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What are wrapped tokens?

In 2022, there are a huge number of cryptocurrencies using various blockchains. There are many applications, platforms and smart contracts on the market that can use tokens from different blockchains. One of the bridges that allows the transfer of crypto assets from one network to another are wrapped tokens.

A wrapped token is a copy of a crypto asset that exists on another blockchain, but is pegged to the value of the original token. It is called “wrapped” because the original asset is placed in a “wrapper”, a kind of digital storage that allows a copy of the token to be created on another blockchain.

How it works?

The principle of operation of wrapped tokens can be easily illustrated by the example of one of the most prominent representatives — Wrapped Bitcoin (wBTC).

wBTC is an ERC-20 token whose value is pegged to BTC, allowing Bitcoin to be used effectively on the Ethereum network. It is essentially a tokenized version of Bitcoin on Ethereum.

Wrapped tokens typically require a “custodian” to operate, an entity that holds an amount of the asset equivalent to the amount wrapped. In the case of wBTC, the custodian must hold 1 BTC for every 1 wBTC issued. The proof of the security of this reserve exists on the blockchain.

What does the wrapping process look like? The trader sends BTC to the custodian account. The wBTC is then issued on Ethereum according to the amount of BTC sent. When wBTC needs to be exchanged back for BTC, the trader sends a burn request to the custodian and BTC is released from the reserves. In the case of wBTC, the choice of custodians is carried out by the DAO.

Sometimes in the crypto community, stablecoins are also referred to as a variant of wrapped tokens, but this is not entirely true. USDT uses not only cash to back its reserve, but also various cash equivalents, financial assets. However, the ideas of stablecoins and wrapped tokens are quite close.

So far, most current implementations of wrapped tokens require trust in the custodian of funds, but technology does not stand still, and perhaps in the future we will see a completely independent option from the human factor.

Where are wrapped tokens used?

BTC and ETH in their pure form cannot participate in smart contracts when it comes to interaction between different blockchains. Wrapped tokens are especially popular on decentralized crypto exchanges like Uniswap or PancakeSwap. Most popular centralized crypto exchanges, including Binance or Coinbase, use wrapped tokens. We at Barter Smartplace also use wBTC and wETH. Any service that works with various crypto assets needs a bridge between blockchains, and wrapped tokens are a time-tested approach.

In addition, wrapped tokens can allow you to bypass the problems of the native token blockchain, such as slow transaction speeds or high fees. Imagine that you need to make a large number of transactions in BTC — on the native bitcoin chain — this will be very slow. Wrapped tokens can move faster and cheaper on other blockchains, although their native version remains with the custodian.

In general, wrapped tokens are a convenient solution used by a huge number of services.

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