What is a wrapped token? Guide into wrapped crypto
Wrapped cryptocurrency was a natural progression in the rapidly evolving realm of decentralised
finance (DeFi) and decentralised apps (DApps). Wrapped tokens make it possible
to use cryptocurrencies such as bitcoin (BTC) on non-native blockchains such as Ethereum without
requiring constant conversion, thus expanding the liquidity and user base of DeFi applications.
As DeFi grows more prevalent and vital for online commercial operations, token
wrapping has become critical for facilitating interactions between holders of multiple tokens.
What are wrapped tokens, then? Wrapped cryptocurrencies, like stablecoins,
have their value tethered to another asset. The crucial distinction is that wrapped
crypto tokens are often linked to the value of another cryptocurrency, whereas stablecoins are
typically anchored to a fiat currency, such as the US dollar, or a real object, such as gold.
What are wrapped tokens and how do they work?
From a technical sense,
the process of minting wrapped crypto tokens and stablecoins is very similar.
As previously stated, wrapped tokens are linked to the value of another cryptocurrency, and the
wrapped token's value will fluctuate in lockstep with the value of the original cryptocurrency.
After 'locking' the original crypto assets in a safe digital vault via
the issuance of a smart contract (which is often a contract for a 1:1 exchange),
the user is awarded an ERC-20 token equivalent to the original crypto assets
(a standard used for creating and issuing smart contracts on the Ethereum blockchain).
If the user wishes to reclaim their original asset, they just exchange their
wrapped tokens back to the smart contract and exit with the original crypto's value.
The first wrapped cryptocurrency was produced for ether, Ethereum's native currency, which
was created prior to the ERC-20 standard's adoption. Due to the fact that ether was
established prior to the ERC-20 standard, it was incompatible with other ERC-20 tokens.
As a result of this lack of interoperability, wrapped Ether (wETH) was established within
the ERC-20 architecture to enable ether users to interact with other ERC-20 tokens.
The ERC-20 protocol is now the most extensively utilised on the Ethereum network, and currencies
generated inside its framework include all of the functionality required to execute smart contracts,
as well as the ability to communicate with all other ERC-20-compliant tokens.
Due to the enormous amount of possible uses for ERC-20 tokens,
several non-native wrapped cryptos have been produced, such as wrapped Bitcoin (wBTC).
Although the Ethereum network remains the most popular destination for wrapped cryptocurrencies,
you may also wrap a huge number of cryptos on the Binance Smart Chain via the issuing of BEP-20
tokens — a Binance Smart Chain token standard with a similar architecture to Ethereum's ERC-20 token.
Explanation of wrapped tokens
The most effective approach to illustrate a wrapped token is with a real-world example.
Bitcoin, the first and most popularly held cryptocurrency, is by far the largest,
with a market value of over $1.12 trillion as of 8 November 2021, according to CoinMarketCap.
While it is the original cryptocurrency, BTC was created primarily as a store of
wealth that can be exchanged for goods and services or transferred between persons.
It does not, however, have the functionality of other tokens,
such as ones based on the Ethereum blockchain, which is where wrapping comes into play.
Similarly to wETH, wBTC is an Ethereum-based coin that adheres to the most widely used ERC-20
standards. This implies it can interact with any other ERC-20-compliant coin.
Individuals wishing to employ Ethereum network functionalities like as insurance placement,
smart contract execution, or liquidity extension deposit their BTC in a safe
digital vault and are credited with the corresponding amount in wBTC.
Thus, wBTC enables interoperability with all other ERC-20 tokens without requiring users to trade BTC
for additional tokens. While the list of wrapped cryptos is lengthy, wBTC remains the largest,
with a market capitalisation of more than $15.4 billion at the time of press.
The advantages of wrapped tokens
DeFi and its associated dApps are constantly expanding to include new user markets. As of
this press, BTC is incompatible with the ERC-20 network except via wrapped tokens.
To illustrate some of the primary benefits of wrapped crypto, we've used wBTC:
Liquidity. wBTC delivers BTC's massive market capitalisation
liquidity to the ERC-20 environment. Wrapping assets and reusing them on
another chain offers seamless integration between previously isolated liquidity.
Earnings generation. wBTC users can make passive revenue by engaging in activities
like as staking and yield farming that the original Bitcoin blockchain does not permit.
Staking is depositing funds in a smart contract until it is executed in exchange for a piece of
the reward, whereas yield farming is essentially the issuance of short-term credit at a profit.
Digital applications and interoperability. Because the BTC blockchain is incapable of running
smart-contract protocols, it must be swapped for other assets. Ethereum is compatible with the
majority of decentralised applications. When utilising wBTC, interoperability,
or the ability to exchange value with other tokens, is enabled with all other ERC-20 tokens.
Transactional velocity. Bitcoin is significantly slower than Ethereum. It typically handles
3-5 transactions per second, whereas Ethereum processes 10-15. Without transferring assets,
wrapped tokens enable users to benefit from continuously improved transaction rates.
Constraints on wrapped tokens
Today, the majority of wrapped tokens require a custodian – a third party that holds an equivalent
quantity of the underlying asset to the wrapped amount. It can take the form of a merchant,
a Decentralised Autonomous Organisation (DAO), or a multisignature wallet (a crypto wallet shared
by two or more users that requires several private keys to sign and send a transaction).
Minting is the process of producing a wBTC.
A merchant initiates the minting process, which is carried out by a custodian. For wBTC, the
custodian must keep one BTC for every wBTC created - consider of it as a wrapper or unwrapper.
However, because wrapped tokens are dependent on the issuing platform,
there is a risk of centralisation.
Due to the fact that wrapping cannot be completed automatically by a smart contract,
it may increase the danger of manipulation and hence undermine the decentralisation premise.
In May 2020, Vitalik Buterin, the Ethereum founder,
expressed his concern on Twitter about the centralised nature of wrapped tokens:
"I'm concerned about some of these coins' trust models.
It would be tragic if there were to be $5 billion worth of Bitcoin on Ethereum
and the keys were owned by a single organisation," Buterin stated.
Additionally, the minting process can be pricey, as it requires gas.
Wrapped tokens' future
As the world embraces DeFi applications, with a Total Value Locked (TLV) of $105.69 billion as of
8 November 2021, the future of crypto in general is one of growing adoption by mainstream banking,
with more functionality and compatibility between currencies.
Wrapping enables traders to exchange non-native tokens for wrapped cryptos
without having to pay exorbitant exchange costs.
While owning bigger market capitalisation assets such as BTC, users can benefit from the greater
DeFi capabilities of networks such as Ethereum. However, this may be a temporary measure.
"Wrapped cryptocurrencies and tokens are a workaround for the issue of transferring
cryptocurrency from one blockchain to another,
such as Bitcoin to Ethereum," Capital.com analyst Mikhail Karkhalev explained.
"It is a chasm that will dissolve when dependable cross-chain platforms
or some next-generation solution that enables the use of bitcoin (or any other cryptocurrency)
on any other blockchain becomes accessible," Karkhalev noted. "As a result, considering it
as an investment vehicle rather than a function if such a requirement arises makes less sense."
Wrapped tokens are linked to the original asset's value and are subject to the same degree of
volatility as the underlying crypto asset. If you want to utilise cryptocurrency as a store of money
with the potential for growth, traditional cryptocurrencies may be a better choice.
Always conduct your own research before investing in any asset and keep in mind
that your decision should be based on your risk tolerance, your expertise in this market,
the spread of your portfolio, and your comfort level with losing money. Never invest more than
you can afford to lose, and keep in mind that previous success does not indicate future results.
If you make frequent transactions and are interested in the DeFi possibilities,
wrapped crypto may be an option.
Your decision-making should be guided by your unique requirements and risk tolerance.
The distinction between stocks and contracts for difference
The primary distinction between CFD trading and stock trading is
that when you trade an individual stock CFD, you do not own the underlying stock.
With CFDs, you never truly buy or sell the underlying asset. You can still profit if
the market swings in your favour, or you can lose money if the market goes against you.
However, in traditional stock trading, you enter into a contract for the exchange of
legal ownership of individual shares for money, and you hold this equity.
CFDs are leveraged products, which means that to start a position,
you only need to deposit a percentage of the total amount of the CFD trade. However,
in typical stock trading, you pay the whole price for the shares.
There is no stamp tax on CFD trading in the United Kingdom, but there is on stock purchases.
CFDs incur overnight expenses to hold the trades
(unless you use 1-1 leverage), which makes them prohibitively expensive.
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