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Wrapped Tokens Explained for Beginners

Wrapped Tokens Explained for Beginners
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tl;dr

  • Wrapped tokens are digital tokens that represent the value of another cryptocurrency or asset.

  • They allow for the transfer of assets across different blockchain networks, and their value can be pegged to the value of the underlying asset.

  • There are two primary types of wrapped tokens: cash-settled and redeemable.

  • Cash-settled tokens are backed by a reserve of fiat currency or other assets, while redeemable tokens are backed by the underlying asset itself.

  • Examples of wrapped tokens include WBTC and WETH.

What are Wrapped Tokens?

Wrapped tokens are digital tokens that are created to represent the value of another cryptocurrency or asset. They are called "wrapped" because they are essentially a token that has been wrapped around another asset. These tokens are usually created to allow for the transfer of assets across different blockchain networks. By wrapping a token, the token's value can be pegged to the underlying asset's value, allowing it to be traded on a different blockchain.

Wrapped tokens are becoming increasingly popular as they enable cross-chain interoperability and liquidity between different blockchain networks. They also allow users to access assets that may not be available on their preferred blockchain network.

Wrapped Tokens Examples

WBTC

WBTC or Wrapped Bitcoin is a tokenized version of Bitcoin that can be used on the Ethereum blockchain. 

It works by locking up Bitcoin in reserve and issuing a token on the Ethereum blockchain that represents the value of that Bitcoin. The process of creating WBTC involves a network of merchants, custodians, and auditors who work together to ensure that the reserve of Bitcoin is secure and that the correct amount of Bitcoin backs the token. 

Once the WBTC is created, it can be traded on DEXs and used in a variety of Ethereum-based applications, such as DeFi protocols.

WETH

WETH, or Wrapped ETH, is a tokenized version of ETH that can be used on the Ethereum blockchain. 

It works by locking up ETH in a smart contract and issuing a token on the Ethereum blockchain that represents the value of that ETH. The smart contract allows for wrapping ETH into WETH and vice versa, which enables ETH to be used in a wider range of decentralized applications. The process of creating WETH involves sending ETH to the smart contract, which then mints an equivalent amount of WETH tokens. When WETH is swapped back to ETH, the smart contract burns the WETH tokens and releases the equivalent amount of ETH to the user. 

This process is designed to be trustless, transparent, and secure, as it eliminates the need for intermediaries and relies solely on the Ethereum blockchain and smart contract code.

Are Wrapped Tokens Safe? 

Wrapped tokens are generally considered safe, as they are backed by the underlying asset they represent. 

However, risks can arise if the custodian of the underlying asset fails to properly secure it. Additionally, there may be risks associated with the smart contract used to mint the wrapped token, as well as the exchange where it is traded.

Wrapped Tokens vs Pegged Tokens

Wrapped and pegged tokens are two different types of cryptocurrencies designed to maintain a stable value by being linked to the value of another asset, digital or physical. While both types of tokens are linked to the value of some underlying asset, the difference lies in how they are backed and managed. 

Pegged tokens are backed by an underlying asset, such as a fiat currency or a commodity, and their value is pegged to the value of that asset. On the other hand, wrapped tokens are backed by another cryptocurrency, and their value is linked to the value of that cryptocurrency.

Wrapped tokens are usually managed by a custodian or smart contract that holds the underlying cryptocurrency and issues the wrapped tokens against it. This makes them fall under the pegged currency classification. However, stablecoins like USDT are not considered wrapped tokens because they peg their value to the US dollar in off-chain cash reserves, which are not audited through an automated protocol.

Bridging Wrapped Tokens

Bridging wrapped tokens, such as WBTC and WETH, has become a popular practice. ChainPort makes the process of bridging these tokens simple, fast, and secure. By leveraging ChainPort, users can easily transfer their wrapped tokens from one blockchain to another, opening up new opportunities for token holders.

Conclusion

The future of wrapped tokens looks promising as they continue to gain popularity. The demand for a more interlinked Web3 landscape is likely to increase the demand for wrapped tokens.

Wrapped tokens, such as wrapped MATIC, allow tokens from one blockchain to be used on another blockchain, providing greater liquidity and accessibility for token holders. This opens up new opportunities for DEXs and other DeFi applications. As the Web3 space grows and evolves, we can expect to see more innovative uses of wrapped tokens and stablecoins, further fueling the growth of the ecosystem.

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