What are Wrapped Tokens? Wrapped Tokens Explained

As the name implies, wrapped tokens are digital coins whose value is determined by the value of another cryptocurrency or an item such as gold, equities, or real estate. A whole new token is created for use on other platforms by "wrapping" the original asset in a digital vault. When non-native assets are wrapped in tokens, they become interoperable with any blockchain, enabling cross-network transactions.

These tokens can be used to represent a variety of assets, including art and collectibles, commodities, cryptocurrencies, equity, and real estate. Wrapped tokens require custodian management because they are linked to another asset and must be unwrapped and rewrapped. When it comes to cryptocurrency's decentralized universe, there is a disadvantage that will be discussed.

Types of wrapped tokens

• Stablecoins

Even if stablecoins differ greatly from more established wrapped coins, it is commonly accepted that they were the first sort of wrapped tokens. Stablecoin, such as USDT (Tether), is backed by a fixed amount of fiat currency, usually one dollar. It is important to note that Tether's reserves do not comprise an exact dollar value for each TUSD held, but rather a mixture that includes a variety of various assets, such as bank deposits, investments, and receivables from loans, among other things.

• Cash settled or redeemable.

Wrapped tokens can be either cash-settled or redeemed. Tokens backed by cash cannot be exchanged for their underlying value. As a result, redeemable tokens allow investors to exchange the wrapped token for the actual asset. Wrapped tokens are hosted on other blockchains. The Monero and ZCash blockchains, for example, host wrapped privacy coins.

Wrapped token vs. other blockchain tokens

Many people play a crucial role in keeping the original token and its wrapped counterpart in sync. This is similar to an Escrow account in certain ways. For a wrapped token to be functional or helpful, it must have one-to-one support. Depending on whom you ask, a central party may be beneficial or detrimental. The wrapped framework, on the other hand, seeks to address this issue in some ways:

1. External third-party quarterly checks that all issued wrapped tokens have the same quantity of assets held across all custodians. Signatures from the Bitcoin addresses in which WBTC is held can be used to show proof of reserves.
2. A merchant would have to initiate minting tokens on behalf of the custodians. As a result, both the custodian and the merchant are involved in creating new tokens.
3. A network of merchant institutions shields user interaction with the custodian. It is not necessary to trust a single trader; rather, it is necessary to trust all merchants collectively.
4. The existing trustworthiness of all institutions involved in the framework is in jeopardy.

How wrapped tokens work?

When a merchant requests that the custodian mint the quantity of the original token on a specific platform, such as Ethereum, the custodian complies with the merchant's request; by following a similar approach, the user can request that the wrapped token be released from the custodian's reserves, allowing it to be changed back into the original asset or into a coin such as Bitcoin as needed. To put it another way, a custodian has one Bitcoin in their hands for every wBTC that is currently in circulation, for instance.

Wrapped tokens suggest a constraint in cryptocurrency because the requirement for a custodian to rely on for asset preservation undermines the premise of an open and decentralized blockchain environment. It is impossible to conduct cross-chain transactions with wrapped tokens without the assistance of a custodian. However, some decentralized options may become available shortly as a result of significant technology breakthroughs in the field.

Is it a good idea to invest in wrapped tokens?

• Decentralized finance will play a significant role in the cryptocurrency world, as wrapped tokens are becoming more widely recognized as a genuine investment option. Approximately one year has elapsed since the first bitcoin exchange for wBTC occurred, providing us with an idea of the current market capitalization.

“According to Arcane Research, there will be 189,000 bitcoins on the Ethereum blockchain by the year 2021. Currently, wrapped Bitcoin tokens are thought to account for a record 1 percent of Bitcoin's total circulation quantity of 18,73 million units, which is a new high.”

• Both decentralized and centralized exchanges benefit from the greater liquidity and capital efficiency provided by wrapped tokens. They can facilitate the movement of assets between numerous chains that would otherwise stay isolated.
• Wrapped tokens are a good alternative for slow blockchains such as Bitcoin and Ethereum because of their lower transaction costs and faster transaction times.
• As opposed to purchasing and holding the complete asset, owners of wrapped tokens can acquire and hold a small portion of it.

Pros of wrapped tokens

1. In the ERC-20 context, wBTC adds BTC's enormous market size and liquidity to the table. To connect otherwise disparate liquidity, the ability to wrap assets and use them on another chain is essential.
2. Staking and yield farming, which are not enabled by the original Bitcoin network, can generate passive revenue for wBTC users. While yield farming is essentially the issuing of short-term loans for interest, staking entails locking funds in a smart contract until the contract has been fulfilled.

1. Smart-contract protocols cannot be operated on the BTC blockchain; hence, they must be traded for another cryptocurrency. Most dApps are compatible with Ethereum. If you use wBTC, you can swap value with any other ERC-20 token that can do so.
2. Transaction speed is an important consideration. Ethereum is faster than Bitcoin. Ethereum, on the other hand, typically executes between five and ten transactions per second. It is possible to leverage quicker transaction speeds with wrapped tokens without trading any assets.

Cons of wrapped tokens

1. Wrapped tokens now require a custodian – a third party that holds an equal amount of the wrapped asset. A merchant, a DAO, or a multisig wallet can all operate as its representative (a crypto wallet shared by two or more users that require several private keys to sign and send a transaction).
2. Minting is the process of producing a wBTC. A merchant orders the minting, which a custodian then carries out. The custodian must hold a BTC for every wBTC created to act as either a wrapper or an unwrapped.
3. The issuing platform's dependency on wrapped tokens poses a risk of centralization. Because smart contracts can't automatically encapsulate transactions, it raises the possibility of fraud and undermines the decentralization idea.

Future of wrapped tokens.

In general, the future of crypto is one of increasing adoption by mainstream banking, with more functionality and interoperability between currencies, as the globe progressively embraces DeFi applications with a Total Value Locked (TLV) of $105.69bn as of 8 November 2021.

Traders can avoid paying hefty exchange costs by exchanging non-native tokens for wrapped cryptos. While owning greater market capitalization assets like BTC, users can use Ethereum's stronger DeFi capabilities. Although this may be a short-term remedy, it's possible.

A temporary solution to the difficulty of moving cryptocurrency from one blockchain to another, such as Bitcoin to Ethereum, is provided by wrapped cryptocurrencies and tokens, according to expert Mikhail Karkhalev at Capital.com

A bridge will come down when dependable cross-chain platforms or some next-level solution that permits the use of bitcoin (or other cryptocurrencies) on any other blockchain becomes accessible, noted Karkhalev. If the need arises, it makes more sense to think of the fund more as a function than an investing vehicle.

Conclusion

As with every crypto asset, the value of a wrapped token is tied to that of its underlying asset. Traditional cryptocurrencies may be a better choice if you're looking to use crypto as a long-term store of value. You should always perform your own research before investing in any asset. Remember that your decision should be determined by your attitude toward risk, your knowledge of the market, your portfolio's spread, and your comfort level with losing money. The past does not guarantee future results, so never put more money into an investment than you can afford to lose. Decisions should be based on your personal needs and risk preferences.