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In a world where we have more than 22,000 cryptocurrencies, the movement of capital and funds around can be quite difficult. This is due to the nature of some blockchains, which cannot communicate between each other.
While the newer blockchains try to eliminate this by trying to be as interoperable as possible, older blockchains are rather difficult or unwilling to adapt and change. Thus, moving or swapping assets between different chains can become exhausting. To help solve this problem, wrapped tokens were created.
Wrapped tokens are cryptocurrencies that are pegged to the value of another, underlying asset. This can be anything from cryptocurrencies, gold, real estate to stocks or shares. It only depends on what the users want to put on the DeFi platform. The communication and participation with different DeFi platforms or protocols is also one of the reasons why wrapped tokens were created.
Thanks to wrapped tokens, users are allowed to participate in different protocols without the need to sell their original coins or tokens. The only thing they need to do is “wrap” the original asset, which goes into a digital vault with new token being minted allowing for transaction to other platforms, protocols or blockchains.
Once the token is wrapped, the users can use it to interact with different DeFi dApps and can benefit from such features as yield farming, earning interest or liquidity mining. These are usually services provided by different protocols, which incentivises the users to lend their wrapped tokens onto the platform in exchange for financial benefit.
Wrapped tokens, however, have other roles as well. They can allow for non-native assets to be used on any blockchain. This means that bitcoins can be used on different platforms and networks, based solely on the protocol onto which they are being wrapped. This helps with building bridges between networks or implementing interoperability in the cryptocurrency world as such.
While wrapped tokens clearly eliminate the need for exchanging or swapping tokens, they have several other benefits that help the cryptocurrency world as such to work better. Their usage can help for instance with the overall progress of the crypto industry or improve upon the user experience.
The wrapped tokens help with bridging different blockchains. The interoperability, which is one of the biggest pitfalls of the cryptocurrency world, is in many cases solved by the presence of wrapped tokens. This is for instance visible when looking at individual blockchains and their advantages. If the wrapped tokens were not introduced, the users would not have the chance to reap the benefits of different blockchains, since they would be isolated from each other. Wrapped tokens solve this.
They also improve the overall transparency and the decentralization, which are core characteristics of the crypto sphere. The whole process of the minting and burning of wrapped tokens, which will be explained in the example of WBTC and WETH, is highly decentralized. Moreover, there is a decentralized organisation whose votes help with addition or removal of new custodians and merchants, meaning that no single entity is in charge. Instead, the votes connected to the DAO help with the whole process.
The information connected to custodians is publicly available, meaning that it can be checked and verified by anyone. This keeps all the parties involved honest, but also allows them to build trust in the whole system.
Wrapped Bitcoin (WBTC) is probably one of the best known wrapped tokens in the world. This is not only because Bitcoin is the biggest cryptocurrency in the market, but also because its holders are usually holding it for a long period of time, during which they can earn interest on other DeFi protocols. It was first announced on October 26th 2018 and launched only a few months after at the end of January 2019.
Wrapped Bitcoin is basically a way to standardise Bitcoin in the ERC-20 format, thus on the Ethereum network. This means that the users can “spend” Bitcoin on Ethereum, whilst the custodian holds the Bitcoin that is equal to the number of WBTC tokens that are being issued. This aims to help with usability of Bitcoin in the DeFi space, by bringing its value onto the Ethereum network.
The WBTC standard also ensures that the wrapped Bitcoin is compatible with Ethereum wallets, smart contracts or decentralized applications. WBTC can also be held on different decentralised exchanges, such as UniSwap. However the list of supporters and projects connected to WBTC is rather extensive.
If the users want WBTC, they first need to initiate a request with one of the merchants. Merchants are entities that are responsible for handling requests to mint or burn wrapped tokens. They are also in charge of managing and distributing the WBTC that is in circulation, while also performing procedures such as KYC and AML. Merchants are thus only mediators between users and custodians.
Once there is a request initiated with merchants to wrap BTC and all the procedures are satisfied, the users can then send the Bitcoin to a wallet address of the given merchant. Following this, the merchant sends it to the custodian, who also mints new wrapped tokens and sends them back to the merchant, who distributes it accordingly.
The wrapped tokens are however never in the hands of merchants. Once the process is completed, the custodian holds the bitcoins in the safe vault, while the WBTC has been distributed to the user who can now use it on the Ethereum network.
The similar process happens if the users want their bitcoins back. First, they need to initiate the request with the merchant, who initiates the burn request with the custodian. After all the necessary checks and transfers are made, the custodian releases BTC that is equal to the number of WBTC transferred by the user. The WBTC token is burned and the user receives the equivalent of BTC back.
This ensures the balance of the peg, with 1 WBTC being covered by 1 BTC. It also means that for every WBTC out there, there is a bitcoin in the hands of custodians maintaining the balance.
Just like Bitcoin, Ethereum, the second biggest cryptocurrency, has its own wrapped version. Wrapped Ethereum (WETH) is a compatible version in the form of ERC-20 token. This might be a bit surprising since Ether is the native currency of Ethereum. However, Ether was created before the ERC-20 standard was implemented.
This means that Ether is not compatible with ERC-20 standard, unless it is in the WETH version. Without it, creating and issuing smart contracts on Ethereum blockchain, which ERC-20 standard offers, is not possible. But with WETH, which is ERC-20 compatible, the users can benefit from a whole lot of DeFi protocols.
All the minting and burning processes work the same as with Bitcoin and wrapped Bitcoin. This means that WETH has to be covered and pegged in a ratio of 1:1 with ETH, while custodians, in this case a smart contract, are having ETH in vaults until the users do not ask for them to be released and WETH burned.
Main reason, however, for the creation of WETH was the elimination of the need for central authority that would swap ETH with any ERC-20 tokens. Before this was allowed, swapping ETH to any ERC-20 compatible token took more steps and led to more transactions. However, now, with a direct swap of ETH to WETH, the unnecessary steps are eliminated and so are the transactions that had the potential to clog the network.
Currently the WBTC is available on two different chains. First one and obviously the most used one is Ethereum, which has, as you can see from the picture below, more than 203,060 BTC in custody worth about $3.48 billion.
The second chain is Tron, which is much less popular with only 100 BTC in custody, worth approximately $1.7 million. When it comes to WETH, the wrapped Ethereum on Tron contains about 2,000 ETH worth approximately $2.5 million.
Wrapped tokens such as WBTC and WETH clearly solve several problems. The demand especially for WBTC shows that there is a gap between the blockchains and their interoperability, which needs to be filled and WBTC with other wrapped versions of tokens are trying to do just that. Their presence in the cryptocurrency world can help this industry grow and progress much faster while helping the users to earn passive income on their investments.
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