As you scroll through CoinMarketcap's coin list, you may have noticed coins like Wrapped Bitcoin and Wrapped Ethereum. And then it's not unjustified to ask yourself what these tokens are, and to what extent they match the original coin.
What are wrapped tokens?
Perhaps you have already had the problem of sending a cryptocurrency to an address that is not suitable for it. This is because there are an awful lot of different coins and tokens these days, all running on a different blockchain
. For example, you might accidentally send an ERC-20 token to a Binance Smart Chain
wallet. In this case, the tokens will not arrive.
This is because the technology between the token and the wallet is different. For example, they both use different protocols. In some cases, you will get your tokens or coins back, but it can also happen that you lose your tokens. And that can be incredibly annoying when they represent a large value.
Wrapped tokens are the solution to this problem. A wrapped token is the token version of a cryptocurrency but on a different blockchain. For example, Wrapped Bitcoin (wBTC) is the token version of the actual Bitcoin, which runs on Ethereum's
The value of the Wrapped Bitcoin token is equal to that of the actual Bitcoin. So if the value of 1 Bitcoin has a value of $40,000, Wrapped Bitcoin has exactly the same value.
How do wrapped tokens work?
Wrapped tokens allow you to use a cryptocurrency in the form of a token on another blockchain. Thus, the value of the cryptocurrency and eponymous token are always equal to each other.
To keep the value the same, a custodian is used to ensure that the same amount is held continuously. Such a custodian can come in different forms. For example, this can be a trader, who keeps an eye on it quite manually, but in most cases is a smart contract or DAO.
The smart contract then ensures that the value will always be the same. Does the contract see that the value of BTC
has increased by $100? Then the price of wBTC will automatically increase by 100 dollars as well. wBTC is on Ethereum's blockchain, so this can be arranged with a smart contract. This is not true for every blockchain. Hence, a custodian of the price looks different on other blockchains.
The benefits of wrapped tokens
We dropped in the beginning what one of the advantages of wrapped tokens is. However, there are many more advantages to using wrapped tokens. Below we will go over the main benefits of wrapped tokens.
Used for Decentralized Applications (dApps)
Many projects run on the Ethereum blockchain. Therefore, you have a lot of different ERC-20 tokens. For example, by converting coins such as Bitcoin to tokens on the Ethereum blockchain, Bitcoin can suddenly be used for these projects. This provides developers of decentralized applications (dApps) with many additional options and can also be useful to the end-user of these applications.
More volume and liquidity
The use of wrapped tokens also creates an additional volume of, say, Bitcoin in an apps, which also brings greater liquidity. And that's especially nice for projects within the DeFi sphere.
Decrease of transaction time
Making a transaction on the blockchain of Bitcoin or Ethereum can sometimes take a long time and incur a lot of costs. This is not the case when wrapped tokens are used. In fact, transaction times and costs are much lower for wrapped tokens, since they run on a different blockchain and are used less.
This is not only nice for the end-user, but also for developers. They suffer a lot from high transaction costs, as it can deter users from using their applications.
Examples of wrapped tokens
Below are some common and well-known wrapped tokens. You'll notice that these all run on Ethereum's blockchain. There's a pretty logical reason for that. After all, Ethereum is the most widely used blockchain for crypto projects.
It makes little sense to run a token version of a coin on a blockchain where few or no projects are running. This is because the token will not be used, and it will lose its function.
Because these tokens run on the Ethereum blockchain, these tokens can be used for the many projects that Ethereum is rich in. This creates many advantages for both developers and end-users of dApps.
- Wrapped Bitcoin (wBTC) - Bitcoin token on the Ethereum blockchain
- Wrapped NXM (wNXM) - NXM token on the Ethereum blockchain
- Wrapped Monero (wXMR) - Monero token on the Ethereum blockchain
- Wrapped Celo (wCELO) - Celo token on the Ethereum blockchain
- Wrapped Matic (wMATIC) - Matic token on the Ethereum blockchain
- Wrapped Ethereum (wETH) - Ether token on the Ethereum blockchain
Why can't Bitcoin run on the Ethereum blockchain?
You may still be asking yourself why Bitcoin can't run directly on Ethereum's blockchain, and thus requires a token. That's because Bitcoin and Ethereum are two different layer 1 blockchains. The eponymous cryptocurrency
is connected to its own blockchain.
Both blockchains use different techniques. For example, Bitcoin uses Proof of Work (PoW
), while Ethereum is transitioning to Proof of Stake (PoS
). Ethereum can additionally support smart contracts, which is very widely used by the applications that can run on the blockchain.
On Bitcoin's blockchain, developers can also build a project, but it is much less accessible. This is because Bitcoin does not support smart contracts in its fundamentals.
The coins use the same underlying technology as the blockchain. For example, Ethereum's coins are programmed in Solidarity, while Bitcoin is primarily programmed with C++.
Due to this fundamental and technical difference between these two blockchains, it is not possible for both coins to run on each other's blockchain. Therefore, it is necessary to create an ERC-20 version of Bitcoin, which thus uses the technology of Ethereum.
Incidentally, all tokens on Ethereum's blockchain use the ERC-20 protocol, so they are all ERC-20 tokens. So just because Bitcoin is the largest cryptocurrency doesn't mean it has a different or more important role on the Ethereum blockchain. The only difference is that the price is always linked to the actual Bitcoin, whereas with most tokens it is determined by supply and demand (except for stable coins of course).
It‘s actually not that difficult at all to understand wrapped tokens. These are simply the token version of already existing crypto coins from a different blockchain. Wrapped Bitcoin, for example, is the ERC-20 token version of the actual Bitcoin. Because Bitcoin cannot run on Ethereum's blockchain, the coin has been converted into a token.
This makes it possible to use Bitcoin on Ethereum's blockchain as well. And this brings several advantages. For example, it ensures lower transaction costs, better usability of dApps and more liquidity for DeFi
So, in this way, step by step, it is ensured that the blockchain and crypto world will work better together. And that, of course, can only benefit the blockchain technology and crypto world.