What are Wrapped Tokens — and How do They Work?

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Whenever you check out the crypto market, you encounter tokens that have the word “wrapped” in front of them, such as Wrapped Bitcoin (WBTC) or Wrapped Ether (WETH).

As their name suggests, such tokens are called wrapped tokens

Wrapped tokens are cryptocurrencies that are implemented in a different blockchain. The reason that wrapped tokens exist is for interoperability, which is the ability of a coin to work in a blockchain that normally does not support it.

In this article, we will elaborate on what wrapped tokens are and how they work.

What is a Wrapped Token?

Wrapped tokens are essentially “wrapped” cryptocurrencies made for the purpose of working in other blockchains. Wrapped Bitcoin is a wrapped version of Bitcoin that will work on other blockchains. Similarly Wrapped Ether is a wrapped version of Ether that works on other blockchains.

Stablecoins, such as Tether, work according to the same logic. Tether is considered a virtual version of USD with the ability to work in a decentralized system. Wrapped tokens work on the same principle. Each type of blockchain differs from another. Some cryptocurrencies might not work in a specific blockchain. Hence, they go through the process of “wrapping,” in order to be utilized in that specific blockchain.

A wrapped token is also known as an ERC-20 token, which means that it identically represents another token, as well as a protocol for issuing such tokens. In fact, ERC-20 stands for “Ethereum Request for Comment.” 

Wrapped tokens were introduced on Ethereum, to allow users to turn their ETH into Wrapped ETH (WETH) – in order to use ETH as ERC-20 tokens and increase function in its blockchain.  

One of the main reasons that Wrapped Tokens were developed was that some decentralized applications (dApps) on the Ethereum network were not compliant with Ether. Thus, wrapping tokens allowed people to convert their ETH into ERC-20 tokens.

How Do Wrapped Tokens Work?

So how exactly do wrapped tokens work?

In order for a token to be wrapped, it needs to have a custodian, which guarantees the same value of the original token as its wrapped version. This custodian could be a set of codes, such as a smart contract, a multisignature wallet (multisig wallet), or a DAO

Smart contracts are sets of codes that are self-executing, and which run in a blockchain to regulate everything that happens in it, including services and transactions.

DAO stands for Decentralized Autonomous Organization, and it works through smart contracts to execute commands on the blockchain.

Multisig wallet (multisignature wallet) is a digital signature signed by different users of a blockchain which ensures security for their funds.

The custodian holds the original token and “wraps” it through a process which is known as minting. 

After the token is minted into a wrapped token, it is then sent to the blockchain that it wants to operate. So, one token will turn into one wrapped token, five tokens will turn into five wrapped tokens, and so on.

The wrapped token can also be “unwrapped” and turned into its original form. This is also done by a custodian through a process which is known as burning

After the wrapped token is burned, it is converted to its original form and sent to its original blockchain. The token and the wrapped token have equivalent prices during the processes of minting and burning.

When a token is wrapped, it can access other blockchains and function normally (fully supported) on them.

Wrapped Bitcoin

Bitcoin itself cannot run in the Ethereum blockchain. Actually, Ethereum’s blockchain offers many more services than Bitcoin’s blockchain. Because of this, some people mint their Bitcoins (BTC) and use their newly Wrapped Bitcoins (WBTC) on the Ethereum network to operate every service that the latter offers. These services include running decentralized applications (dApps) in the decentralized finance (DeFi) ecosystem.

Wrapped Bitcoin was introduced in 2019. It was founded collectively by three organizations: BitGo, Kyber Network, and Ren. 

According to Consensys, 141,322 BTC were minted and running in the Ethereum network by the end of 2020.

But is it possible to directly buy Wrapped Bitcoins without having to buy Bitcoins first, and then mint them into Wrapped Bitcoins?

The answer is yes. You can directly buy Wrapped Bitcoins using MetaMask, which is a crypto wallet/software that interacts with the Ethereum blockchain.

Such crypto wallets are used for protecting your private keys, funds and other information, as well as a way of exchanging your tokens in a decentralized manner.

Wrapped Bitcoin (WBTC) price and its ratio to Bitcoin (BTC). Source: Coinmarketcap.com

As seen in the above graph, the price of Wrapped Bitcoin [WBTC, in green, with the relative price of Bitcoin (BTC) in yellow] has been fairly constant over the last two years.

Other Wrapped Tokens

Besides Wrapped ETH (WETH) and Wrapped Bitcoin (WBTC), other important wrapped tokens are worth mentioning. Wrapped tokens on Ethereum need to be compliant with ERC-20. Some of the other wrapped tokens on Ethereum are as follows:

  • Basic Attention Token (BAT): One of the most popular wrapped tokens on Ethereum, the Basic Attention Token (BAT) tackles advertising problems on the Web. BAT is awarded to people based on their active feedback on the Web. Using these tokens, people can advertise products. Essentially, BAT monetizes activity and attention. 
Basic Attention Token price (2017–2021). Source: Coinmarketcap.com
  • OMG Network (formerly known as OmiseGO): The purpose of OMG tokens is to lower the gas fees and increase the efficiency of the Ethereum network. A portion of Tether (USD) has been released on the OMG network. By increasing the efficiency of the Ethereum network, OMG lowers the time needed to complete a transaction. This makes OMG a crucial wrapped token on ERC-20.

OMG Network price (2018–2021). Source: Coinmarketcap.com

However, Ethereum is not the only network that supports wrapped tokens. Binance Smart Chain is another blockchain on which wrapped tokens such as WBTC and WETH can run. 

These wrapped tokens on the Binance Smart Chain need to be compliant with BEP-20 tokens. The aforementioned tokens can be wrapped through the Binance Bridge, which is one of the safest ways to mint new wrapped tokens and launch them in the Binance Smart Chain. Wrapped tokens on the Binance Smart Chain can be used for either cryptocurrency transactions or for yield farming applications.

Be aware that the process of wrapping (minting) and unwrapping (burning) tokens is not free. Some gas fees need to be paid in order to successfully wrap or unwrap tokens. Fortunately, wrapping and unwrapping fees on the Binance Smart Chain are lower than on other blockchains that support wrapped tokens. 

Some of the most important wrapped tokens that can run in the Binance Smart Chain are WBTC, WETH, Wrapped Ripple (WXRP), and Wrapped Polkadot (WDOT).

Pros and Cons of Using Wrapped Tokens

As with every other token, wrapped tokens have many benefits, but also some disadvantages. For you to understand clearly the importance of wrapped tokens as well as their flaws, here are their pros and cons.

Pros

Interoperability: The biggest benefit that wrapped tokens offer is interoperability. Unlike in the past, you can now use your Bitcoins on the Ethereum network by wrapping them. Not only can you still conduct transactions through wrapped tokens, but you can also use them for different services, such as running and launching DApps, or running DeFi services.

Liquidity: A huge benefit that comes with the utilization of wrapped tokens is the increase in liquidity. Capital efficiency can be increased together with the liquidity of an asset, whether it is centralized (fiat currencies) or decentralized (cryptocurrencies). 

Transaction Speed: Another big advantage that wrapped tokens offer their owners is faster transaction services. For instance, buying or selling Bitcoin in its blockchain can take up a considerable amount of time. However, using Wrapped Bitcoin in the Ethereum network is much quicker. Keep in mind, however, that time is a valuable asset in the crypto market, due to the high volatility of cryptocurrencies.

Enhanced Security: Wrapping your tokens can actually increase the security of your funds because you have more control over private keys. Additionally, custodians (DAO, smart contracts, or multisig wallet) focus on secure exchanges.

Transaction Fees: Last but not least, lower transaction fees are another way that you can benefit from using wrapped tokens.

Cons

Custodian Reliance

Wrapped tokens are continually improving. They still rely on a custodian to be able to be minted (wrap) or burned (unwrap). If the custodian is somehow flawed, the wrapping or unwrapping process will be flawed as well.

Centralization

The whole purpose of cryptocurrencies is to operate in a decentralized system. However, since wrapped tokens are issued by a custodian, they are prone to centralization. According to Medium, even the founder of Ethereum, Vitalik Buterin, has acknowledged the fact that wrapped tokens are “sensitive” to centralization because they’re made in a centralized manner.

“I’m worried about the trust models of some of these tokens. It would be sad if there ends up being $5b of BTC on Ethereum and the keys are held by a single institution,” Buterin said. 

The problem is that when wrapped tokens are minted, it’s not done directly in the desired blockchain but rather through a central program.

Mint Costs

Another minor disadvantage that comes with wrapped tokens is the minting costs. Wrapping and unwrapping tokens require gas fees, which can then result in slippage

Nevertheless, the benefits of wrapped tokens outweigh the negative features. Moreover, in the future, it is expected that these minor disadvantages will be removed. Perhaps a custodian (DAO, smart contracts, or multisig wallet) may not be needed in the future to wrap or unwrap tokens.

Should I Invest in Wrapped Tokens?

So, is investing in wrapped tokens a wise idea?

Overall, wrapped tokens are becoming progressively more important because of the increasing need to use other cryptocurrencies in a specific blockchain. Therefore, investing in wrapped tokens can be very profitable in the long run, especially with the likes of WBTC.

Wrapped tokens are similar to normal tokens. In fact, they are bought and sold for the equivalent price. Thus, if the price of a token rises, the price of the wrapped token may also rise.

When it comes to the price of WBTC, it depends on the price of BTC itself. Credible prediction sites estimate a relatively large increase for both BTC and BTC.

According to Digitalcoin, the price of Bitcoin could go as high as $89,000 in 2021 and reach six figures by 2022, at around $103,000. This could be followed by a steady increase throughout the decade. It may eventually reach a soaring high of around $264,000 by the year 2028. Since WBTC is the same token (built for a different blockchain), it will also follow the same path as BTC at equivalent rates. To illustrate, Digitalcoin predicts that the price of WBTC may reach around $258,000 when BTC reaches its high point in 2028.

Other wrapped tokens are likely to follow the same trajectory. Of course, not every cryptocurrency can go as high as Wrapped Bitcoin, since Bitcoin is the world’s leading cryptocurrency. But other cryptocurrencies are also predicted to increase relatively in price.

The Bottom Line

Ultimately, wrapped tokens have made cryptocurrencies much more efficient and useful. 

DApps benefit from the variety of wrapped tokens on blockchains. Thus, they have even more potential than before, and can positively influence the crypto world if they keep growing at their current rate. 

Ever since the utilization of wrapped tokens, they have been used to increase the efficiency of cryptocurrencies.

Disclaimer

This article is intended for and only to be used for reference purposes only. No such information provided through Bybit constitutes advice or a recommendation that any investment or trading strategy is suitable for any specific person. These forecasts are based on industry trends, circumstances involving clients, and other factors, and they involve risks, variables, and uncertainties. There is no guarantee presented or implied as to the accuracy of specific forecasts, projections, or predictive statements contained herein. Users of this article agree that Bybit does not take responsibility for any of your investment decisions. Please seek professional advice before trading.

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