Wrapped Tokens: Explained with Examples, Advantages, and Disadvantages

Have you ever noticed that some tokens have the word “wrapped” in front of them? In this video, we will explore wrapped tokens, how they work, and some of the advantages and disadvantages that come with them.

What are Wrapped Tokens?

Wrapped tokens are essentially tokens that have been wrapped so they can work on other blockchains, and their value is tied to that of the underlying cryptocurrency. For example, one wrapped BTC is equal to one BTC.

Why do we need Wrapped Tokens?

Most blockchains are not interoperable, which means that they cannot work with other blockchains. Wrapped tokens solve this problem. They act as a bridge between different blockchains, allowing investors to use their tokens on other blockchains.

How do Wrapped Tokens Work?

For a token like Bitcoin to be wrapped, there are three major players: the investor, the token to be wrapped, and a custodian. The custodian is a set of codes that acts as the bridge between the investor, their original token, and the wrapped token. The custodian guarantees that the value of the original token is the same as its wrapped version. When an investor sends their tokens to be wrapped, the custodian will mint an equivalent amount in wrapped tokens. Since new tokens are created in the process, the original tokens have to be locked in a special kind of digital vault. The wrapped token can also be unwrapped and turned into its original form via the same custodian through a process known as burning.

Popular Wrapped Tokens

There are several popular wrapped tokens available. WBTC, which is Bitcoin on Ethereum, allows users to easily tap into the DeFi ecosystem and its applications. Wrapped Ethereum (WETH) is a tradable version of Ethereum that's compliant with DeFi protocols. Other wrapped tokens available for other chains include Wrapped BNB and Wrapped AVAX, to name a few.

Advantages and Disadvantages of Wrapped Tokens

The advantages of wrapped tokens include interoperability, increased liquidity, and access to more services. However, there are also disadvantages, such as the need for a custodian, the risk of losing the original tokens, and the possibility of custodian fraud.

Conclusion

Wrapped tokens have opened up a world of possibilities for investors, allowing them to use their tokens on other blockchains and access more services. While they do come with their own set of advantages and disadvantages, the future looks bright for wrapped tokens and their role in the blockchain ecosystem.