What are ‘wrapped tokens’?
Wrapped tokens have opened up a whole new world of possibilities in the cryptocurrency market. But what are they? How do they work? Where can you find them? What’s the difference between wrapped tokens and regular tokens?.
Wrapped tokens are a type of tokenized cryptocurrency. Unlike traditional cryptocurrencies, which are digital currencies that operate on their own blockchains, wrapped tokens are based on a different blockchain but operate similarly to cryptocurrencies. The main thing that sets wrapped tokens apart from other digital currencies is that they’re “wrapped” inside of another blockchain. That means that if you have a wrapped token, you actually have two things: the underlying asset, and the actual token itself. The underlying asset is traded on the blockchain of its own currency, while the token itself is traded on whatever blockchain it’s wrapped in. For example, if you had 1 Bitcoin (BTC), you might want to trade it for an Ethereum-based currency like Wrapped Ether (WETH). WETH is technically just ETH wrapped in Ethereum, but it works as its own separate currency within Ethereum just like ETH does.
It’s basically just one cryptocurrency (like Bitcoin) being used as collateral for another cryptocurrency (like Ethereum) so that the second cryptocurrency can perform some of the functions of the first cryptocurrency.
Why use wrapped tokens?
Wrapped tokens are essentially the same as the coins they represent, but because they’re built on top of another blockchain, they can be traded much more easily. The vast majority of cryptocurrency exchanges only accept cryptocurrencies that exist on the Ethereum blockchain, so if you want to trade a coin that isn’t based on ETH, you have to use a wrapped token.
For instance, wrapped tokens can improve liquidity by lowering the spread between the bid and ask prices. They can also facilitate cross-chain transactions in cases where two blockchains don’t have an available bridge.
Finally, wrapped tokens can be used for arbitrage purposes: if there’s a difference in price between two blockchains for the same crypto asset, you can use wrapped tokens to make money by buying cheap crypto on one chain and selling it for a higher price on another chain.
Let’s say that you have all of your crypto-assets in an Ethereum wallet. You can only send and receive Ethereum and other ERC-20 tokens from that wallet. But if you have Bitcoin, you can’t send it directly to your Ethereum wallet because Bitcoin isn’t an ERC-20 token. So you decide to wrap your Bitcoin into an ERC-20.