A wrapped token is a cryptocurrency token linked to another cryptocurrency’s value. Because the original asset is placed in a wrapper—a sort of virtual safe—which enables the creation of the wrapped version on another blockchain—it is known as a wrapped token.
Several blockchains have varying capabilities. Also, they are unable to communicate with one another. The Ethereum blockchain is completely unknown to the Bitcoin blockchain. Wrapped tokens allow for additional connections across other blockchains, nevertheless.
A wrapped token is comparable to a stablecoin since it draws its value from another asse. However, stablecoin, that is typically fiat money. It’s typically an asset that resides natively on another network in the case of a wrapped token.
As separate systems, blockchains, there isn’t a suitable mechanism to transfer data across them. Wrapped tokens improve cross-chain compatibility because the underlying tokens can essentially move between blockchains.
How do they work
Wrapped tokens are available for direct purchase, or a merchant can turn your current coin into a wrapped token. Your cryptocurrency is delivered by the merchant to a custodian, who stores it in a virtual safe. The custodian mints a wrapped token that serves as a substitute for your original coin after the coin has been safely stored.
For the custodian to mint bitcoins, a merchant sends them. According to the amount of BTC provided, the custodian then mints WBTC on Ethereum. The merchant submits a burn request to the custodian in order to release the BTC from the reserves when the WBTC has to be converted back to BTC. The custodian is essentially the person who wraps and unwraps gifts. In WBTC’ case, a DAO is responsible for adding and removing custodians and merchants.
A wrapped token must be destroyed or burnt in order to exchange it for the original unwrapped cryptocurrency. Burning is the procedure through which the custodian releases the actual cryptocurrency and destroys the wrapped token.
What are the benefits of these tokens
Provide interoperability: Wrapped tokens, like WBTC, enable cross-blockchain functionality so users may move assets with ease and utilise features and apps on other blockchains. These benefits could include reduced fees, quicker transaction times, or chances for yield farming.
WBTC has been slowly expanding in supply. However, blockchain bridges, a technology that enables you to wrap your own tokens and transfer them across blockchains, are also used extensively.
Enhanced security: Smart contracts, which are self-executing contracts with the conditions of the deal put directly into the code, are used to produce wrapped tokens. More security and transparency may be offered than with conventional financial products.
Higher liquidity: By making it simple to buy and sell particular assets on digital asset exchanges, wrapped tokens can boost the liquidity of those assets. This may facilitate the buying and selling of assets by investors, resulting in more effective price determination and higher market activity.
Improved effectiveness: Wrapped tokens can promote quicker and more effective asset transfer and settlement, obviating the need for middlemen and lowering the possibility of mistakes or fraud. Users may benefit from faster and more easy banking transactions as a result.
Conclusion
Wrapped tokens aid in building additional connections between blockchains. An asset that naturally resides on another blockchain and has been tokenized is known as a wrapped token.
This promotes interoperability within the ecosystem of cryptocurrencies and Decentralized Finance (DeFi). Applications may easily share liquidity with one another, and wrapped tokens bring up a world where capital is more efficient.
Nancy J. Allen is a crypto enthusiast and believes that cryptocurrencies inspire people to be their own banks and step aside from traditional monetary exchange systems. She is also intrigued by blockchain technology and its functioning.
Source: https://www.thecoinrepublic.com/2023/03/07/all-you-need-to-know-about-wrapped-tokens-and-their-use/