What is a Wrapped Token?
The virtual asset that is equal to the value of the cryptocurrency in the blockchain network at a ratio of 1:1 and can work in different blockchain networks is called a Wrapped Token.
Wrapped tokens are developed so that the cryptocurrency can be transacted outside of the original blockchain network to which it belongs.
The Wrapped token is indexed to the value of the original asset and can be traded for the value of the original currency at the time of trade. They are similar in structure to stablecoins, which derive their value from fiat currencies.
While the stablecoin gets its value from fiat currencies, the Wrapped Token value is indexed to a digital asset running on a different blockchain.
Cause of the wrapped structure, it is possible to switch between blockchains, as well as the ability of the original token to move on more than one blockchain.
As it is known, the blockchain structure is similar to a long registry with its own registration system. In the blockchain system, which does not work in a typical database logic and where transactions are sequentially sequenced, data is archived in closed-loop logic.
Normally, data on the Bitcoin network cannot interact with those on the Ethereum (ETH) network. But thanks to the wrapped tokens, there is a chance to be directly involved in transactions on the Ethereum network.
How Does the Wrapped Token Work?
A safety deposit box is needed when creating the wrapped token. Wrapped tokens are issued in the amount corresponding to the cryptocurrency paid to the escrow. The party we refer to as “depositor” here may be a service provider, multi-signature wallet, or a Decentralized Autonomous Organization (DAO).
If we go from the Bitcoin example, if 1 BTC is transferred for transaction on the Ethereum network, this amount is processed into the smart contract in accordance with the Proof of Reserve (PoR) algorithm and 1 WBTC is created and transferred to the user.
The terms of the smart contract work in reverse when the user wants to convert the WBTC savings back into BTC after completing the transaction. While the BTC placed in the safe deposit box is released and delivered to the user, the related WBTC is destroyed by burning.
Pros of Wrapped Tokens
Apart from being able to be used across different blockchain networks, Wrapped tokens can provide both liquidity and capital efficiency for cryptocurrency exchanges, whether they are centralized or decentralized.
It may allow the occurrence of trading pairs that cannot be created under normal conditions and the realization of new trading possibilities.
Transaction costs and transfer times can also be improved with the Wrapped token. For example, since transactions in the Bitcoin network are processed over 10-minute blocks, they are slower and with higher transaction fees than alternatives. With alternatives such as Wrapped Bitcoin, these problems are likely to go away.
Cons of Wrapped Tokens
In clearing transactions, absolute trust must be placed on the depository party. Because these tokens are based on the principle of creating a version that works on the alternative network, instead of performing cross-chain transactions. So having a trustee is essential.
On the other hand, the token generation process can cause price fluctuations. Sometimes, high gas fees can become more expensive than normal.