different blockchain than the native one. For instance, Wrapped Bitcoin (WBTC) is a cryptocurrency on the Ethereum blockchain that is associated with Bitcoin (BTC).
Wrapped tokens address a fundamental issue in the crypto space: interoperability. Different blockchain networks often do not have the direct communication ability, this diminishes the utility and capacity of assets. Wrapped tokens facilitate the use of cryptocurrencies across different blockchain platforms, which increases the liquidity of the cryptocurrency, and allows for more intricate financial transactions.
Here are some benefits of wrapped tokens:
Wrapped tokens facilitate communication between different blockchain networks. For instance, WBTC, which is wrapped around Bitcoin, can be utilized in Ethereum-based decentralized applications (dApps).
By wrapping tokens from one blockchain with those from another, the total amount of liquidity in the system is increased. For example, WBTC incorporates the liquidity of Bitcoin into the DeFi platforms of Ethereum.
Wrapped tokens facilitate cross-chain transfers and transactions. Users can transfer assets from one blockchain to another, thereby extending the utility of the original token.
Wrapped tokens facilitate the participation of decentralized finance applications (DeFi) on different blockchain platforms. For instance, utilizing wrapped Bitcoin (WBTC) to participate in various DeFi protocols on the Ethereum network.
Some blockchain platforms, such as Bitcoin, do not have native support for smart contracts. Wrapping Bitcoin as WBTC will allow it to be utilized in smart contracts on Ethereum, which will expand the functionality and uses of the blockchain.
Transactions involving wrapped tokens are typically faster and more cost-effective than native tokens on their own blockchain, depending on the network conditions and fees.
Wrapping allows owners of assets that are otherwise difficult to utilize in certain ecosystems to release value and utilize their assets. For instance, Bitcoin owners can utilize their Bitcoin in DeFi projects that do not require the sale of their Bitcoin.
Investors can diversify their portfolios by taking part in different blockchain-based activities without having to actually own the assets associated with those activities.
These benefits contribute to the value of wrapped tokens in the blockchain ecosystem, they enhance communication, liquidity, and utility between different networks.
The procedure of creating and managing wrapped tokens typically involves the minting of tokens and burning them, every wrapped token is backed by the same amount of the initial asset.
The procedures of minting and burning tokens ensures that wrapped tokens have a 1:1 peg with their associated assets, facilitating the use of cross-chain assets while taking advantage of the benefits and liquidity of different blockchain ecosystems.
To create a wrapped token, a user deposits the original asset (e.g., Bitcoin) into a designated custodian or smart contract. This custodian could be a single-centralized figure or a consortium of similar-sized entities, or it could be a decentralized smart contract.
Once the deposit is officially approved, the custodian or smart contract verifies the transaction and binds the original asset to the wrapped token, which prevents the latter from being used or transferred while the former is still in circulation.
The guardian or smart contract then ensures that the same amount of wrapped tokens is minted (e.g., WBTC) onto the target blockchain (e.g., Ethereum). These tokens are the original possession and can be utilized in various decentralized apps (dApps) and DeFi protocols on the blockchain target.
To redeem the original asset, the user begins a burning procedure by sending the wrapped tokens back to the custodian or smart contract.
The guardian or smart contract is responsible for verifying that the wrapped tokens are received and burned, removing them from use. This guarantees that the total supply of the wrapped token is accurately supported by the original resource.
Once the wrapped tokens are destroyed, the custodian or smart contract releases the equivalent amount of the original asset to the user, completing the process.
WBTC is a token based on ERC-20 that is backed by Bitcoin. It facilitates the transfer of Bitcoin's liquidity to the Ethereum network, allowing holders of BTC to utilize their funds in Ethereum-based decentralized applications (dApps) and DeFi protocols.
WETH is a token in the ERC-20 series that represents Ether (ETH) on the Ethereum blockchain. Since ETH is not a token from the ERC-20 list, WETH enables the conversion of ETH to other tokens in the ERC-20 list and the DeFi ecosystem without difficulty.
WBNB is a BEP-20 cryptocurrency that represents Binance Coin (BNB) on the Binance Smart Chain. It facilitates the use of BNB in DeFi apps on BSC.
Wrapped tokens have a significant role in decentralized finance (DeFi) by enabling various applications and enhancing the entire ecosystem.
Users can store wrapped tokens like WBTC or WETH as a collateral to borrow other cryptocurrencies. This facilitates their ability to utilize their assets without actually selling them, instead, they receive interest on their holdings.
Example of lending and borrowing platforms: Aave, Compound.
Wrapped tokens facilitate the exchange of assets from different blockchain chains on decentralized platforms. For example, WBTC can be exchanged for ERC-20 tokens on Uniswap, this increases the liquidity and trading potential of the token.
Example of DEXs: Uniswap, SushiSwap, PancakeSwap.
Users can participate in protocols that award rewards for holding wrapped tokens. For instance, staking WBTC or WETH in a liquidity pool can lead to a yield of interest or tokens of authority.
Example of yield farming platforms: Yearn Finance, Harvest Finance.
Wrapped tokens can be employed as a form of collateral to create stablecoins. For example, users can utilize the WBTC function in MakerDAO to create the stablecoin DAI, this is backed by Bitcoin and provides a consistent value.
AMMs employ liquidity pools that are composed of wrapped tokens to facilitate transactions. Users can sell tokens that are wrapped in liquidity, such as WBTC, and receive fees for transactions within the pool.
Example of AMMs: Balancer, Curve Finance.
Wrapped tokens can be employed in derivative and option transactions. For example, users can create and exchange options on WBTC, which allows for hedging and speculative behaviour.
Example of platforms: Opyn, Hegic.
Wrapped tokens facilitate cross-chain bridges, allowing assets to move between different blockchain's. For instance, RenVM allows Bitcoin to be transferred to Ethereum as renBTC, this facilitates the cross-chain communication.
Wrapped tokens can be employed in decentralized platforms for insurance that cover the various activities of DeFi. For example, users can utilize WBTC to purchase insurance regarding the smart contract's risks.
Example of decentralized insurance platform: Nexus Mutual.
These uses of wrapped tokens demonstrate the versatility and necessity of these tokens in increasing the functionality and reach of DeFi, increasing liquidity, interoperability, and the overall efficiency of the system.
While tokens wrapped in paper are beneficial, they also have a potential for risk and difficulty.
Wrapper tokens are often supported by the original asset held by a custodian or a smart contract. If the custodian is corrupt or shows malicious intend, the value of the wrapped token could be adversely affected.
Wrapper tokens are based on smart contracts that facilitate the process of minting, burning, and managing assets. Bugs or holes in these smart contracts can cause funds to be lost or misused.
The liquidity of wrapped tokens can be lower than the native value of the tokens. If the liquidity is lacking, users may have problems purchasing or selling wrapped tokens.
Wrapped tokens may be subject to regulatory oversight as they represent assets that cross multiple chains and could be governed by different regulations. Regulatory actions could affect their availability and utilization.
Some wrapped tokens require a centralized entity to maintain custody or release them, this is in contrast to the decentralized nature of the blockchain. Centralization can lead to a single place of failure.
The value of wrapped tokens should be equal to the value of the underlying asset. However, the conditions of the market or trust issues can cause the peg to fail, which leads to price disparities.
Understanding the functionality of wrapped tokens and the associated dangers requires a specific amount of technical knowledge. Understanding the processes can lead to misuse and significant losses.
Wrapped tokens involve complex, technical-based cross-chain operations that are prone to issues. Troubles with the bridging process can lead to problems or a lack of funds.
Incentives for different stakeholders (custodians, users, developers) must be harmonized in order for the system to operate smoothly. Misalignment can cause conflict or a lack of participation.
Low liquidity or centralized control can lead to the wrapped tokens being susceptible to market manipulation, which can lead to a decrease in price and instability.
Understanding these risks and difficulties is pivotal for the users and developers of DeFi applications in making decisions about or creating wrapped tokens in the DeFi ecosystem.
Wrapped tokens serve as a unique bridge between different blockchain ecosystems, which enhances the flexibility and liquidity of digital assets. Nonbank, as a comprehensive financial management solution, allows users to easily integrate and manage these diverse assets, including wrapped tokens, within a single platform.
Nonbank allows users to observe their holdings across chains, participate in decentralized finance (DeFi) activities, and optimize their portfolios without the need for multiple interfaces. This single approach facilitates the management of assets and provides a comprehensive understanding of one's financial situation, which will allow users to utilize the entire potential of their wrapped tokens in conjunction with other cryptocurrencies and traditional financial assets.
Wrapped tokens are a powerful component of the cryptocurrency ecosystem, they enable interaction, increase liquidity, and release the full potential of DeFi apps. By comprehending the way wrapped tokens function and the benefits and risks associated with them, users can more easily navigate the cryptocurrency landscape and take advantage of the opportunities it provides.
