What Is Wrapped Token?

By reading the article “What is a Wrapped Token” published in Adaas Investment Magazine, you will be fully familiar with what wrapped tokens are, how they work, and their role in the blockchain ecosystem. This level of familiarity can be enough when you need educational information about this topic.

Perhaps the most innovative, yet most exciting thing that is happening in the crypto space is when tokens are wrapped. They then take the love that is in your cryptocurrencies and create a way for you aka users to interact with them and use them on different blockchain networks they don’t natively support.

In this post, we will walk you through all there is to know about wrapped tokens and in which world you can find it. On top of that we will talk about advantages of using wrapped tokens and disadvantages of using them.

Now the custodian or a protocol fills the gap by locking the underlying asset into a secured vault, and minting the same amount of wrapped tokens. Then, the users get the wrapped tokens and use them on the blockchain network on which they have been minted.

How does a wrapped token work?

The technical process of wrapping tokens varies depending on the custodian or protocol involved. However, the general process is as follows:

1- The user deposits the underlying asset with the custodian or protocol.

2- The custodian or protocol locks up the underlying asset in a secure vault.

3- The custodian or protocol mints an equivalent amount of wrapped tokens.

4- The wrapped tokens are distributed to the user.

Why are wrapped tokens becoming popular?

Wrapped tokens are becoming increasingly popular in the crypto space for a number of reasons, including:

– Increased liquidity: Wrapped tokens allow users to get access to liquidity on different blockchains. This is really useful if crypto is not natively supported on popular Decentralized Finance (DeFi) platforms — and is great for crypto that has intrinsic value but is rarely used in DeFi, such as open source protocols.

– Cross-chain compatibility: and help users to interact with and use by using its favorite cryptocurrencies in a wrapped form on different blockchain networks. For example, it’s important for cross chain applications like decentralized exchanges and bridges, because decentralized exchanges are in theory limited to a single chain.

– Improved usability: Just like native tokens, wrapped tokens can be used on a blockchain network. It also significantly reduces barriers for users to work with their favourite cryptocurrencies on various platforms.

Wrapped tokens are a very powerful tool that unlocks the full potential of the crypto ecosystem. When you know how wrapped tokens work, you can then use them for your advantage.

In the next section, we elaborate on advantages and disadvantages of wrapped coins, and benefits and challenges of such approach.

What Is Tokenization?

Tokenization is the act of representing an actual tangible or intangible asset in the form of a token. This token then can be usable for trading, storing and used within a blockchain network.

Tokens can represent a wide range of assets, including:

• Cryptocurrencies
• Securities
• Real estate
• Collectibles
• Intellectual property
• Carbon credits

What is a token in the digital environment, and what does it mean?

A token is an item that has been assigned a value and is stored on a blockchain network a token comprises of an array of strings. It is a special number that is linked to the physical assets and their possession.

Tokens can be employed in order to represent ownership of real-world objects such as ones and zeroes or property in the physical world such as real estate or gold. There could also be the use of NFTs in ownership representation, for instance, cryptos, video game in-game items, etc.

In what way do tokens function in the blockchain environment?

Tokens are very important in the blockchain environment. They are used to:

– Represent ownership: Tokens can be used to represent having ownership in some object or even some space in the physical world or the digital.

– Facilitate transactions: Such tokens can represent goods, services, and even financial values in an economy in the traditional commerce blockchains on behalf of funds. For instance, buying or trading Bitcoin or Ethereum allows users to spend actual tokens to pay for the fees required for a certain transaction in its network.

– Provide access to products and services: Tokens are also used to gain and unlock the right to products or services within blockchain networks. For instance, utility tokens are employed to gain access to products, and services DEXs along with other DeFi applications.

Benefits of tokenization

Tokenization offers a number of benefits, including:

Liquidity: Tokens are more easily tradeable than traditional assets such as stocks or even real estate.

Divisibility: Security can be subdivided and this will make tokens more appealing to the investors.

Transparency: Token operations are network transactions that are publicly and securely recorded via the use of blockchain.

Efficiency: It will also give an opportunity for tokens to improve the effective flow or even automate many more business processes.

Accessibility: Tokenization can also help ordinary individuals to participate in a new asset class and to invest in it.

What Are Wrapped Tokens?

Wrapped tokens are just a type of a digital asset that is used to represent a cryptocurrency on a separate blockchain network. A wrapped token is another denomination of a cryptocurrency but tokenized. With this, the users can interact and use the cryptocurrency on the various blockchain networks where the platforms do not natively support.

Which type of tokens are created wrapped ones?

A custodian or protocol creates wrapped tokens by locking up the underlying asset in a secure vault and minting an amount equal to that of wrapped tokens. Users are then given the wrapped tokens, and can use them on the blockchain network which they were minted in.

So what does the wrapped token represent?

Wrapped tokens represent cryptocurrency on another blockchain network, wrapped into the cryptocurrency. Wrapped Bitcoin (WBTC) is an example of Bitcoin on the Ethereum blockchain.

Examples of popular wrapped tokens:

• Wrapped Bitcoin (WBTC)
• Wrapped Ethereum (WETH)
• Wrapped Litecoin (WLTC)
• Wrapped Solana (SOL)
• Avalanche (AVAX)

Need for wrapped tokens:

Interoperability between chains requires wrapped tokens. That is to say, cross chain interoperability is the capability allowing assets and data to transfer from one part of the blockchain network to another. Wrapped tokens are tokens that allow users to trade their favorite cryptocurrencies on various blockchain networks without that network natively supporting it.

An example would be if a user wants to wrap their Bitcoin, wrap it to create WBTC, and use WBTC on the Ethereum blockchain to interact with DeFi applications. At that point, the user can unwraps their WBTC in order to redeem their Bitcoin.

How Wrapped Tokens Work

Technical process of wrapping tokens:

The technical process of wrapping tokens is different depending on custodian or protocol involved. However, the general process is as follows:

1- User deposits the underlying asset into the custodian or protocol.

2.) The underlying asset is securely locked up in a vault by the custodian of protocol.

The custodian/protocol mints an equivalent amount of wrapped tokens.

2- The tokens are wrapped, and the user is given the wrapped tokens.

Role of custodians or smart contracts in wrapping tokens:

The wrapping process depends heavily on custodians, or smart contracts, involved. It sits in secure vaults and is held by custodians in their charge. The wrapped tokens are minted and distributed by means of the smart contracts.

Backing assets and collateralization:

Wrapped tokens are backed by the fund behind them. What that means is that for every wrapped token in circulation there is a custodian or a protocol holding an equivalent amount of the underlying asset.

The collateralisation process is just locking the underlying asset into a vault that’s secure. So, wrapped tokens are backed in circulation by the underlying asset.

Transparency and security features of wrapped tokens:

They are transparent and secure wrapped tokens. Wrapped tokens transactions are kept on a blockchain network. That allows tracking the movement of wrapped tokens, and also to ensure that they are backed by the underlying asset.

Furthermore, the wrapping and unwrapping process is usually handled through smart contracts. A self executing contracts called smart contracts are stored on the network of the blockchain. Clear and tamper proof.

Use Cases and Benefits of Wrapped Tokens

Their use cases in DeFi can range from all types of applications like:

Liquidity provision: One can provide the Wrapped tokens with liquidity across different blockchain networks for Defi applications. That might provide even better liquidity in the Defi market and, therefore, could be more available to the end user.

Trading and investment: Additionally, the wrapped token would be applied with a view to trading and investment in crypto assets across different blockchain networks. In this way, there will be more options for users regarding trading and investments in crypto assets.

Cross-chain interoperability: With the feature of wrapped tokens, it can be said that one can move their assets and information across blockchains. Users can use their favorite crypto assets in the case of numerous other blockchains that might not natively support such assets.

Real-world examples of wrapped token project utilities:

– AAVE is another famous DeFi lending and borrowing platform. It enables users to be able to lend and borrow crypto assets. AAVE also supports various wrapper tokens, such as WBTC and WETH.

– Uniswap is a decentralized on-chain exchange where people can trade crypto assets. The coins supported on Uniswap include but are not limited to WBTC, WETH, and WLTC.

– Curve Finance is an AMM optimized for trading in stablecoins. Curve Finance also supports all forms of wrapped stablecoin, including USDT and USDC.

Advantages of using the wrapped token for trading and investment:

Higher liquidity: Owing to the wrapping of tokens, one is in a position to make more liquidity across the blockchain networks. Wrapped tokens are easier to buy and sell out since their price is fair.

Larger avenues for trading: This kind of wrapped token allows their users the capability to trade in crypto assets across different blockchain networks. This would ensure the diversification of a portfolio and better returns.

Reduced risk: The utilization of Wrapped Tokens might reduce some risks in trading and investment in crypto assets. This is because the wrapped token is usually backed up by the underlying assets, therefore creating some level of security.

Risks and Challenges of Wrapped Tokens

Of course, in addition to all the advantages of wrapped tokens, their use also faces certain risks and difficulties.

Custodial risk: Wrapped tokens are generally collateralized by some kind of underlying asset that is kept in a safe vault by a custodian or by the underlying protocol. In other words, one is trusting a custodian or protocol to keep one’s assets safe. Should the custodian or the protocol get hacked or go bankrupt, users stand to lose.

Maintaining the peg: There is also a challenge in maintaining the peg between the wrapped tokens and their underlying assets themselves. This might indeed be hard, in particular when market volatility is very high. When the peg breaks, users may stand to lose some money.

Custodian or protocol selection: While using wrapped tokens, one must select a credible custodian or protocol. Investigation of the custodian or protocol is quite necessary, whether the record is good or not.

Tips for mitigating risks:

Custodian or protocol selection: As identified earlier, the selection of a reputable custodian or protocol for the wrapped tokens is necessary. A little research by the user on the custodian or the set protocol should be done to ensure that it has a good track record.

Multi-custody or multiple protocols: Again, to reduce the custodial risk, every user might opt for multi-custody or multiple protocols. In that case, if one of the custodians or protocols gets hacked or declares bankruptcy, the user will not lose his or her entire asset.

Awareness of risk: A very important fact in using this aspect of the concept of wrapped tokens is the fact that a user should not move in to use these tokens before he has weighed the risks and benefits that may result from their use.

Conclusion

Wrapped tokens are a pertinent aspect that can be used to realize the full potential of the crypto ecosystem. These tokens allow the users to utilize their favorite cryptocurrencies across various blockchain networks which they cannot use because of lack of native support.

Wrapped tokens offer a number of advantages including the following:

• Enhanced liquidity
• Cross chain inter-operability
• Improved usability

Nonetheless, it is equally important to understand the downsides that encompass the use of wrapped tokens such as custodial risk and the difficulty in maintaining the bind. People need to weight the risks with expected rewards while making decisions regarding using wrapped tokens.

For wrapped tokens enthusiasts, it is advisable to do good research first and find good custodians or protocols that are reputable. It is also advisable to start with small investments so that large sums are not put at risk while one is unfamiliar with wrapped tokens.

Some of the custodial and protocol services such as Wrapped Bitcoin, Wrapped Ethereum have websites which one can use to gain more information about wrapped tokens. One can also research about wrapped tokens by reading articles and blogs dedicated to the topic like this one.

After getting familiar with wrapped tokens, the next step would be figuring out how to take advantage of them. For example, you can use wrapped tokens to provide liquidity to DeFi applications or to trade and invest in crypto assets on different blockchain networks.

The End Words

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