Wrapped Coins: Everything to Know

Overview

Wrapped coins are crypto coins that are on one blockchain, such as Bitcoin, but are backed by a token on another blockchain, like Ethereum. The most popular wrapped coin is Wrapped Bitcoin (WBTC), which is tied to the value of Bitcoin.

WBTC is an ERC-20 token on the Ethereum blockchain. It is backed by an equivalent amount of Bitcoin. A user can spend or invest Wrapped Bitcoin in the Ethereum ecosystem and access decentralized applications (dapps) and smart contracts there.

A wrapped coin is created when a user puts a certain amount of a cryptocurrency aside to be held, by a decentralized autonomous organization (DAO), merchant, multisignature wallet or smart contract. The holder then mints the wrapped coin, which is backed by the deposited amount. The user can trade the wrapped coin on any blockchain networks that will support it. If the user wants to "cash in" the wrapped coin, they return it to the holder. The holder then releases the amount of the cryptocurrency that the user deposited.

A Brief History

The first wrapped coin was Wrapped Bitcoin. Wrapped coins were developed a bit later than initial coins because they are meant to address the lack of interoperability between blockchain networks. Initially, most cryptocurrencies operated on separate blockchains. This limited cross-chain functionality. Wrapped coins have made it more possible to link interactions on different blockchains.

Wrapped coins require a setting aside of the "backing" coin. The user who is acquiring a wrapped coin needs to trust the instrument or actor setting aside the "backed" coin. Innovations in security and transparency measures help users gain more confidence in the concept of wrapping.

Wrapped Coins: Everything to Know

• How Wrapped Coins Work. Wrapped coins function through tokenization. When a user wants to wrap a specific cryptocurrency, they send it to a custodian who holds the original cryptocurrency. In exchange, the custodian mints an equivalent amount of wrapped coins on the desired blockchain network. Users then use the wrapped coins within the designated blockchain ecosystem.
• Use Cases of Wrapped Coins. Wrapped coins have various purposes in the cryptocurrency ecosystem. They enable users to access DeFi applications like lending platforms, decentralized exchanges and yield farming protocols. These apps are built on specific blockchains like Ethereum. Wrapping cryptocurrencies makes it possible for users to build liquidity and engage in activities on these platforms.

Additionally, wrapped coins facilitate cross-chain transactions. Such transactions allow value transfers between different blockchain networks. There is no need for complex processes or intermediaries. This is why cross-chain transactions enhance liquidity.

• Trust and Security Considerations. Wrapped coins involve custody of the original cryptocurrency, so trust and security are crucial. Users must trust the custodian responsible for minting and redeeming the wrapped coins. Choosing reputable custodians with robust security measures is essential to minimize the risk of vulnerabilities or theft.

Transparency in the wrapping process is also important. Most wrapped coins offer mechanisms for users to verify the collateralization of the wrapped tokens. This ensures a one-to-one correspondence between the wrapped coins and the original cryptocurrency held by the custodian.

• Popular Wrapped Coins. Examples of wrapped coins include Wrapped Litecoin (WLTC), Wrapped Zcash (WZEC), Wrapped Filecoin (WFIL) and Wrapped Chainlink (WLINK). Each of these wrapped coins caters to users' needs within their respective blockchain ecosystems.

Getting Started

Increases the value of the original cryptocurrency. Backing a wrapped coin with a recognized cryptocurrency increases the value of the backing coin. The backed coin has provided new opportunities to develop a profit.

Promotion of interoperability. Wrapped coins make it more possible for users to interact with different platforms.

Enhances the reputation and credibility of custodians. Custodians such as DAOs and merchants which hold the backing coins have the opportunity to do a good job with the service. They can use their efforts to grow their goodwill and experience.

Unique Aspects

Facilitates interoperability between different blockchain networks. Wrapping a cryptocurrency allows a user to bring the coin into a different ecosystem. Then they can take advantage of the features and functionalities offered by the new blockchain. This opens up possibilities. Users can access decentralized applications (dapps), decentralized exchange (DEX) and other services that are unavailable on the original blockchain.

Increases cross-chain liquidity. A user can leverage the value and liquidity of one cryptocurrency, such as Bitcoin, within another ecosystem, such as Ethereum. Cross-chain compatibility expands the utility of cryptocurrencies. It promotes easy integration across various blockchain networks.

Allows users to employ a wider range of assets as collateral. DeFi protocols like lending platforms and decentralized exchanges usually require collateral in the form of specific cryptocurrencies. Not all cryptocurrencies are directly compatible with these protocols. Wrapped coins bridge this gap because they allow users to employ more assets as collateral. Wrapped coins increase the accessibility and liquidity of DeFi services.

Facilitate faster and more cost-effective transactions. Some blockchain networks, like Ethereum, have faced scalability issues. This results in high fees and slower confirmation times. Wrapping a cryptocurrency means a user can employ a different blockchain with faster transaction speeds and lower fees. Wrapping allows a user to overcome a blockchain's limitations and enjoy a more efficient transaction experience.