What Are Wrapped Tokens, And How Do They Work?

One can understand blockchains in another way as distinct disseminated databases. Since these blockchains are separate and distributed, it is difficult for them to communicate. For instance, you can’t use Bitcoin on Ethereum’s blockchain since Ethereum’s blockchain can only identify Ethereum.

To solve this problem, developers created Wrapped tokens. Wrapped coins allow users to move cash between different blockchains conveniently. Furthermore, Wrapped tokens will enable users to use the transferred assets within the cryptocurrency ecosystem.

What are They?

Wrapped tokens permit the value of an asset from blockchain A to be transferred to another blockchain (B). The most known wrapped token is the WBTC-Wrapped Bitcoin. Since the Wrapped Bitcoin is pegged to Bitcoin, the value of 1 WBTC is equal to that of one Bitcoin. Wrapped Bitcoin is also available in the form ERC-20 and TRC-20; this means that the WBTC can be traded on both Tron and Ethereum blockchains,

Wrapped tokens are in a way similar to stablecoins. For instance, the USDT is pegged to the U.S dollar and assumes the price of the U.S dollar. Similarly, the WBTC follows the price of Bitcoin.

It is important to note that wrapped tokens are not just wrapped tokens because they are pegged to other assets in a 1:1 ratio. The underlying technology and its value backing and maintenance are also responsible.

Working

The creation and destruction of wrapped tokens occur by mining and burningMinting of a wrapped token occurs when the underlying asset is transferred to an overseer responsible for storing the underlying asset in a digital vault. When the underlying asset has been held successfully, the equivalent amount of a wrapped token for the underlying asset is minted. The minting process can also be known as wrapping since the base asset is wrapped up inside an e-vault, and another wrapped asset is minted to be used on a different blockchain.

The burning process is simply a reversed minting process. The wrapped token is first removed from circulation. A corresponding amount of the underlying token is feedback into circulation from the digital vault. The burning process can also be viewed as an unwrapping process. The nature of these processes, i.e., wrapping and unwrapping, tell us that all wrapped tokens are supported by an equal amount of their base currency. If 100 renDOGE are minted, 100 DOGE are sent to a digital vault to back the wrapped token’s value.

Why are They Special?

With wrapped tokens, users can transfer assets from one blockchain to another. This way, users can enjoy the features and applications of other blockchains. These features accompany advantages such as cheaper fees and higher transaction speeds, among others. It is worth noting that the number of circulating wrapped tokens, such as the WBTC, has increased. This has proliferated bridges.

This turn of events has left bridges more vulnerable to attacks from cyber criminals such as hackers. Vitalik Buterin, the Ethereum creator, cast his doubts over the cross-chain applications.

Wrapped Tokens’ Future

The main problem that arises from the creation of wrapped tokens is that the number of bridges will grow exponentially with an increase in blockchains. Developers are still trying to find a way to make bridging across different blockchain platforms more efficient, secure, and manageable. One solution that has been developed is the bridge hub. A bridge hub is a central bridge where all the blockchains bridge to. Darwinia is an example of a bridging hub undergoing construction on Substrate.

For now, interoperability and cross-blockchain communication will be facilitated by wrapped tokens and bridges.

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Disclaimer: This article is provided for informational purposes only. It is not offered or intended to be used as legal, tax, investment, financial, or other advice.