What Are Wrapped Tokens In Crypto, And How Are They Used?

What Are Wrapped Tokens In Crypto, And How Are They Used?

It's confusing to see BTC and ETH sold alongside WBTC and WETH, but wrapped tokens are not used for the same purposes as their native counterparts.

 

Many crypto exchanges' cryptocurrency listings include 'wrapped tokens' called WBTC, but they serve a different utility than Bitcoin, which might lead newbies to mistakenly purchase them instead of BTC, and in the worst case scenario, withdraw it into their BTC hardware crypto wallet. Sharing and sending cryptocurrencies from one blockchain network to another is impossible at the protocol level, and requires specialized applications.

 

This wasn't an issue until Ethereum's blockchain smart contracts came along and changed the game forever, at which point users began demanding the ability to use BTC in Ethereum smart contracts and Ethereum financial applications. However, BTC lives on Bitcoin, while decentralized finance (DeFi) applications live on Ethereum, and the two networks cannot communicate with each other without some kind of off-chain communication network.

SCREENRANT VIDEO OF THE DAY

 

Related: How To Create An Ethereum Crypto Wallet With Metamask

That's where token 'wrapping' comes in, such as Wrapped Bitcoin (WBTC). The Motley Fool explains that WBTC is created by depositing BTC into a special vault on the Bitcoin network, and an equivalent amount of WBTC is minted on the Ethereum network. To wrap a token, there must exist a bridge between both blockchains that can lock up the cryptocurrency on one side until the wrapped tokens are returned on the other side, and the bridge must be extremely secure to prevent exploits. Token wrapping allows BTC to be used on Ethereum in the form of WBTC, but it also requires trusting the WBTC network to properly manage the BTC it holds.

 

What Are Wrapped Tokens Used For?

 

Wrapping tokens allows cryptocurrencies on one blockchain to be used on another blockchain, particularly smart contract blockchains like Ethereum or its Layer-2 scaling solution Polygon. WBTC is now a big part of many DeFi applications on Ethereum, and allows holders to use their bitcoins for more than just holding and spending. WBTC is created by the WBTC network, a network of merchants who custody clients' BTC and create WBTC on Ethereum, while also complying with Know Your Customer (KYC) and Anti-Money Laundering (AML) regulations. A competitor to WBTC is the Ren network, which operates in a completely decentralized and automated way that bypasses KYC and AML compliance, and is denoted by the tickers renBTC and RENBTC.

On the other hand, there is also ETH and Wrapped ETH (WETH). CoinMarketCap explains that while ETH and WETH both exist on Ethereum, WETH is compatible with more Ethereum applications than native ETH is, but WETH cannot pay Ethereum's blockchain gas fees.

 

This is because ETH existed prior to the adoption of the ERC-20 token standard, and the code for interacting with ETH is different. Rather than having two sets of code for handling ETH and ERC-20 tokens in every smart contract, Ethereum developers created a smart contract to wrap ETH as an ERC-20 token called WETH, which allows developers to write simpler and safer smart contracts. ETH is still required to pay gas fees when using WETH, so this distinction can be confusing at first.

Wrapped tokens are necessary for transferring assets from one blockchain to another for use in smart contracts on other networks. Wrapped Bitcoin (WBTC) was one of the first wrapped cryptocurrencies to exist to take advantage of Ethereum's smart contract capabilities, and to this day it is still used heavily in Web3 decentralized applications. Similarly, WETH was created to improve ETH's compatibility with Ethereum smart contracts. Wrapped tokens are essential for improving blockchain interoperability, and are necessary for a diverse and healthy blockchain ecosystem.

 

Source : screenrant.com/crypto-wrapped-tokens-explained-used-how/ by Phoenix Angell - November 15, 2022

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