What Is Wrapped Crypto?
|— A wrapped crypto token is a tokenized representation of a particular cryptocurrency, with the exact same value, that is operable on another blockchain.|
— Wrapped tokens make it easy to transfer value across blockchains, which otherwise lack interoperability, and power a cross-chain decentralized finance ecosystem.
— Some of the most popular wrapped tokens are WBTC, WETH, WMATIC, and renBTC.
One of the biggest challenges facing the blockchain and crypto space is the lack of interoperability of different blockchains and their respective assets.
That means you cannot directly transfer a cryptocurrency based on chain X to chain Y and use it there. Blockchains, by design, cannot enable such cross-chain digital asset support.
With decentralized finance (DeFi) predominantly on Ethereum, but coins and tokens existing across multiple other blockchains, supporting assets cross-chain has become crucial for cryptocurrencies and DeFi.
This is where wrapped crypto tokens come into the picture. You might have heard people mention “wrapped Bitcoin” or “wrapped Ether”. But what are they exactly?
What Is Wrapped Crypto?
Wrapped crypto or wrapped tokens are digital assets that; represent the exact value of an original cryptocurrency from a different blockchain or follow a different token standard to the chain its on. WBTC and WETH are good examples of the former and latter respectively.
Wrapping original tokens to mint new tokens compliant with another blockchain allows users to use assets from one chain on another chain entirely.
For instance, let’s use Bitcoin (BTC) as an example. By design, bitcoin can originally only function inside the Bitcoin ecosystem. But what if you want to use the world’s largest cryptocurrency on the world’s largest dApp blockchain Ethereum?
In short, there’s a way to deposit your BTC from your Bitcoin wallet and receive wrapped Bitcoin (WBTC) — an ERC-20 token — in your Ethereum wallet.
The WBTC you receive will be a wrapped crypto token. In short, it represents the original value of the BTC that you deposited. Owning that wrapped Bitcoin then means you can use Ethereum-based decentralized application that support wrapped bitcoin transactions. Put simply, you can transfer the value of bitcoin while using Ethereum’s infrastructure.
As mentioned, “wrapping” is a just figurative term used to describe the minting or creation of a new token that derives its value from an underlying digital asset.
To understand this better, let’s take a look at how wrapped crypto actually works.
How Do Wrapped Crypto Tokens Work?
So far, you know that a wrapped token is an equivalent representation of a cryptocurrency based on a different blockchain. Or, in some cases, it is a representation of an asset based on the same chain, but having a different token standard.
But how do we exactly “wrap” these tokens?
Let’s go back to wrapped Bitcoin (WBTC) for a moment.
For starters, there are three types of entities involved in the wrapping of BTC to create an equivalent amount of WBTC on Ethereum:
1. Merchants: Entities that lock their BTC to mint new WBTC on Ethereum or, conversely, burn WBTC to free up the locked BTC.
2. Custodians: Organizations responsible for securing the BTC reserves on the Bitcoin network.
3: Wrapped Tokens DAO: A set of organizations that constitute a decentralized autonomous organization (DAO) and collectively decide what custodians and merchants to add or remove to WBTC Network. The organizations in the DAO use a multi-sig wallet to make these decisions.
Now that you understand the three key players in WBTC, let’s look at a simple step-by-step process of token wrapping:
Step 1: A merchant sends 10 Bitcoin (BTC) to the custodian.
Step 2: The custodian adds it to a reserve (a crypto wallet) whose proof is published on-chain.
Step 3: An equal amount of ERC-20 compatible WBTC is minted on Ethereum.
Merchants can follow a similar process to request to burn WBTC on the Ethereum blockchain and free an equal number of BTC on the Bitcoin network.
While WBTC relies on a DAO model to ensure security and decentralization, wrapped tokens are issued either by centralized entities or smart contracts.
However, most DeFi proponents advise against using a wrapped token managed by a centralized entity. This is because a central entity may, at any point, defraud its users by tampering with the asset reserves. These reserves determine a wrapped token’s value. Thus, in situations like these, a wrapped token can lose significant value in a short time.
Apart from WBTC, there are several other wrapped tokens such as WETH, WMATIC, renBTC, WFTM. Across the DeFi space, there are multiple wrapper platforms issuing such tokens.
Now that we’ve understood how wrapped tokens work, let’s check out what benefits they offer.
Benefits of Wrapped Crypto Tokens
There are 197 countries in the world using around 180 different currencies. These countries have a combined total of thousands of banks.
Imagine a world where you were not able to send money from one bank to the other. Further still, imagine you visited a country that didn’t allow you to exchange your currency for its own. That would make for a terrible financial ecosystem, where people would fail to experience anything beyond the limits of their own country or bank.
Currently, the same would be the case with users of different blockchains if not for wrapped tokens.
At the time of writing, BTC makes up over 40% of the crypto market’s value. Following BTC is ETH, making up almost 20% of the market capitalization.
Thanks to WBTC and other wrapped representatives of BTC, Bitcoin users no more need to stay cut off from Ethereum, which boasts the largest DeFi ecosystem. They can simply go to a decentralized exchange and purchase WBTC. That way, the user gets the same exposure to BTC, but on Ethereum.
But it’s not just about Bitcoin and Ethereum. In fact, there are a wide variety of wrapped tokens for transferring value between popular chains, such as Polygon, Solana and Avalanche.
With the help of wrapped tokens, users don’t need to transfer their assets on one chain to a centralized exchange, convert it to another asset, and send it to another compatible chain. Instead, they can get their hands on a wrapped token representing their original asset.
What Is Wrapped Bitcoin (WBTC)?
Wrapped Bitcoin (WBTC) is a joint initiative run by three Web3 entities: Kyber, Ren, and BitGo. These are three of the 15 entities in total that make up the Wrapped Tokens DAO. Collectively, they are responsible for minting and burning wrapped bitcoin. They also manage, i.e. add or remove, merchants and custodians.
A total of 65 projects, protocols, and companies currently make up the Wrapped Bitcoin Network. These include lending and borrowing platforms, decentralized exchanges, centralized custodians. Wrapped Bitcoin is a now an integral part of many leading platforms and apps; from DeFi to much more.
Plus, it’s really easy to get started. Users can directly exchange their existing ERC-20 tokens to wrapped Bitcoin and back as it behaves just like any other fungible Ethereum token.
Wrapped Tokens on Ethereum
At the time of writing, the total value locked in DeFi is over $42 billion. More than $25 billion of that is on Ethereum, making it the single largest DeFi ecosystem. That only makes it practical for almost every project to make its token compatible with Ethereum token standard ERC-20.
Wrapped crypto comes to the rescue for projects building on different blockchains. Wrapping tokens, therefore making them ERC-20 compliant, enables a project’s users to experience the speed and scalability of other chains. Plus, all of this is possible without missing out on Ethereum’s large user base and liquidity.
In fact, since ETH was created before the ERC-20 standard was established, it does not comply with ERC-20. Hence, we use a wrapped version of ETH called ‘wrapped ether’ (WETH) across DeFi protocols on Ethereum.
How To Secure Wrapped Crypto Tokens
Wrapped tokens, or crypto tokens or any kind for that matter, are a form of digital value. And much like physical assets in the real world, protecting your digital assets (such as wrapped tokens) is imperative.
Ledger wallets keep your private keys and seed phrase offline at all times, ensuring no one can virtually tamper with or access your wrapped tokens. Despite your keys being offline, you can still access a wide range of DeFi protocols online through Ledger Live — a mobile and desktop application that connects with your Ledger wallet.
This brings maximum security to your wrapped tokens without compromising on your flexibility to use them across DeFi platforms.