What is a wrapped token?
With a wrapped token, you can invest in Tesla shares with Bitcoin. In this article, you will read everything you need to know about wrapped tokens!
What is a wrapped token?
A wrapped token is a cryptocurrency whose value is equal to that of another asset such as a Bitcoin or a share. The equal value is achieved through smart contracts or by purchasing the underlying assets.
With a wrapped token, it is possible, for example, to use Bitcoins on Ethereum. The technology behind wrapped tokens is complicated, but fortunately, you don’t need to understand it to use them.
How does a wrapped token work?
Tokens are wrapped within a smart contract. The wrapped token is then created on a second blockchain.
These smart contracts are drawn up by decentralized autonomous organizations (DAO). The first letter of the wrapped token usually refers to the name of the DAO used.
Unwrapping a token also occurs through a request from the trader to the DAO (custodian). The token is then burned, and proof of this is provided.
What are the benefits of a wrapped token?
It increases interoperability
Since blockchains all work differently, there is no good way to move information between these systems. Wrapped tokens increase interoperability (the extent to which systems can work together) between different blockchains.
Using a wrapped token such as Wrapped Bitcoin enables integration into the Ethereum ecosystem. Ethereum has the largest ecosystem of any cryptocurrency you can find at the moment.
This enormous network includes, among other things, exclusive wallets, Dapps, DEXs, games, and smart contracts. Users of wrapped tokens can use DeFi lending and borrowing networks without giving up or trading their Bitcoin directly.
Another important advantage of a wrapped token is the greater liquidity. The Ethereum ecosystem is very diverse and spread out. As a result, DEXs (decentralized exchanges) and other platforms may lack the liquidity needed to function properly.
With wrapped tokens, liquidity in the market increases, which increases tradability.
Lastly, wrapped tokens provide more scalability. Because wrapped tokens exist on the Ethereum blockchain instead of the Bitcoin blockchain, transactions executed with wrapped tokens are faster and cheaper.
What are the disadvantages of wrapped tokens?
You have to trust the custodian
When you wrap a Bitcoin into a wBTC, you no longer own the private key. In this case, you give up some control and must trust the party responsible for custody.
Another disadvantage of wrapped tokens is the gas fees you have to pay. Especially for the Ethereum network, the costs of wrapping your tokens are currently high.
You need a custodian to wrap tokens. This creates centralization, which goes against the idea of Bitcoin.
You lose your private key
When you wrap a cryptocurrency, you lose the private key. Giving up your private key is always a risk.
Extra features with wrapped tokens
When using wrapped tokens, you can suddenly use new features.
Smart contracts are self-executing, pre-programmed contracts. When the conditions are met, the content of the contract is executed.
Smart contracts are impossible with normal Bitcoins. However, by using wrapped tokens, you can still use smart contracts with Bitcoin.
The emergence of DeFi (Decentralized Finance) has made wrapped tokens really popular. DeFi applications try to convert traditional centralized financial services into a decentralized version.
Staking is one of the most popular DeFi functionalities. There are currently multiple versions of staking protocols that you can use as an investor. Most require a user to lock up their cryptocurrency in a smart contract for a specified period in exchange for rewards.
Users who convert their BTC to Wrapped Bitcoin can benefit from the new protocols. Platforms such as CoinList make it possible, for example, to automatically earn money by staking your Wrapped Bitcoin.
What are the most well-known wrapped tokens?
Wrapped Bitcoin (WBTC) was created after the announcement of a partnership between Kyber Network and BitGo in October 2018. The two companies aimed to work together to create a bridge that would be capable of creating ERC20 tokens linked to the real market value of Bitcoin.
The project was eventually launched in January 2019. Wrapped Bitcoin is an ERC-20 token that is fully backed by BTC in a 1:1 ratio. Unlike Tether’s reserves, the main custodian of WBTC holds the same number of coins for its entire ERC20 token supply.
renBTC is the second well-known wrapped token that came out just after WBTC. renBTC was developed by Ren Protocol, which is a special open-source liquidity protocol that aims to bridge the gap between different blockchain networks.
Stable coins vs. wrapped tokens
A stable coin like Tether (USDT) is nothing more than an on-chain representation of the dollar linked to the real price of the fiat currency.
The same goes for Wrapped Bitcoin. With this wrapped token, investors can choose to switch to an Ethereum-based version of their asset instead of selling the original coin and buying Ether.
The difference is that Wrapped tokens are therefore linked to a specific project and are not tied to normal fiat currencies like the dollar or euro.
Are wrapped tokens safe?
The technology behind wrapped tokens is secure. However, you must be able to trust the custodian. In theory, a custodian can run away with the Bitcoins.
This is not a sustainable business model, of course: if a company has been around for a while, this is a good sign. However, hacks or mistakes can still happen, so always remain critical when investing in crypto.
Are wrapped tokens a good investment?
Whether wrapped tokens are a good investment depends on two factors:
- Do you believe in the long-term value of both assets?
- Do you trust the custodian?
Wrapped tokens increase the functionality of, for example, Bitcoin. However, often, it may be more practical to invest directly in the underlying asset. You can simply buy Tesla shares instead of wrapped Tesla shares.