What Are Wrapped Tokens? – Everything You Need To Know

by | Feb 26, 2021 | Altcoins, Tutorial | 0 comments

Today, we’ll be discussing wrapped tokens, the bridge between blockchains.

Imagine being rich in bitcoin yet you cannot use it to perform a particular transaction on another blockchain.

Frustrating, right?

Gratefully, this is a problem that wrapped tokens are created to solve.

Keep reading to learn more!

Post Summary

For an easy read, this post is grouped under these subheadings:

  1. What Are Wrapped Tokens?
  2. How Are Wrapped Tokens Created?
  3. Uses Of Wrapped Tokens
  4. Limitations Of Wrapped Tokens
  5. What Does The Future Hold For Wrapped Tokens?
  6. FAQs
  7. Conclusion

A click on any item above will reveal its content.

Enjoy your read!

1. What Are Wrapped Tokens?

wrapped tokens

A wrapped token can be defined as the tokenized form of another cryptocurrency.

Put simply, it is transforming (wrapping) a coin to become useful in a blockchain that is not its native blockchain, without losing its value.

The idea is to enable interaction between different blockchains despite their uniqueness.

For example, Bitcoin cannot be used for transactions on Ethereum blockchain.

But when it is converted into a wrapped Bitcoin (WBTC), which is an ERC-20 token, it can then be used on the Ethereum blockchain.

Even ETH which is the network token of the blockchain cannot be used to process ERC-20 smart contracts until it is wrapped (WETH).

The above examples portray that the concept of wrapped tokens was initiated to make non-Ethereum tokens compatible with the network.

While this statement is not far-fetched, other blockchains like the BCH and TEZOS blockchains also support wrapped tokens.

You should also note that the rise of DeFi apps on the Ethereum blockchain contributed to the creation of wrapped tokens so that other blockchain coins can join the trend.

Furthermore, a wrapped token retains the value of its original coin (1 WBTC = 1 BTC).

You can also unwrap the token at any time to redeem its original nature.

Think of it as a stablecoin, which retains the value of the fiat currency that it represents.

Got it? Good!

In the next section, we’ll see how these tokens are created.

Tag along!

2. How Wrapped Tokens Are Created

There are 3 parties involved in the creation of wrapped tokens namely:

  • A user – the individual that needs the tokens
  • Merchant – a platform that distributes wrapped tokens. It can initiate the minting and burning of the tokens
    • Examples are Kyber, GoPAX, AirSwap, Coinlist, and DeversiFi.
  • Custodian – the platform that holds the original assets and mints the wrapped tokens. It can be a DAO, a multisig wallet, or a smart contract.
    • Examples are BitGo, Binance Smart Chain (BSC), and RenVM.

Here are the steps involved (using WBTC as an example):

a. The user contacts a merchant and indicates his interest for WBTC 

b. Next, the merchant proceeds to the custodian with a request to mint WBTC.

c. The custodian then sends the WBTC to the merchant’s Ethereum wallet address after receiving an equivalent amount of Bitcoin from him.

During this process, the custodian may take the merchant through KYC and AML.

d. Finally, the user and the merchant swap BTC and WBTC on an exchange like Binance, Uniswap, or Kyber.

Note: You may not need to contact a merchant to own WBTC, simply visit an exchange that supports the token and trade it with what you have.

You can find trading pairs like ETH/WBTC, USDT/WBTC, and so on.

Unwrapping A Token

As mentioned, a wrapped token can be redeemed or unwrapped.

To achieve this, the merchant places a burn request to the custodian, who then releases the required BTC.

Simple and easy!

Moving on, we’ll see the uses of these tokens.

Keep reading!

3. Uses of Wrapped Tokens

a. Ability to explore other blockchains

Since a large chunk of DeFI ecosystem is based on Ethereum, it is rather frustrating for Bitcoiners to tap into it.

But with the advent of Wrapped Tokens, Bitcoiners can comfortably participate by wrapping their BTC.

On MakerDAO, Compound, and KyberNetwork, you can deposit WBTC as collateral.

b. Greater liquidity

This helps to boost functionality and liquidity for both centralized and decentralized exchanges.

Since the liquidity of BTC is far greater than that of other blockchains, wrapping your BTC converts the high liquidity to Ethereum. BTC gets to interact with the Ethereum chain too.

Another example is wrapped Zcash.

The Ethereum blockchain enjoys the privacy function of the coin while Zcash users get to interact with the financial applications on Ethereum.

Either way, it is a win-win case for both blockchains.

c. Increases scalability

The scalability issues of Bitcoin is no longer new in the crypto-verse.

Now since Wrapped Tokens exist on Ethereum, transactions conducted there are faster and costs less.

This way, you are able to perform more transactions at a lesser cost.

Impressive, huh?

Next, we’ll see the limitations of these tokens.

Read on!

4. Limitations of Wrapped Tokens

The benefits of these tokens notwithstanding, they have their limitations.

Firstly, a custodian must mint the tokens.

This poses a risk of losing funds should something go wrong with the custodian.

Also, we cannot really say that transactions involving wrapped tokens are truly cross-chain since they have to pass through a custodian.

Moreover, it costs high gas fees to mint these tokens cost and there may be some slippage.

So, is the future bright for these tokens?

Find out in the next section.

5. What Does the Future Hold for Wrapped Tokens?

The future is bright because these tokens improve interoperability between blockchains.

Also, many DEXs and protocols like Compound, Bitgo, Ren, Uniswap, Gnosis, and Kyber have adopted wrapped tokens.

And these tokens are doing well in the market.

As of 26/02/21, WBTC ranks #15 on CoinMarketCap with a market cap of €4,596,603,813 and 123,420 WBTC are in circulation. Cool!

As time goes, the concept of wrapped tokens will most likely be adopted in equity markets.

This will enable the wrapping of corporate bonds and municipal debt and their placement on the blockchain.

Thereby bringing in lots of buyers and boosting the liquidity of the blockchain.

Lastly, advancement in blockchain technology is not slowing down.

Therefore, we can look forward to a future where the minting and redemption of wrapped tokens will become decentralized.

Cheers to that!

6. FAQs

Are all wrapped tokens hosted on Ethereum blockchain?

Yes. They are ERC 20 tokens.

How do I redeem Wrapped Bitcoin (WBTC) for BTC?

To get this, you simply need to unwrap your token.
Steps to do that are:
i. Visit your favorite merchant
ii. Click “Unwrap” from your WBTC wallet.
iii. Next, you enter the amount of WBTC you wish to swap into BTC.
iv. Then click “Confirm Unwrap” to receive BTC directly in your BTC wallet.

How does Wrapped Tokens differ from Stablecoins?

A Stablecoin is a cryptocurrency that is pegged to an asset with a stable value, such as gold, crypto, or fiat money like the US dollar.
So Wrapped Tokens can be said to be a type of Stablecoins. I make this assertion because Wrapped Tokens too are pegged to cryptocurrencies and have the same value as the coin it is pegged to e. g 1 WBTC = 1 BTC.
But that’s as far as their similarity can get.
The aim of pegging coins is to stabilize their prices to wedge against inflation while the whole idea of wrapping tokens is to enable their usage on another blockchain e. g WBTC can be used comfortably on the Ethereum blockchain.

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7. Conclusion

We have now come to the end of our discussion on wrapped tokens. I hope you enjoyed the read.

So, tell me: what’s your take on these tokens? Do you think they are a positive addition to Fintech?

What coins would you love to wrap and for use on which blockchain?

Let me hear your thoughts in the comments section right now.

Also, share this post with other crypto lovers on your list, thank you!

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Chinma Udeji
Professional Cryptocurrency Writer. I break down complex crypto topics into simple words.