What are wrapped tokens? Wrapped tokens are a type of cryptocurrency whose price is related to the price of another cryptocurrency at a 1:1 ratio. Wrapped tokens are very useful when you want to move one currency created in one blockchain network to another blockchain network and conduct transactions there. This is a great advantage because it allows users of different blockchains to work across multiple networks and expands the possibilities of financial interaction.
The principle behind wrapped tokens is that they “package” the original currency into a smart contract in its native network. Then, in the second blockchain we need, an equivalent of that currency, known as “wrapped,” is created. The entire process of wrapping the original currency and creating a new wrapped currency is managed by smart contracts, the operation of which is publicly available. Such smart contracts can be published by any individual or organization.
The process of unbundling, or “unpacking,” occurs in reverse order. First there is a request to burn the wrapped tokens in a second blockchain. Once the burn process is confirmed, the original token in the wrap smart contract in the first blockchain is released and sent to its owner’s address. The wrapping and burning processes are extremely delicate, as an error at this stage could result in duplicate assets entering circulation. Duplication can greatly reduce the value and credibility of the wrapper, and reduce its usefulness, just as the issuance of counterfeit banknotes hurts a country’s economic system. An example of a wrapped token is WBTC. WBTC is a wrapped version of bitcoin in the Ethereum blockchain.
A wrapped token is a token that circulates in one blockchain but is backed by cryptocurrency from another blockchain. Such tokens are designed for cryptocurrency transactions in other cryptocurrency blockchains. For example, we want to trade bitcoins on a decentralized exchange running on an Ethereum blockchain. But we can’t move bitcoins on the Ethereum blockchain. Fortunately, the problem is solvable. To do this in the bitcoin blockchain, we send coins to an address belonging to the operator of the exchange on Ethereum, and that operator issues tokens in the Ethereum blockchain that are backed by our bitcoins. We can already sell these tokens on the Ethereum exchange: the buyer can return them to the exchange operator and get the corresponding amount of bitcoins in return.
For traders, the whole scheme looks exactly the same as depositing bitcoins on the exchange, making transactions with them, and withdrawing them. Only instead of bitcoins, the trades involve wrapped tokens. They are called wrapped tokens because the first such token was called “wrapped bitcoin” (wBTC). By analogy, all tokens backed by assets from third-party blockchains became known as wrapped tokens.