● Intermediate Technology

What are Wrapped Cryptocurrencies?

8 minutes 2 years ago

Bitcoin still remains the world number one cryptocurrency, however, some consider its protocol outdated. Why? Because it isn’t designed with smart contract capability in mind. If you wanted to use Bitcoin on platforms powered by smart contracts such as certain NFT marketplaces, you would have to trade or swap it for a different token that is compatible with said marketplace.

However, considering Bitcoin is the most widely adopted token to date, new solutions to address this interoperability issue have been developed. One of these being wrapped in cryptocurrencies.

Wrapped cryptocurrencies are 1:1 representations of a crypto asset such as Bitcoin that is hosted on a different blockchain protocol. The wrapped token tracks the value of the original asset while allowing you to use it on non-native platforms.

This lets you take advantage of advanced functionalities such as lending, loan collateral and liquidity pools among others.

Wrapped Bitcoin

One of the best examples of wrapped cryptocurrencies is wrapped Bitcoin (wBTC). Wrapped Bitcoin was created in 2019 by Bitgo, Kyber, and Ren. You can swap your Bitcoin for an equal number of wBTC through a centralised exchange or specialised protocol.

A popular form of wBTC is the ERC-20 version that can be used on Ethereum DApps such as exchanges and DeFi platforms.

Wrapped Ether

There are also wrapped versions of Ether, despite the fact that Ether is native to the Ethereum ecosystem. This is because Ether is not compatible with some ERC-20 tokens used in DApps in said ecosystem.

A group of Ethereum projects called 0xLabs came together and created a form of wrapped Ether or wETH that is compatible with ERC-20 protocols. It also uses smart contracts to lock up Ether that you send and returns an equal number of wETH in a 1:1 ratio.

What are the Pros and Cons of Using Wrapped Cryptocurrencies?

Pros

  • More Flexibility
    Wrapped cryptocurrencies can allow non-income-generating assets to become yield-bearing assets by allowing their use in certain DApps.
  • Interoperable
    When an asset becomes wrapped, it becomes easier to use cross-chain, as many bridges allow for the easy transfer of a wrapped asset to different chains.

Cons

  • Less Secure
    The major drawback of wrapped cryptocurrencies is that it loses the security of the original network and instead uses the security of the wrapped network. This means when BTC is moved over to Ethereum as wBTC, your wBTC has the security of the Ethereum Network opposed to the Bitcoin Network.
  • Less Liquidity
    While some wrapped cryptocurrencies like wBTC have a lot of liquidity and on/off ramps, it has significantly less liquidity than BTC. This is similar to most wrapped cryptocurrencies, in that they will often have less places and liquidity to exchange them than their original counterpart. In most cases, to ensure you get the best price when trading, you’d need to unwrap the token and bring it back onto its original network.

…And That’s a Wrap

Wrapped cryptocurrencies may sound like an extra and complicated step, but they are crucial. They solve the big problem of interoperability between different blockchain ecosystems with fundamentally different protocols and increase liquidity as well as the flow of assets.

Wrapped cryptocurrencies also significantly increase the utility of major tokens. For example, Bitcoin does not support smart contracts, but wrapped Bitcoin opens up a new vista of decentralised finance and money-making opportunities.

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