What is Wrapped Tokens? How do wrapped tokens work?

Have you ever felt uncomfortable not being able to use BTC on Ethereum? Or ETH on Binance Smart Chain? Transferring coins that exist on a certain blockchain to another is not easy. Wrapped tokens are a way to overcome this limitation and use assets that are not sourced on the blockchain. So what is wrapped token? How do they work? Let’s find out with Wikibinance in the article below.

What is wrapped token?

Wrapped token is the encrypted version of another cryptocurrency. It is attached to the value of the asset it represents and can usually be redeemed (uncoated) at any time. Simply put, the Wrapped token represents a token that does not exist on the blockchain in which it was issued. In addition, you can also understand wrapped tokens like a stablecoin because it takes value from another asset. In the case of stablecoins, that asset is Fiat money, with wrapped tokens, it is usually an inherent asset on another blockchain. Since blockchains are separate systems, there is no effective way to move information between blockchains. Wrapped tokens increase interoperability between different blockchains – in essence, the underlying token can move across the chain. It’s worth noting that if you’re a regular user, you don’t have to worry about the wrap and unwrap process, you just have to trade these Wrapped tokens just like any other cryptocurrency. For example, when trading WBTC/BTC pairs right on Binance.

How do wrapped tokens work?

For example, with Wrapped Bitcoin (WBTC), the encrypted version of Bitcoin on Ethereum with the ERC-20 standard is worth 1-for-1 with BTC, allowing you to use BTC effectively on Ethereum. Wrapped tokens usually require a supervisory party – an entity that holds an amount of assets equivalent to the amount of wrapped tokens generated. This supervisory party can be a trader, multi-signature wallet, a DAO, or even a smart contract. In the case of the WBTC, the supervisory party needs to keep 1 BTC for every 1 WBTC cast. Therefore, all evidence of this reserve exists on the chain.

How does the Wrap process work?

A trader sends BTC to the casting supervisor (creating wrappted tokens). The supervisory party will then cast wbtc on Ethereum according to the amount of BTC submitted. When it is necessary to return the WBTC to BTC, the trader will send the combustion request to the supervisor and the BTC will be released from the reserve. You can consider the supervisory party to be wrapper and unwrapper. In the case of the WBTC, the addition and deletion of supervisory parties and traders is carried out by the DAO. Although some investors view Tether (USDT) as a Wrapped Token, this is not accurate. While USDT typically trades at a 1:1 ratio to USD, Tether does not hold the exact amount of USD for each USDT circulating in its reserves. Instead, this reserve includes real-world cash and cash equivalents, assets, and receivables from lending. However, the idea is similar. It can be said that each USDT token acts as the enveloped version of the USD fiat currency.

Wrapped tokens on Ethereum

Wrapped tokens on Ethereum are tokens from other blockchains created to comply with the ERC-20 standard. This means you can use assets that are not Ethereum’s original assets on Ethereum. Wrapping and unwraping tokens on Ethereum will cost gas. The process of implementing these tokens can be very different. An interesting example of wrapped tokens on Ethereum is Wrapped ether (WETH). In a quick summary, users must have ETH to pay for transactions on the Ethereum network, while ERC-20 is the technical standard for issuing tokens on Ethereum. For example, the Basic Attention Token (BAT) and OmiseGO (OMG) are ERC-20 tokens. However, because ETH was developed before the ERC-20 standard, it did not comply with this standard. This raises the issue, as many DApps require you to switch between ETH and an ERC-20 token. This is why wrapped ether (WETH) was born. It is an ETH version wrapped in compliance with the ERC-20 standard. Basically, it’s a tokenized version of ETH on Ethereum.

Wrapped tokens on Binance Smart Chain (BSC)

Just like wrapping tokens on Ethereum, you can wrap Bitcoin and many other cryptocurrencies to use on Binance Smart Chain (BSC). Binance Bridge allows you to wrap cryptocurrency assets (BTC, ETH, XRP, USDT, BCH, DOT, etc.) for use on Binance Smart Chain as a BEP-20 token. After putting assets on BSC, you can trade or use these assets in multiple Yield farming applications. However, gas fees for wrapping and unwrap on BSC are significantly lower than on other blockchains.

Advantages of using wrapped tokens

Interoperability: Although many blockchains have their own token standards (Ethereum’s ERC-20 or BSC’s BEP-20), these standards cannot be used on multiple chains. Therefore, wrapping tokens will allow users to use tokens that are not original tokens on a given blockchain.
Liquidity: Wrapped tokens can help increase liquidity and capital efficiency for both centralized and decentralized exchanges. The ability to wrap idle assets and use one asset on another chain can increase connectivity between isolated sources of liquidity.
Time and fees: While Bitcoin has some attractive attributes, it’s not the fastest and sometimes costly. While everything in Bitcoin seems fine at the moment, there may be some problems from time to time. These issues can be alleviated by using the warped version on the blockchain with faster transaction times and lower fees.

Limitations of using wrapped tokens

Right to supervise: Most current token wrapped deployments still have to rely on a supervisory party for the wrap or unwrap process to warrant. With today’s technology, users can’t use wrapped tokens for real cross-chain transactions – which usually have to go through a supervisory party.
Centralization: Some of the more decentralized options are being implemented and may be launched in the future to help cast and convert wrapped tokens more visually.
Casting costs: The casting process can also be relatively expensive due to high gas fees and can create some slippage problems.