Why Would Anyone Need To Wrap A Token?
This blog post will cover:
- Understanding Wrapped Tokens
- Benefits of Wrapping Tokens
- Examples of Wrapped Tokens
A wrapped token is a blockchain-based cryptocurrency derivative that circulates outside of its original asset’s native blockchain.
These allow crypto holders to “bridge” the value of their digital asset holdings to other chains, without losing exposure to their underlying investments.
For example, as of August 2022, over 1% of all Bitcoin in existence circulates as Wrapped Bitcoin (WBTC) – a Bitcoin derivative token that exists on the Ethereum blockchain.
That’s 236,810 Bitcoin sitting on another chain, capturing over $5.4 billion in value.
But why would so many people choose to hold a “wrapped” version of Bitcoin or other crypto assets, rather than the real thing?
Understanding Wrapped Tokens
To understand the utility of wrapped tokens, we must first understand how they work.
Technically speaking, a wrapped token is an all-new token on a new blockchain – but is designed to closely track the price of an existing coin. This is typically achieved by fully backing the new token with reserves of the asset its attempting to mimic, and providing constant, 1:1 redeemability for the underlying.
This creates arbitrage incentives such that the value of both tokens always remains joined at the hip. In fact, the model is very similar to that of stablecoins: cryptocurrencies are price-pegged to fiat currencies using a fully-backed supply of cash-based reserves.
Stablecoins are useful because they let users effectively store, send, and receive dollars over the blockchain. Blockchains often make for cheaper, faster, and more feature-rich payment rails than the traditional banking system.
The same can be said of wrapped tokens. By bridging one’s assets to another chain, he/she may extract benefits from the new chain that the old chain could not provide.
Benefits of Wrapping Tokens
Some of the most noteworthy benefits of wrapping tokens onto other blockchains may include:
- Lower Fees: Different blockchains may offer significantly lower transaction costs due to their underlying technology or modest network activity. Wrapping a token onto such a chain can help crypto users save when they spend.
- Faster Transfers: Depending on network congestion and block speed, a transaction may take very long to process if conducted on its native chain. To make time-sensitive payments more feasible, wrapping an asset may be your best bet.
- Defi and NFTs: Some blockchains – including Bitcoin – do not offer the programmability and tokenization for holders of the cryptocurrency to partake in the Web 3 economy.
However, by converting one’s Bitcoin into WBTC on Ethereum, users can use their holdings to both trade digital collectibles and access decentralized financial services.
Examples of Wrapped Tokens
- Wrapped Bitcoin (WBTC): The most popular wrapped token, WBTC brings the largest digital asset by market cap to Ethereum – the largest ecosystem for decentralized apps. It is governed by the WBTC DAO.
- Wrapped ETH (WETH): Created by 0x labs, WETH is a wrapped version of ETH that is compliant with ERC-20 – a technical standard for issuing Ethereum tokens. This lets one’s ETH be used in various dapps and defi protocols with which it is otherwise incompatible.