The introduction of wrapped tokens was aimed at overcoming the problem of blockchain fragmentation. The user can own BTC, store the coin, and, if necessary, perform a BTC to ETH swap using the services of any trading platform. However, it is technically impossible to transfer BTC to another blockchain without changes. The solution to this problem is provided by the use of wrapped tokens, allowing assets to be efficiently moved between different blockchains and interacted with them in the crypto ecosystem.
What Are Wrapped Tokens?
Wrapped tokens are assets that enable the transfer of value of an underlying asset between different blockchains. An example of such a token is Wrapped Bitcoin (WBTC), pegged to the price of Bitcoin (BTC) in a 1:1 ratio. Thus, one WBTC is always equal to one BTC. A special feature of WBTC is its availability in the form of ERC-20 or TRC-20 tokens, which are used on the Ethereum and Tron blockchains.
This means their price should ideally stay very close to $1. You can check the current USDT price on many cryptocurrency exchanges or financial websites. The exchange of BTC to WBTC is carried out in a 1:1 ratio, similar to the exchange of 1 USDT for 1 dollar. The similarities between wrapped assets and stablecoins do not end there. They are also traded on CEX along with base coins, although finding a platform where it is possible to sell WBTC to XMR will be much more difficult. However, the key feature of a wrapped token is not only its 1:1 pegging to the price of another asset, but also the technology behind it and the methods used to support and secure its value.
How Wrapped Tokens Work
The process for wrapped tokens is based on processes known as “minting” and “burning”. Creating a wrapped token such as WBTC begins by sending the underlying asset (such as BTC) to a custodian responsible for storing it in a digital vault. Once the underlying BTC is locked, an equivalent amount of WBTC is released. This process is also known as “wrapping”. The underlying asset is “wrapped” into digital storage using a smart contract, and a new token is created for use on another blockchain.
To “burn” WBTC, the reverse process is performed. WBTC is removed from circulation and an equivalent amount of BTC is removed from digital storage and returned to circulation. Just as issuance can be thought of as “wrapping” the underlying asset to create a token of equivalent value for use on another blockchain, burning can be thought of as “unwrapping” the underlying asset.
This process of “minting” and “burning”, or “wrapping” and “unwrapping”, ensures that all assets of this type, from WBTC to renDOGE (the wrapped form of Dogecoin), are backed by an equivalent amount of the base currency. For example, for every 100 renDOGE issued, there are 100 DOGE held to back the value of the wrapped token.
Why Are Wrapped Tokens Important?
WBTC and similar assets play an important role in facilitating interaction between different blockchains. This allows you to easily move assets and use features and applications available on other blockchains. Benefits include improved transaction speeds, reduced fees and new profit opportunities.
As the number of WBTC in circulation grows, so does the number of bridges—solutions that allow users to wrap their tokens to move them between blockchains.
However, despite these benefits, bridges also come with certain risks. They have been the target of hacker attacks, and Vitalik Buterin, the creator of Ethereum, has expressed pessimism about cross-chain applications due to bridge security vulnerabilities, which he mentioned in January 2022.
How Secure Are Wrapped Tokens?
From a technical point of view, WBTC is considered secure. It is typically stored on trusted platforms such as Ethereum or Binance Smart Chain, and once converted into an ERC-20 or BEP-20 token, provides security to the corresponding network.
However, a significant disadvantage of WBTC is the need to trust the custodian managing the underlying asset. If the custodian unlocks and transfers real BTC to another party, holders of ERC-20 tokens corresponding to BTC risk being left with a worthless asset.
A centralized custodial bridge where BTC is stored requires trust in an organization that promises, for example, the issuance of ERC-20 tokens on Ethereum. Users should ensure that such organizations, at a minimum, are provided with guarantees and insurance against possible problems.
In a decentralized crypto environment, a decentralized bridge managed by a smart contract would be the preferred option. In this case, there is no need to trust a third party, since you can only rely on the time-fixed, immutable smart contract code.”
