Op-Ed by Danielle Davis
Why do we need wrapped tokens?
You’re into crypto, and you probably know one of the biggest issues of the industry in 2021 is interoperability.
There are now unprecedented capitals invested, increasing adoption rates (especially since Bitcoin crushed all-time-highs again), and many blockchains, big & small.
Interoperability means connecting isolated blockchains
Cryptocurrency consists of multiple chains each with their native assets; Ethereum, Bitcoin, Polkadot, Binance Smart Chain, etc. What does this mean? You cannot take a token from one chain and simply send it to another, because it doesn’t exist on that blockchain. One way to work around this limitation is something called wrapped tokens.
Wrapped tokens do not contain the original token.
A wrapped token is essentially one token on the “destination” blockchain pegged to the value of the “origin” token, for example wrapped Bitcoin is pegged to the price of Bitcoin but exists on the Ethereum blockchain. It is not actually Bitcoin, but it represents Bitcoin that is locked in a vault back on its original chain.
You can simply buy already wrapped tokens, on the chain you wish to have them on. There is enough liquidity of the wrapped tokens you can simply buy WBTC on ETH via Uniswap. However, you can also wrap your own Bitcoin from its native chain and receive WBTC on the ETH network.
Despite the name, the tokens are not actually “wrapped” and to allow them to move across other blockchains. Tokens are staked in a locked vault. When you do this, an equal value of a new token on the “destination” blockchain is generated for you, and this new token is a direct representation of the value of the original asset.
You can unstake tokens to unwrap them, or remove them from this “vault”, to get the original back.
Every blockchain is different and enforces its own standards, meaning many tokens cannot be used across other chains. Wrapped tokens allow for non-native tokens to be used on other blockchains.
You can compare wrapping to a compatibility patch, or a replacement car while yours is in the shop: a quick fix to an outstanding issue.
Wrapped tokens increase liquidity and capital efficiency for exchanges, as they offer their users with greater trading options.
And lastly, the transaction fees and times vary on each chain, this can be used to your benefit. If you are moving an asset like Bitcoin, we all know the transaction times can be very long, but moving WBTC is much quicker.
Wrapped tokens are a form of staking which requires a custodian, to hold the tokens in the vault, so it’s not really decentralized.
Fees for wrapping tokens are also quite high, but buying them already wrapped will help alleviate that cost.