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Arcana’s Guide to Understand Wrapped Tokens

Ajay Shetty
Ajay Shetty

Wrapped Tokens

Wrapped tokens are crypto tokens pegged to the value of another crypto asset.

They are called “wrapped” because these tokens contain another asset that is put in a wrapper (which can also be considered a digital vault). An easy example of a wrapped token is stablecoin. A stablecoin in essence derives its value from the fiat currency that it holds.

As the mere definition of wrapped tokens doesn’t offer much food for thought, let us dive into the key problem they solve– interoperability. But why is interoperability important?

Interoperability

Among various blockchain networks and DeFi platforms, interoperability is a huge hurdle. This is because fundamentally speaking, each blockchain is a distinct network that has its own currency for facilitating transactions in its ecosystem.

As a result, one can’t use Bitcoin on Ethereum blockchain and vice versa. But what if one wanted to use BTC on Ethereum? Would Ethereum support such interoperability where another blockchain’s currency can function as a native on its blockchain? No. And this is precisely where wrapped tokens come to the rescue.

Wrapped tokens, minted according to the standard of a certain blockchain, can contain any crypto asset from other blockchain(s). So that means you can now use Bitcoin on the Ethereum blockchain.

Consider Wrapped Bitcoin (WBTC), for instance, which is a tokenized version of Bitcoin on the Ethereum blockchain. In this case, WBTC is an ERC-20 token that contains Bitcoin in it– so Bitcoin is wrapped in a token that is minted according to Ethereum’s standard.

Now, with WBTC, one can use Bitcoins across Ethereum, which is nothing but the solution to the interoperability problem.

Technicalities of Wrapped Tokens

Let us consider the same example we’ve used previously– WBTC. Now in this case, the wrapped Bitcoin is minted through an ERC-20 token. For WBTC, one Bitcoin wrapped in the token is equivalent to its value in ETH on the Ethereum network. To ensure that the equivalent value of WBTC is provided on Ethereum, a custodian is put in place. This custodian could be a smart contract, a merchant, or a DAO.

If you consider Arcana Network’s recent NFT airdrop, we’ve wrapped our XAR tokens into NFTs. Around the time of our XAR token launch, these NFTs can be redeemed for our tokens. So in this case, we have created NFT wrapped tokens which are analogous to wrapped tokens.

Why Use Wrapped Tokens

  • For using non-native tokens on various blockchain networks.
  • For increasing liquidity as well as efficiency for decentralized exchanges.
  • For working around transaction fee and time constraints of certain blockchain networks.

The discussion of wrapped tokens and their technicalities doesn’t end here as it is an expansive topic. An extensive guide on the technicalities of prominent wrapped tokens will be published soon. Subscribe to our mailing list to never miss an update.