One limitation of blockchain is that it is not possible to use crypto like bitcoin on the Ethereum blockchain or vice versa. Crypto that work on one blockchain (such as ERC-20 or BEP20) cannot (unfortunately) be used on another blockchain. Nor can these be traded on another blockchain. By "wrapping" crypto, you can transfer crypto from one blockchain to another. This allows you to leverage the benefits of the different blockchains.
What is a wrapped token?
With every transaction of crypto, it is extremely important to check from which blockchain you are sending and receiving the transaction. If you send a crypto to an incompatible blockchain or wallet, you will lose your crypto. When sending the crypto, there is often a warning that you do need to send the crypto to the correct blockchain/wallet that supports that crypto. In practice, there are different types of tokens, such as the ERC-20 token and the BEP2 tokens of the Binance Smart Chain.
A wrapped token is an ERC20-tokenized version of an existing crypto. This tokenized version of the existing crypto is linked to the current value of the crypto it represents. Suppose you have 100 euros of Bitcoin. The tokenized version (wrapped bitcoin) has the same value, which is 100 euros.
Each blockchain has a different network and system. Each blockchain also has its own protocols. It is not currently possible to use different blockchains. In other words, the blockchains cannot communicate with each other (no interoperability). However, through such tokenized crypto (wrapped tokens) it is possible to communicate between blockchains. The crypto can move between different blockchains. The advantage of this is that wrapped tokens transactions are much faster because crypto can work cross-chain.
How does a wrapped token work?
A wrapped token is an equivalent of the original crypto. One bitcoin is equivalent to one wBTC (wrapped bitcoin) at the time of trading. Bitcoin is the best known crypto at the moment. But there are more and more crypto projects coming to the crypto market that are also doing well, such as Ethereum. With the arrival of more and more crypto projects, it has become more interesting to trade the crypto or use it on other blockchains. Since that is not possible, the wrapped tokens were created. In our example the wBTC. The wBTC is a token that can be used or traded on the Ethereum blockchain. The wBTC is an ERC-20 token (tokens that can run on the Ethereum blockchain) and represents the value of the 'real' bitcoin.
A wrapped token can be thought of as a sort of middleman that holds the bitcoin for you and creates an equivalent on the other blockchain (the wrapped token). This can be a real person, a smart contract or a Decentralized Autonomous Organization (DAO). Many people who have a wrapped token use smart contracts or DAO as intermediaries who create the wrapped tokens. This intermediary ensures that the value of the wrapped token is exactly the same as the "real" crypto. In our example, if 1 bitcoin is worth 1000 euros, then the wrapped token (which can run on the other blockchain) is also worth 1000 euros.
Pros and cons of wrapped tokens
Pros
- Transaction time
A big advantage of wrapped tokens is the transaction times and costs. Bitcoin has some great features, but processing a transaction can take a long time and can sometimes be very expensive. By using a wrapped version of a token on a blockchain, you get faster transaction times and lower costs. It is cheaper and easier to send an ERC-20 transaction representing Bitcoin (wBTC) instead of Bitcoin itself. - Ethereum Decentralized Applications (dApps).
Wrapped variant of Bitcoin (wBTC) brings the Bitcoin to the DeFi industry. This creates additional volume of BTC in dApps and also greater liquidity in the liquidity pool. Stablecoin projects and loan schemes can then use wrapped Bitcoin as collateral.
Cons
- Gas fees
If you want to use wrapped tokens, it is necessary to wrap your tokens first. By itself, this is a very easy process, but the major drawback here is the high gasfees presently on Ethereum's network. There are several new projects working hard to provide an alternative so that they can take advantage of Ethereum's often excessive transaction fees. One alternative is the Binance Coin (BNB).
- Private Keys
For example, when you have wrapped your Bitcoin for a wBTC, you are no longer in possession of the private keys of this Bitcoin. ''Not your keys, not your coin '' is a very well known phrase. Critics will therefore be very skeptical when wrapping a token because they no longer own the private keys.- As for the currently available technology, wrapped tokens can’t be used for true cross-chain transactions – they usually need to go through a custodian.
- This is a really big disadvantage of wrapped tokens. You have to trust the custodian that holds the money. If it is a custodian that is trustworthy, nothing bad should happen. But always, be mindful that there are a lot of bad actors in the crypto space.
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