Have you ever gift-wrapped something to stealthily enter a party? Well, I have, and this is the reason why I feel that Wrapped Tokens need to be discussed at length, considering their numerous benefits and a concept that makes cross-chain transactions rewarding and fun.
- The Concept behind Wrapped Tokens
- Wrapped tokens still represent the native assets
- Wrapped BTC is ERC-20 compatible
- Wrapped BTC has BitGo as the crypto custodian
- Wrapped BNB adheres to the BEP-20 standards
- Wrapped tokens bring liquidity of native assets to programming-intensive blockchains
- Wrapped tokens can be used to lend, borrow, stake, and deposit the native crypto across chains
- It is important to keep a note of gas fees while wrapping
- Once the wrapped token is unwrapped and redeemed, it is burned to avoid asset duplication
And trust me when I say, Wrapped BTC and BNB do resemble wrapped gift packs, which guarantee your entry into disparate blockchains with different capabilities. But the question here is, how do we even put these wrapped tokens into perspective, especially when the crypto-space is already replete with numerous players?
If you look closely, you will find different varieties of Bitcoins changing hands in the market. And considering the immense popularity of BTC as the most significant crypto-player to have graced the decentralized space, things can really get confusing for a standard user when a term like Wrapped BTC or WBTC comes floating around.
Similarly, if someone is into the Binance Chain and BNBs, Wrapped BNB can come across as an overwhelming term for the uninitiated. Therefore, it is necessary to chalk out the hierarchy of these wrapped tokens to understand the WBTCs and WBNBs better.
But first, an analogy.
Imagine it’s raining incessantly, and you immediately need to head out. As the umbrella can get swayed out of the way by the accompanying wind, it is better to wrap yourself up with a raincoat. This form of wrapping allows you to move freely, even in the rain.
Wrapped tokens follow a similar concept. Only the ‘Rain’ here is synonymous with a different blockchain and is explored on purpose.
What are Wrapped Tokens?
For starters, wrapped tokens are like tokenized crypto assets that allow them to exist on a different and non-compatible blockchain whilst allowing these assets to leverage the potential of the concerned chain. Also, the wrapped tokens are standard derivatives with their values pegged to the actual asset. This means a Wrapped BTC is dependent on the price action of the BTC and is expected to show similar movements.
When creating the wrapped tokens, the native crypto asset is first placed in a digital vault or rather a wrapper, which then becomes usable on the Blockchain it is intended for. And the fun part here is that you can unwrap these tokens to redeem them at any given time.
But there is more to wrapping a token than just placing it in a chain-relevant vault, for creating one unit of a wrapped token, one unit of the actual crypto-asset needs to be submitted to a trusted custodian, who then wraps and unwraps the same, as preferred.
However, I will discuss the benefits in detail while discussing specific wrapped tokens in the subsequent sections.
The Concept of Wrapped BTC
Nothing against native tokens like BTC, but they do suffer from a lack of interoperability! At some point, the crypto-space will outgrow mere trading and investing. While money-making will still be the primary concern, crypto evangelists will try and make the entire space more inclusive. This would mean imparting the desired levels of flexibility to one Blockchain and its native tokens so that they can be used on a more affordable, fast, and energy-independent chain.
Despite BTCs having numerous benefits, including security and transparency, they aren’t particularly receptive towards smart contracts, which at present is one of the leading blockchain-driven technologies. This is why WBTCs have come into the picture as they represent the potency of Bitcoin and the flexibility of the ERC20 token standards relevant to the Ethereum blockchain.
Put simply, WBTC is a bridge that allows Bitcoin to exist on the Ethereum ecosystem. With Bitcoins standardized to the ERC20 format, it becomes possible for a host of Ethereum-intensive projects to use the same. Just to reiterate, WBTC is a bitcoin-backed, ERC20 token, in a 1:1 ratio, where the Custodian wrapping the BTC has one Bitcoin on hold for every unit of WBTC.
The process of leveraging Bitcoin for WBTC and vice versa is segregated into three steps, which include:
- Minting- Where the merchant asks for a WBTC by sending over a Bitcoin in 1:1 ratio to the Custodian
- Receiving- Where a standard customer asks the merchant for a Wrapped Token. This is a standard process where Bitcoin and KYC details are sent over, and a WBTC is received.
- Burning-Where the merchant raises the burn request, Custodian confirms it using the Smart contract, and the held Bitcoin is released to the merchant, who then releases it to the customer.
WBTC Inception and How Does it Work?
The process of minting WBTC requires the merchant to send over a request and the requisite amount of Bitcoin to BitGo, which is the Custodian for wrapped bitcoins. BitGo wraps the BTC in a 1:1 ratio and sends the WBTC over to the merchant.
A token representing Bitcoin has several benefits as it primarily does one job, i.e., transferring the value and liquidity of the underlying Bitcoin to diverse financial apps and Ethereum-based Decentralized Exchanges. Therefore, it wouldn’t be wrong to state that a WBTC, as an ERC20 token, can revolutionize Ethereum’s rapidly evolving Defi network.
This means, if you have idle BTCs lying around, you can deploy them as WBTCs to lend and borrow on select Defi platforms like MKR, make use of liquidity to make platform-specific trades, and even stake them on select platforms to earn interest.
The Concept of Wrapped BNB
The Binance Blockchain and the concerned native tokens, i.e., BNBs, aren’t compatible with the BSC or the comparatively new Binance Smart Chain that is precisely launched for supporting Smart Contracts and programming capabilities. As an advanced Blockchain, BSC lets you create Dapps and make extensive use of smart contracts.
However, for transacting in the BSC, it is important that the tokens follow the BEP-20 standard, which is why the Wrapped BNB was conceptualized in the first place. With WBNBs in place, you can directly trade with BSC-relevant altcoins.
How does WBNB Work?
As mentioned, a BNB isn’t BEP-20 compatible and hence needs to be wrapped as WBNB, with the Binance Coin being the underlying asset, period. But things get more interesting hereon.
In the Binance Smart Chain, you might end up creating a decentralized application, which then implements its very own Alt token. As the Dapp generated token is BEP-20 compatible, it becomes possible to transact and trade them with WBNB.
Plus, WBNB also comes in handy during cross-chain crypto transfers as the compatibility extends right to the ERC-20 standard, eventually making the blockchains interoperable. And yes, wrapping and unwrapping are initiated by the Binance Bridge.
Why and How to Utilize these Wrapped Tokens- Let’s Trace the Cryptonomics?
A wrapped token is a good way to generate passive income by lending the asset-linked token on a Defi platform via smart contracts. Moreover, if you have a Bitcoin and you want cash against it without having to sell the same, converting it to WBTC and loaning against it is also an option, provided you get the funds via US dollar-pegged stablecoins for instant liquidity and access to fiat.
Still unsure about the real-time exploits of the wrapped tokens? Well, here is an analogy that you can follow to get a better grasp of this concept.
Important: Imagine you want to deposit some BTC on the Ethereum-backed Defi application, AAVE. However, you simply cannot use bitcoin and expect this ERC-20-powered setup, i.e., AAVE, to accept.
This is when you wrap the Bitcoin and make it a usable token on the Ethereum Blockchain. And the best part is that WBTC is a real-time representation of the original Bitcoin, which makes it price-sensitive and responsive to how the native asset moves.
To simplify further, getting a wrapped token means mortgaging your standard asset to the Custodian to procure some cross-chain benefits.
In addition to these utilities, Wrapped BTCs and BNBs can also be used for staking and making deposits in specific liquidity pools to earn rewards and commissions, respectively. And if you are only looking to leverage the benefits of fast block processing speeds of a given blockchain, these wrapped tokens can be quite useful.
Things to Consider while Relying on Wrapped Token
Now that you are familiar with how wrapped tokens work, it is important to go through a few pointers that might help you understand the nitty-gritty of the same better. Here are the ones to keep in mind:
- Wrapping a token doesn’t double up the asset value. The original crypto-asset still underpins it, and once the wrapped token has lived out its usefulness, it can be redeemed via unwrapping, which is then followed by burning the wrapped version and deleting it from existence.
- At present, real-time, cross-chain trades using wrapped tokens are a tad sluggish as each transaction needs to go through a trusted custodian to hold the native crypto assets. However, we might soon experience a trustless way of wrapped minting and subsequent redemptions.
- Before you wrap a token to use it on a different blockchain, be mindful of the gas fees for minting the same. You certainly do not want to move to a network that incurs higher Gas fees and leads to slippage.
Important: Slippage is a term synonymous with the financial space that concerns settling for different asset prices while trading, as compared to the requested ones.
To sum it up, Wrapped BTCs and Wrapped BNBs are more like bridges allowing you to push a native asset to a completely non-compatible blockchain network. While blockchain interoperability gets a ready boost with these wrapped players around, the concept is nothing short of a Defi-market mover, courtesy of effective capital usage and improved liquidity.
FAQs on Wrapped Bitcoin
Q1. Can I use Bitcoin in the Ethereum Ecosystem?
A1. No, unless you wrap the Bitcoin and convert it into WBTC, it is possible to deploy it across the Etherum ecosystem.
Q2. Are there other wrapped tokens apart from WBTC and WBNB?
A2. Yes, there are quite a few wrapped tokens being traded extensively as we interact. One such wrapped player is WETH or Wrapped Ether, which allows standard Ether tokens to become ERC-20 compatible and, therefore, usable across the Defi and Dapps ecosystem.
Q3. Is token wrapping free?
A3. No, wrapping tokens to make them usable across blockchains requires minting and, therefore, has transactional costs of gas fees associated with it.
Q4. Who is a custodian for the wrapped tokens?
A4. Custodians are in charge of the native assets and play an active role in wrapping, unwrapping, and burning wrapped tokens. In the case of WBTC, BitGo, a DAO, is the Custodian. However, depending on the Blockchain, the Custodian might vary and can even be a smart contract or a multisig wallet.
So that’s a wrap for now. If you are interested in learning about similar concepts, read more and get ahead of the crypto concepts with us.
Disclaimer : Crypto products and NFTs are unregulated and can be highly risky. There may be no regulatory recourse for any loss from such transactions. The information provided in this post is not to be considered as investment/financial advice from CoinSwitch. Any action taken upon the information shall be at user's own risk.
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