One reason why there is an increasing need to develop cross chain solutions is because of the proliferation of blockchains today.
Ethereum alternatives like BNB Chain, Solana and Polkadot may boast quick transaction speeds and lower gas fees; but the reality is that many tokens are still built on the dominant Ethereum blockchain.
Why do we need wrapped tokens?
Blockchain technology so far does not allow for coins minted on one blockchain to be traded in their original form on another blockchain. Bitcoin cannot be traded directly on the Ethereum blockchain.
Cross chain development is a long-term solution. For a quick fix, the simplest way to circumvent this restriction is to use wrapped tokens.
The concept is simple. Wrapped tokens are tokenized versions of crypto on another blockchain, thus they utilise a different token standard.
For example, the ERC-20 version of bitcoin is wrapped bitcoin (wBTC). Similar to how a stablecoin is pegged to the value of fiat currency, WBTC is pegged to BTC in a 1:1 ratio and is worth the same value. For every 1 WBTC, there is 1 BTC backing it.
Wrapped tokens are traded on non-native blockchains and later redeemed for the original crypto. They create greater cross-chain interoperability between blockchains and crypto to open up more use cases of the crypto.
For example, traders could inject wBTC into DeFi lending, borrowing and liquidity mining protocols built on Ethereum to earn passive income.
One wrapped token outlier is wrapped Ether (wETH). While wETH is traded on its native Ethereum blockchain, Ether was created before the now-default ERC-20 token standard. Hence, it is wETH, and not ETH, that would be more compliant with newer DeFi protocols.
Obtaining wrapped tokens
Wrapped tokens are usually minted. To acquire wBTC, for example, you could deposit BTC on a centralized custodial platform (centralized wrapping). The platform will then allocate you the corresponding amount of wBTC from their reserves. Alternatively, you could deposit into a DeFi protocol with a smart contract programmed to mint wBTC (decentralized wrapping).
When you are ready to redeem your wBTC for bitcoin, the platforms will burn the wBTC before returning the bitcoin back to you.
The views expressed in this article are the author's alone and do not necessarily represent the views of ApolloX.
Risk Reminder: Crypto trading carries a risk. All trading activities are done at your discretion and at your own risk. The information here should not be regarded as financial or investment advice from ApolloX. ApolloX will not be liable for any loss that might arise from your use of any financial product.
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