Just like cryptocurrencies, individual blockchain networks number in the hundreds and most likely there will be more of them to come. However, there being a plethora of blockchain ecosystems, with no single universal chain creates one major problem: cryptocurrencies that exist on one blockchain can’t be transferred to (and used on) other networks. Bitcoin, for instance, can’t be directly transferred for use on the Ethereum blockchain. Here’s where wrapped tokens come into play.
Wrapped tokens are unique digital tokens tracking the value of an underlying cryptocurrency like BTC or ETH. The value of these wrapped tokens (theoretically) moves 1:1 with the price of the asset it represents, meaning they can be redeemed, or “unwrapped,” at any point for the prevailing market price. Their purpose is to allow cryptocurrencies to operate within a non-native blockchain ecosystem, facilitating cross-chain functionality in the process.
Coins held in reserve are managed by an independent third party. This framework allows digital assets to be utilized within non-native blockchain networks. This cross-chain compatibility and communication is secured through what’s known as a blockchain bridge. A blockchain bridge is a software protocol facilitating the cross-chain transfer of data and other digital assets. They utilize what’s known as a mint and burn protocol to ensure token supply is constant across all blockchain networks. When a cryptocurrency leaves its native blockchain ecosystem the assets are “burned” (locked) and a new wrapped token operating within a different ecosystem is “minted” (created). The same process works in reverse when users want to convert their wrapped tokens back to the underlying crypto.
Stablecoins, although quite different from wrapped tokens, do provide a theoretical foundation for understanding the concept. Like stablecoins, wrapped tokens maintain their 1:1 peg by holding an underlying crypto in reserve. This helps to stabilise the price and gain trust from investors who have been subjected to the very volatile prices of regular crypto assets. They are a better alternative for a number of people, and especially in countries where crypto is favoured over the original fiat currency in times of economic uncertainty, such as Venezuela and other parts of South America. Although stablecoins aren’t the same as wrapped tokens, you can use the example to gain a deeper understanding of how they work. Just like stablecoins, wrapped tokens are also pegged to the value of another asset.
Due to the wrapped token being only a representation of the cryptocurrency, this means that it can be moved on to other blockchains. For example, the wrapped token Wrapped Bitcoin (WBTC) ensures that BTC can be transferred on the ETH network. In this way, it provides a bridge between the different blockchains and allows for assets to move freely without being stuck on one network. So, it makes it much easier to trade with others on blockchains – especially on the Ethereum network, which happens to be the biggest DeFi system in the crypto world. In addition to allowing non-smart contract compatible assets like Bitcoin and XRP to be utilized within DeFi ecosystems, wrapped tokens allow developers to move their tokens onto networks that process transactions at a far higher rate and lower cost than Ethereum. This is some of the reason why wrapped tokens are quickly becoming popular with developers of decentralized applications.
However, wrapped tokens do have disadvantages. They, of course, don’t allow for complete blockchain-to-blockchain transfers as they are only pegged to the value of the original asset. For these wrapped tokens to work, the presence of a third party is needed which can incur extra fees for a transfer – something which can be very inconvenient to deal with! Still, though, there’s no doubt that wrapped tokens are able to close the gap between different blockchains. It’s why we can make transfers such as WBTC on the ETH network with ease.
For the world of cryptocurrency to move forward, it can be argued that wrapped tokens are a staple. They make transfers across different blockchains much easier, granting users more freedom with their coins. Although these tokens can add extra fees, they’re currently the best solution for the problem with cryptocurrencies being stuck on their native blockchain. So, it can be asserted with some certainty that wrapped tokens are bound to become further intertwined in a world of decentralized finance with no blockchain universality now or on the horizon…but there’s also the possibility that wrapped tokens’ days are numbered. More advanced forms of cross-chain communication may overtake, and relegate them to irrelevance. Although, wrapped tokens are quickly becoming popular with developers of decentralized applications. In addition to allowing non-smart contract compatible assets like Bitcoin and XRP to be utilized within DeFi ecosystems, wrapped tokens allow developers to move their tokens onto networks that process transactions at a far higher rate and lower cost than Ethereum – and this is a major positive for many people.