A beginner’s guide to understanding wrapped tokens.
Introduction
Wrapped tokens are cryptocurrency tokens pegged to the value of another asset. These wrapped tokens are called this way because the original asset is put in a wrapper. A wrapper is a digital vault that allows a wrapped token version to be minted on another blockchain.
The reason for wrapping tokens is that different blockchains offer different functionality. The reason that we need to wrap tokens is that different blockchains can’t talk to each other. For example, The Solana blockchain doesn’t know what’s happening on the Ethereum blockchain. Wrapped tokens are the solution to this problem as there can be more bridges between different blockchains allowing them to talk to each other.
What is a wrapped token?
A wrapped token is a tokenized version of an asset, usually another cryptocurrency, but it can also be an NFT. Wrapped tokens are pegged to the value of the asset they represent and can generally be redeemed for it (unwrapped) at any point. Wrapped tokens more often than not represent an asset that doesn’t natively live on the blockchain that it’s issued on; however, with the increased popularity of fractionalized NFTs, this has begun to change as these assets are usually wrapped on the native chain. Another way you can think of a wrapped token is of it being similar to a stablecoin. Stablecoins derive their value from another asset. In the case of most stablecoins, it’s usually a fiat currency like the USD or the Euro. In the case of a wrapped token, it’s usually an asset living natively on another blockchain.
As most blockchains are distinct, independent systems, there is no reliable way of moving information between them. Wrapped tokens increase the interoperability between different blockchains and their underlying tokens.
How do wrapped tokens work?
To explain how wrapped tokens work were are going to use WETH (Wrapped ETH) as an example. WETH is a tokenized version of ETH and is the most wrapped asset as it is used on both Ethereum and other blockchains. WETH Comes in many forms, from an ERC-20 token to Solana SPL and BSC BEP20 tokens. WETH is supposed to hold a one-to-one peg to the value of Ethereum, allowing users to use ETH on different blockchains.
Wrapped tokens typically require a custodian, an entity that holds an equivalent amount of the asset as the wrapped amount. Custodians are usually smart contracts, DAO’s Merchants, or exchanges. In the case of WETH, for every WETH, the custodian holds 1 ETH. Proof of this reserve exists on-chain. For example, the WETH contract on Ethereum has roughly 30 billion USD worth of ETHat the moment of writing. You can check the current status of the WETH smart contract here. In addition, many other providers provide WETH, such as Solana’s Wormhole Bridge.
When wrapping ETH to receive WETH, a user sends ETH to the custodian to mint WETH. After receiving the ETH, the custodian mints WETH and sends it back to the user who can now use it. When the WETH needs to be converted back to ETH, the user puts in a burn request with the custodian, who then burns the WETH and unlocks an equal amount of ETH from the reserves to the user.
Wrapped tokens on Ethereum
Ethereum is currently the largest smart contract platform, attracting a lot of activity from users. The growth of the Ethereum ecosystem has led many projects to launch on the platform as an ERC-20 token to be able to use the platform. This has also led people from other communities to come to Ethereum and want to use their assets in the Ethereum ecosystem, where wrapped tokens on Ethereum come in.
Wrapped tokens on Ethereum are tokens from other blockchains that are made to be compliant with the ERC-20 standard. This means that you can use assets that are not native to the Ethereum ecosystem.
There are many different implementations of wrapped tokens, from DeFi purposes to fractionalized NFTs.
Wrapped tokens on SafeCoin
Just like wrapped tokens on Ethereum, you can wrap tokens on SafeCoin.
SafeCoin’s Wormhole bridge that is set to release in Q1 2022 will allow users to wrap their crypto assets and NFTs on the SafeCoin blockchain. The SafeCoin Wormhole bridge is currently launched on testnet and can be used here. Once you’ve brought your assets to the SafeCoin, users will be able to trade them on the upcoming SafeSwap, and Safely Dex are also set to release in Q1 2022.
Benefits of using wrapped tokens
There are many benefits to using wrapped tokens. Even though many blockchains have their own token standards, Ethereum ERC 20, Solana has SPL, and BSC uses BEP20. Unfortunately, these standards can’t be used across multiple chains, and that’s where wrapped tokens come in as they allow non-native tokens to be used on a given blockchain.
In addition, wrapped tokens can increase liquidity and capital efficiency both for centralized and decentralized exchanges. The ability to wrap inactive assets and use them on another chain is a great way to capture and rescue otherwise isolated liquidity.
And finally, a great benefit of wrapped assets is their ability to save on transaction times and fees. While Ethereum has some fantastic properties, it can sometimes be expensive to use. While that’s fine for larger traders, it makes Ethereum almost unusable for smaller traders. These issues can be mitigated by using a wrapped version on a blockchain with faster transaction times and lower fees such as SafeCoin, BSC, or Solana.
Limitations of using wrapped tokens
Currently, most implementations of wrapped tokens require trust in the custodian holding the funds. However, some more decentralized options, such as Solana’s Wormhole bridge, allow for entirely trustless wrapped token minting and redemption. Aside from that, the minting process for wrapped tokens can also be relatively costly thanks to high gas fees on Ethereum and the slippage that can occur.
Closing thoughts
Wrapped tokens help with creating more bridges between different blockchains. Wrapped tokens are a tokenized form of an asset that usually lives natively on another blockchain.
Wrapped tokens help with interoperability in the cryptocurrency ecosystem as it allows for fractionalized NFT ownership and more capital efficiency within the DeFi (Decentralized Finance) ecosystem.
