Wrapped tokens make it possible for digital assets, such as bitcoin, to be used on blockchains other than the network they natively operate on to address the issue of blockchain interoperability.
In this guide, you will learn what wrapped tokens are, how they work, and where they are primarily being used for.
What is a Wrapped Token?
A wrapped token is a crypto token whose underlying value is pegged to another digital asset for cross-chain functionality.
In other words, a wrapped token is a version of an original cryptoasset that has been ‘wrapped’ to enable it to be used on a different blockchain other than its native chain.
Wrapping a token involves securing an original cryptocurrency in a digital vault, and using the wrapped version of the token on another crypto network. A wrapped token can ultimately be redeemed for the original asset by “burning” the equivalent amount of wrapped coins.
Wrapped tokens aim to improve the cross-chain functionality of native crypto assets to operate on non-native blockchains. The inherent security features and design of blockchains make interoperability a challenge. For instance, you can’t use bitcoin (BTC) on the Ethereum network. The reverse applies to ERC-20 tokens on the Bitcoin blockchain.
For instance, wrapped bitcoin (WBTC) is an ERC-20 compatible token that can be used on the Ethereum network. Similarly, cryptoassets can be wrapped to conform to the BEP-20 standard to be used on BNB Smart Chain.
When wrapping tokens, a custodian is required to mint the tokens. The process works by a merchant initiating a request to the custodian to mint a wrapped version of a native crypto token on a different blockchain.
Merchants in this case can include Airswap, AAVE, and CoinList.
The wrapped tokens are minted while the equivalent of the amount issued is held in reserve on-chain. For example, the custodian will retain 1 BTC in reserve for each 1 WBTC that is minted. In essence, the custodian is the wrapper of the original token.
The tokens are unwrapped when the merchant puts in a request to the custodian to destroy the wrapped tokens and release the original asset in reserve.
Top Wrapped Tokens
Wrapped tokens are becoming popular among investors. The total market capitalization for wrapped coins is close to $10 billion.
Here is a list of the top wrapped coins according to market capitalization.
Wrapped Bitcoin (WBTC)
Wrapped Bitcoin (WBTC) is by far the most popular wrapped coin accounting for over 75 percent of the total market capitalization of wrapped tokens. WBTC is an ERC-20 version of bitcoin (BTC) that can be used in DeFi and decentralized applications (DApps).
The token was launched in 2019 by the trio of BitGo, Kyber, and Ren. WBTC allows you to tap into the Ethereum ecosystem, particularly the DeFi economy. You can use WBTC to earn interest as a lender or fees and token rewards as a liquidity provider.
Remember, WBTC is collateralized by bitcoin (BTC) with a ratio of 1:1. You can wrap your bitcoin by using a merchant such as CoinList. Your BTC will be transferred to a custodian who will mint an equivalent amount of WBTC to the BTC you sent.
Conversely, if you want to redeem your BTC the custodian will unwrap your wrapped bitcoin by burning it and transferring the original asset to you. At the time of writing this article, the total market capitalization of wrapped bitcoin (WBTC) is $7,614,971,730.
Wrapped BNB (WBNB)
Wrapped BNB (WBNB) is the BEP-20 version of BNB that can be used directly on BNB Smart Chain (BSC). WBNB can be traded for other tokens on BSC or swapped for ERC-20 tokens to facilitate cross-chain transfers. You can also use WBNB on non-native networks, such as Solana and Terra.
To wrap your BNB, you will use a BSC asset conversion bridge to turn them to WBNB. The current total market capitalization of WBNB is $1,240,402,808.
renBTC (RENBTC)
renBTC (RENBTC) is an ERC-20 version of bitcoin that is pegged to the value of BTC. Unlike WBTC, which relies on a burn mechanism to maintain its 1:1 peg to bitcoin, renBTC works on a direct supply peg that ensures the bitcoin in reserve is enough to cover the circulating supply of renBTC.
Launched in 2021, RENBTC is a product of RenVM, which supports cross-blockchain deployment of assets. In this case, RenVM acts as the custodian responsible for securing bitcoin and minting the corresponding amount of wrapped coins on Ethereum.
RenVM can also redeem your coins by requiring you to send your wrapped coins and refunding you the equivalent in the original asset. The wrapped tokens will be destroyed to maintain an equilibrium price and supply.
renBTC has a current market capitalization of $1,292,020,564.
Top Wrapped Token Use Cases
The successful deployment of wrapped assets such as BTC and BNB on Ethereum, Binance Smart Chain, and other chains has led to the emergence of several use cases. Here are the top five use cases.
Margin Trading
Margin trading crypto involves borrowing funds from an exchange and using them to place trades. Wrapped coins like WBTC can be used by traders to trade on margin on decentralized derivatives exchanges.
DeFi lending
DeFi lending operates by depositing cryptoassets into crypto lending pools to earn interest. Wrapped coins, such as WBTC, can be used to lend bitcoin through DeFi lending protocols. You can lend your WBTC on Aave, MakerDAO, and Compound.
Liquidity Provision
Wrapped coins can be used to provide liquidity to the Ethereum ecosystem from bitcoin users. WBTC and renBTC can be deposited into DeFi liquidity pools and earn yield for investors.
Crypto Loan Collateralization
Crypto collateralization allows borrowers to use digital assets as collateral for crypto loans on DeFi lending protocols. This means a certain amount of crypto is held in reserve until your loan amount is repaid.
Typically, the collateral was provided in the form of ETH. However, using ETH alone as collateral exposes Ethereum to a high risk of volatility and threatens the stability of the network. To remedy this wrapped tokens like WBTC can be used as collateral. This lessens the pressure on the network and increases liquidity.
Examples of protocols that allow you to use wrapped tokens for collateralized loans include MakerDAO, Compound, and Aave.
Yield Farming
Wrapped token holders can yield farm on lending protocols or AMMs by depositing wrapped coins into liquidity pools. In addition to liquidity pool rewards, investors are also rewarded with a protocol’s governance tokens as an incentive.
An example would be Compound, which rewards you with COMP governance tokens as a reward for providing liquidity to its pools.
Source: https://crypto.news/what-are-wrapped-tokens-what-are-they-used-for/