# Wrapped tokens

By [Flend Research Group](https://paragraph.com/@flend-research-group) · 2023-10-25

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**Wrapped tokens**, a fascinating concept in the crypto space, bridge the gap between disparate blockchains and enable a seamless exchange of assets. Blockchains, like Bitcoin and Ethereum, with their unique protocols, face interoperability challenges. Wrapped tokens step in as a solution, allowing different assets, from stocks to real estate, to transcend their native blockchains.

At their core, wrapped tokens peg an original asset to a digital representation, facilitating its use on diverse blockchains. These tokens bring a new dimension to decentralized finance (DeFi), where the swift movement of funds is paramount. While newer blockchains like Polkadot aim for interoperability, the need arose for a solution to link early networks like Bitcoin and Ethereum – hence wrapped tokens.

These tokens, pegged to the value of another asset, serve as versatile tools in the crypto space. Whether it's art, commodities, or traditional assets, wrapped tokens enable their use across various blockchains, creating bridges between networks. Notable examples include wrapped Bitcoin (wBTC) on Ethereum and tokens compliant with Ethereum ERC-20 and Binance Smart Chain BEP-20 standards.

Wrapped tokens come in two types: **cash-settled** and **redeemable**. While the former cannot be exchanged for the underlying asset, the latter allows investors to swap the wrapped token for the original asset.

So, how do wrapped tokens function? Merchants, acting on platforms like Ethereum, initiate the process by requesting the custodian to mint an equivalent amount of the original token. The custodian, like a digital vault, ensures the token's backing and mints the wrapped version for use on other platforms. While this process introduces a custodian, a **centralized entity**, it facilitates cross-chain transactions.

Wrapped Bitcoin, the pioneer, debuted in January 2019, unlocking the potential for Bitcoin within the Ethereum ecosystem. While maintaining the same value as Bitcoin, wrapped Bitcoin offers enhanced functionality, enabling participation in DeFi transactions. Lenders can deploy Bitcoin through smart contracts, earning fixed interest rates, and borrowers use their crypto as collateral.

The mechanics of wrapped Bitcoin involve three primary actors: the DAO, merchants, and custodians. The DAO, a Decentralized Autonomous Organization, oversees the protocol's governance, while merchants trigger the minting process by sending Bitcoin to custodians. Custodians, acting as secure vaults, ensure the backing of wrapped Bitcoin and mint equivalent tokens on Ethereum.

However, the need for custodians introduces a limitation in the decentralized ethos of blockchain. Trust in custodians becomes paramount, raising concerns about the security of wrapped tokens. While technically secure, the reliance on custodians poses risks. A decentralized smart-contract-managed bridge emerges as an ideal solution, eliminating the need for trust in third parties.

The safety of wrapped Bitcoin tokens hinges on the custodian's trustworthiness. Centralized custodial bridges require users to trust the entity holding Bitcoin, whereas decentralized smart-contract-managed bridges eliminate this need. The debate over the security of wrapped BTC bridges remains a hot topic in the DeFi community.

As for their investment potential, wrapped tokens gain traction in the crypto world. Over $800 million worth of Bitcoin has transitioned into wrapped Bitcoin in just over a year, underlining their growing market capitalization. These tokens enhance liquidity and capital efficiency for exchanges, offering quick transactions and lower fees compared to native blockchains.

In **conclusion,** wrapped tokens emerge as a pivotal force in the dynamic landscape of cryptocurrency. Bridging blockchains, enhancing liquidity, and redefining how assets are utilized, they signify a promising evolution in decentralized finance. As technology evolves, the quest for decentralized options intensifies, shaping the future of wrapped tokens in the crypto sphere.

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*Originally published on [Flend Research Group](https://paragraph.com/@flend-research-group/wrapped-tokens)*