Imagine you’re watching a space thriller. The astronauts are going through an asteroid field and their ship is taking damage. They need to get out there to repair the ship and the bravest astronaut volunteers for the job. So what do they do? The really important thing here is to put on a spacesuit people are usually best suited to be on earth breathing some crisp pure earth air not dying in a vacuum of space, to phrase this somewhat oddly, they wrap themselves up to be able to survive in a different environment exactly like a wrapped token.
1. Wrapped Tokens
In this article, we’re going to explain what wrapped tokens are, how they work and why we need them so, first off what exactly is a wrapped token? The many different layers and situations can make this concept confusing, but at its most basic a wrapped token is just an asset in disguise. You take an asset, wrap it up, and then you can use it on a different blockchain. To understand this, we first have to understand how tokens work you can read our article on coins versus tokens. But basically, what you have to know is that each blockchain has its coin, but developers on that blockchain can create their tokens. So what are the benefits of a wrapped token? Well, the problem is that tokens are tough to use on different blockchains.
2. Earn Interest
For example, say you want to deposit some bitcoin on a popular blockchain application called ave. We have an entire article about ave, but it is an application that allows you to earn an interest rate by lending out your crypto. However, ave is only available on the Ethereum network. You can’t use your bitcoins on it. So what do you do? You can wrap up your bitcoin and make it a token on the Ethereum network called wrapped bitcoin. What you’re doing is locking up your true bitcoin and then you simply get a wrapped bitcoin as a token on Ethereum to use.
Then you have that token. You can use it on the Ethereum network, but it is a representation of your original bitcoin. The point of all this is that some blockchains can do things that other blockchains can’t and some coins aren’t even available. So what did the early developers do? They made representations and called them wrapped tokens so that you can essentially have the main coin but use it on any other network. A good way to think about using wrapped tokens as collateral. Imagine you’re trying to buy a house and you don’t have enough money for it, so you get what is called a mortgage.
If you have something else that has value, you can take a loan on it, because the bank or party loaning, the money knows that you have something valuable they can take if you don’t pay them. A wrapped token is similar to this rap. Tokens are pretty similar to stable coins or cryptocurrencies that are pegged to a fiat currency’s value.
5. Wrapped Asset
A wrapped token, like wbtc, retains the value of the wrapped asset, and in this case, it would be bitcoin, so one wbtc always equals one bitcoin stable coin. Pretty much. Do the same thing, they are wrapped fiat currencies used for improved transaction efficiency. How do they do this? Well, if you own one wrapped bitcoin, you can turn it into a real bitcoin at any time, so wrapped bitcoins are 100 backed by a real asset that they are representing. This way, traders are incentivized to keep the price of the wraps token. The same as the real coin now, depending on which coin you have and which blockchain you want to use, the benefits of rap tokens can vary, but if you have an asset with a slow blockchain and want to make the transaction done faster, wrapped tokens can be An advantage a blockchain like Ethereum, clears blocks quicker than bitcoin, which of course, provides a speed advantage to users of the chain.
Polygon is even faster than Ethereum, and the native coin is matic, so many users use wrapped Ethereum on the polygon blockchain. To do things they would normally do on the Ethereum blockchain, but much quicker and with much lower fees. Alright great, so we have a cool new shiny tool to use crypto more effectively, but doesn’t this create other problems? What happened to that rap tokens when it’s done being used does create another asset of the same value, mean you’re, just doubling your money out of thin air. This is a good question. First, wrapping a token does not mean you are any richer than before. It’s kind of like if you write a check from your checking account writing the check, doesn’t create a new asset.
7. Attached to Original Asset
It’s still tied to your original asset that has value also because of the security or double-spending issues that could potentially arise from this. There, of course, has to be what is called a custodian now. This custodian is a third party. It could be a smart contract. The point is that you have to have a way to verify that you have a certain amount of the currency that you say that you have this way.
Nobody could create a wrapped token based on coins that they do not have a custodian verifies that the person creating the rap token has the original valuable collateral coin. In short, someone has to initially take your real bitcoin and then give you the corresponding amount of wrapped bitcoin. Then, if someone else comes to the custodian with a wrapped bitcoin, the custodian can give them a real bitcoin now, normally, this is all done with code.
It's not a real person, so we don’t have to trust that someone won’t run away with all our real coins or print a ton of fake tokens. Can there be more wrapped tokens than real coins? The short answer is no, in the same way, that there can only ever be 21 million bitcoins. There could only ever be 21 million wrapped bitcoins because you have to verify that you own the asset first, to mint a wrapped token, once you wrap your bitcoin trade it and then the transaction is over. The wrapped bitcoin is given to the person you sold it to eventually that person might come back to the custodian and say I want a real bitcoin. The custodian will take their wrapped bitcoin and give them a real bitcoin and then destroy the wrapped bitcoin forever.
10. Leveraged Position
Lastly, who even uses rapt tokens well, the example that we’ve been working with so far is a simple one, wrapped bitcoin, so we can understand the underlying concept. Now, This is a great use case and the share of bitcoin being used for rap bitcoin is over one percent and increasing every day. This is, of course, not a massive amount, but it is steadily increasing as the demand for the Ethereum network and dapps increases over time. It seems to be the case that, as d5 grows, the demand for wrapping all kinds of coins to use on Ethereum is also growing. For example, a lot of people are using wrapped bitcoins to interact with decentralized applications to earn an interest rate or even create leveraged positions. A company called rin has expanded, blockchain interoperability.
11. Wrapped Tokens
This lets users create wrapped tokens on Ethereum, like wrapped bitcoin, wrapped cash, wrapped bitcoin cash, and many other tokens summing it all up. Wrapped tokens may seem like a simple idea that just lets people improve how they make transactions, but the problem that it solves is much bigger. Interoperability or the ability to easily move between blockchains is becoming a very important and recurring problem to solve, as the entire d5 landscape expands.
Whether the eventual solution to this problem is wrapped tokens or maybe something else, wrapped tokens are certainly a viable solution that is only becoming more popular.
Thanks for reading this article. We hope that you enjoyed it.