You might have heard of wrapped Bitcoin or crypto tokens as a crypto enthusiast. Every crypto blockchain in the space has varying protocols and functionalities. As such, with the difference in their algorithms, they cannot talk to each other.
Such a trait in blockchains preserves an individual's blockchain's sovereignty and security. However, it challenges the existence of an interoperable ecosystem where data and information should be exchanged easily.
Wrapped Crypto Tokens
Wrapped crypto tokens are cryptocurrencies pegged to the value of another original crypto or assets like gold, stocks, shares, and real estate and put to work on the DeFi platforms.
The original asset is 'wrapped' into a digital vault, and a newly minted token is created to transact on other platforms. Wrapped tokens allow non-native assets to be used on any blockchain, build bridges between networks and implement interoperability in the cryptocurrency space.
Essentially, wrapped tokens are copies of the original asset created for other blockchains. In other words, they allow assets to be traded on chains other than the one they're built on.
So Wrapped Bitcoin can be traded on Ethereum, Avalanche, or any other blockchain that wishes to adopt the token. If you hold Bitcoin, this dramatically increases your trading possibilities.
They can represent anything from arts and collectibles, commodities, crypto assets, equity, and stocks to fiat currencies and real estate. Since wrapped tokens are pegged to another asset, they must be regarded and managed by a custodian entity that will wrap and unwrap the asset. We will see why this is also a limitation in the decentralized world of cryptocurrencies.
What makes a wrapped token a wrapped token is not just whether it is pegged 1:1 to the price of another asset. It's the technology behind it and how its value is backed and maintained.
How do Wrapped Tokens Work?
Wrapped tokens are created and destroyed by "minting" and "burning." To mint, a wrapped token such as WBTC, the underlying asset, in this case, BTC, is sent to a custodian who stores the BTC in a digital vault. Once the underlying BTC has been locked away, an equivalent amount of WBTC can be minted.
This process can also be understood as "wrapping." The underlying asset is "wrapped up" in a digital vault using a smart contract, and a newly wrapped asset is minted for use on another blockchain.
Just as minting wrapped tokens can be considered "wrapping" the underlying asset to create a token of equivalent value for use on another blockchain, burning wrapped tokens can be considered "unwrapping" the underlying asset.
This process of minting and burning, or wrapping and unwrapping, means that all wrapped tokens, from WBTC to renDOGE (a wrapped form of Dogecoin), are backed by an equivalent amount of their underlying currency. For every 100 renDOGE minted, 100 DOGE are being held to back the value of the wrapped token.
Final Thoughts
Achieving interoperability between different blockchains is a challenge for the industry. One problem is that as more blockchains are created, the number of bridges needed to ensure that assets on a blockchain can quickly transfer to every other blockchain increases exponentially.
For the foreseeable future, at least, bridges and wrapped tokens are set to continue to be a central part of the solution for interoperability.
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