Wrapped tokens, also known as wrapped crypto, are digital assets that represent the exact value of an original cryptocurrency from a different blockchain or a different token standard. For example, WBTC and WETH are examples of wrapped tokens that follow the former and latter respectively.
The process of wrapping an original token involves creating a new token compliant with a different blockchain, which allows users to use assets from one chain on another chain. For instance, Bitcoin (BTC) can originally only function within the Bitcoin ecosystem. However, wrapping BTC on the Wrapped Bitcoin Network enables users to deposit BTC and receive WBTC, an ERC-20 token, in their Ethereum wallet.
The WBTC received represents the original value of the deposited BTC, allowing users to use the wrapped token on any Ethereum-based decentralized application that supports WBTC transactions. Essentially, wrapped tokens enable the use of a cryptocurrency on a different blockchain network, providing a way for users to access the benefits of multiple blockchain networks without having to hold multiple cryptocurrencies.
The wrapping process of BTC to create an equivalent amount of WBTC on Ethereum involves three types of entities:
To wrap tokens, a merchant first sends BTC to the custodian, who adds it to a reserve wallet. The proof of the wallet is published on-chain, and an equivalent amount of WBTC is minted on the Ethereum network.
Similarly, merchants can request to burn WBTC and free up an equal number of BTC on the Bitcoin network.
Although wrapped tokens are issued by either centralized entities or smart contracts, DeFi proponents advise against using wrapped tokens managed by a centralized entity due to the risk of fraud. The value of a wrapped token is determined by its asset reserves, which can be tampered with by a central entity, leading to significant loss in value.
Apart from WBTC, there are several other wrapped tokens such as WETH, WMATIC, renBTC, and WFTM, and multiple wrapper platforms issue such tokens in the DeFi space.
In conclusion, wrapped crypto or wrapped tokens are digital assets that represent the exact value of an original cryptocurrency from a different blockchain or token standard. Wrapped tokens enable users to use a cryptocurrency on a different blockchain network, providing a way to access the benefits of multiple blockchain networks without holding multiple cryptocurrencies.