An In-Depth Guide to Understand Wrapped Tokens
We recently wrote a blogpost that offers a quick overview of wrapped tokens. This article would cover most of the areas the previous blog post did, but in greater detail.
Wrapped tokens solve an age old problem persistent across all markets — both traditional and crypto.
Let’s say a foriegn entity wants to list itself on The New York Stock exchange. Doing so isn’t straightforward, and would need the foreign entity to depend on an intermediary to represent its shares on the NYSE. Now this intermediary that the foreign entity went to, gave it something called “American Depository Receipts (ADRs)” to represent its shares in the US stock market.
Now did the foreign entity’s shares really change when they were traded on the NYSE? No. They were just represented differently. And that is precisely what wrapped tokens do. They are like the ADRs that represent a foreign entity (which could be an asset) and make it tradable on a particular blockchain. Similar to how a foreign entity can’t directly list its shares on the NYSE, BTC can’t be used for any transactions or trading on the Ethereum chain.
So in summary, wrapping solves the “interoperability” problem while offering cross functionality.
Here’s another question to ponder upon: Why do blockchains need interoperability, and if they do, why are they incapable of it naturally?
Bitcoin, which is one of the most popular and successful use cases of cryptocurrency, was made to function in an exclusive network of its own (Bitcoin network). When Bitcoin came out, no one really envisioned a future where multiple blockchain networks, crypto currencies, and tokens would exist. So the entire Bitcoin network architecture as a whole is built to only support its native cryptocurrency, the BTC.
Consider Ethereum for instance. The majority of DeFi apps, DApps, and other aspects of the crypto ecosystem exist on Ethereum. While this makes the Ethereum chain prominent, it also highlights the fact that people can only use the chain’s native tokens to navigate around the world of innovations being developed on it.
As cryptocurrencies grew and trading picked up, interoperability problems kept surfacing. This is because various chains, such as Ethereum and Bitcoin, kept getting isolated with no means for cross-chain transactions. That was when wrapped tokens were created. These tokens simply mirrored the value of their underlying asset in the network they’re native to.
If you wrap a Bitcoin in Ethereum and create a WBTC (Wrapped Bitcoin), you have a Bitcoin that will represent its equivalent value in ETH (while adhering to real-time price fluctuations) on the Ethereum chain.
We have now solved the interoperability problem and figured out a method to help cryptocurrencies cross chains. So why was this important and what difference would it make?
Wrapping tokens and making them interoperable improves liquidity and increases the scope for generating revenue. Now a token which is only confined to its native chain can suddenly enter other chains, unlocking a range of use cases and possibilities. Like how a WBTC on Ethereum chain can help BTC holders operate on the Ethereum chain.
Creating Wrapped Tokens
While we have explained the theory behind wrapped tokens and what they are from a conceptual standpoint, we explore the design options and technicalities of wrapped tokens in this section.
First up, when wrapping tokens, some basic criteria need to be met: the value of the token being wrapped must reflect the value of the native token in which it’s being wrapped; and the tokens should be redeemable for their underlying asset at any point of time.
When a token is unwrapped, then it is essentially “burnt” as the underlying asset is taken out.
In most cases, wrapping is done with tokens that really have a utility outside of their native chains. Before we explore some popular examples of wrapped tokens, let us dive a little deeper into the various types of wrapped tokens based on their design, with the blockchains they support specified in brackets.
- Centralized Wrapped Tokens (Ethereum)
The most popular example of centralized or custodial wrapped tokens is WBTC: wrapped Bitcoin minted as an ERC-20 token. Now the value of this wrapped token (WBTC) is ensured by two parties (or intermediaries): a custodian and a merchant. Both these parties are responsible for Proof of Stake (PoS) and validate if the underlying wrapped Bitcoin in the ERC-20 token is stored safely. Say you want to mint a WBTC, you would first have to take your BTC and approach a merchant to get equivalent ETH tokens. This merchant will take the BTC provided as collateral to a custodian and get them minted as wrapped tokens (which is WBTC). Both the custodian and merchant will charge fees for converting BTC into wrapped tokens eligible for use on Ethereum chain.
- Non-Custodial Wrapped Tokens (Ethereum)
In the above case, for minting wrapped tokens, one has to deal with a merchant and custodian. But in the case of non-custodial or trustless wrapped tokens, you simply rely on a DAO to take care of the entire PoS process. An example of non-custodial wrapped tokens is WETH (wrapped Ethereum), which is also the first wrapped token created. More on this later.
- Hybrid Wrapped Tokens (Ethereum, BSC, Polygon, Solana, and Avalanche)
Just like the name implies, hybrid tokens operate with both a centralized custodian and an automated smart contract to wrap tokens. Hybrid tokens, while not being acceptable or compatible with DeFi protocols at this point, offer immense interoperability and flexibility. This is their biggest advantage. RenBTC is one such example. It is available on multiple chains, and is essentially an ERC-20 token that pegs the value of one Bitcoin.
Wrapped Tokens on Ethereum & Binance Smart Chain (BSC)
In this section, we will explore some popular wrapped tokens on both Ethereum and Binance Smart Chain.
Tokens compatible with the ERC-20 standard are generally used for wrapping non-native tokens. It goes without saying that wrapping or unwrapping (also known as burning) tokens on the Ethereum chain would cost you gas.
Apart from WBTC, another popular wrapped token on Ethereum is WETH. Yes, you read that right. Do you wonder why we need to wrap ETH?
ETH was developed way before the ERC-20 standard was established. Most latest developments on the Ethereum chain, including several DApps and DeFi protocols, support ERC-20 standard tokens only. By wrapping ETH with an ERC-20 token, it becomes tradable and compliant with various DeFi protocols.
Binance Smart Chain
Binance facilitates wrapping of various crypto assets, such as ETH, XRP, BTC, and USDT by means of the “Binance Bridge.” Through the bridge, crypto assets are wrapped in BEP-20 tokens, which can then be used for a host of use cases on the Binance Smart Chain.
Similar to the Ethereum chain, you would also have to pay gas for wrapping or unwrapping a token on BSC.
Arcana Network’s NFT-wrapped $XAR Tokens
We have recently airdropped NFT-wrapped $XAR tokens to our early community and supporters. Similar to how a non-native asset is wrapped in another token, we have wrapped our $XAR tokens into NFTs (ERC-20 tokens). These NFTs can be unwrapped and redeemed for $XAR tokens post the official Token Generation Event (TGE).
Our Airdrop is currently live and is in phase one of two, where we give away NFT-wrapped tokens to 5,500 winners. Learn more about our airdrop here.
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You can check out the brief, quick guide we wrote earlier to understand wrapped tokens 👇
About Arcana Network
Arcana is the Web3 Infra to manage your data layer. Web3 App and wallet developers use Arcana’s SDK to authenticate users by generating wallets with Social and Passwordless Auth, Store Encrypted Data, and Manage Access. Built for Ethereum and EVM based chains, with Arcana’s privacy stack, developers can build secure and privacy-preserving apps with a seamless user experience.
Arcana has raised 2.7Mn USD from some of the leading investors and founders in the ecosystem such as Balaji Srinivasan, Founders of Polygon, Woodstock, Republic Crypto, and Digital Currency Group.
Watch out for Arcana’s upcoming Testnet and Mainnet in 2022.