Wrapped tokens in the crypto world are tokenized representations of one blockchain that are issued on another blockchain, allowing the value of the original asset to be used in a different ecosystem. A common example is Wrapped Bitcoin (WBTC), which is a representation of Bitcoin (BTC) on the Ethereum blockchain.

Functions and Benefits of Wrapped Tokens

Interoperability: Wrapped tokens allow assets from one blockchain to be used on another. For example, WBTC allows Bitcoin to be used in DeFi (Decentralized Finance) applications on Ethereum.

Liquidity: By allowing tokens from one ecosystem to be used in another, wrapped tokens can increase liquidity across different DeFi platforms.

Use in Smart Contracts: Blockchains that support smart contracts, such as Ethereum, can use wrapped tokens for various complex DeFi applications, such as lending, yield farming, and decentralized exchanges.

How Wrapped Tokens Work

Pegging: Wrapped tokens are pegged one-to-one to the original asset. For example, 1 WBTC can always be exchanged for 1 BTC. This is done through a “custody” mechanism where the original asset is stored by a trusted entity (custodian) or through secure smart contracts.

Creation and Burning: When someone wants to create a wrapped token, they send the original asset (e.g. BTC) to the custodian, who then prints the wrapped token (e.g. WBTC) on the target blockchain. Conversely, when someone wants to return the wrapped token to the original asset, the wrapped token is burned, and the original asset is returned.

Wrapped Token Example

Wrapped Bitcoin (WBTC): Bitcoin that is wrapped for use on Ethereum.

Wrapped Ether (WETH): Ether that is wrapped for use in applications that require ERC-20 tokens.

Wrapped Binance Coin (WBNB): Binance Coin that is wrapped for use on various other blockchains.

Security and Trust

The security of wrapped tokens is highly dependent on trust in the custodian and the smart contracts mechanism used. Some wrapped tokens are issued by centralized entities, while others use decentralized solutions to manage the wrapping and unwrapping process.

Conclusion

Wrapped tokens play an important role in the crypto ecosystem by enhancing the interoperability, liquidity, and usability of various assets on different blockchain platforms. They allow users to utilize their assets in a more flexible and efficient way, opening up many opportunities in DeFi applications and beyond.