Clear DefinitionsWrapped Token
1 min read
Pronunciation
[rapt toh-kuhn]
Analogy
Imagine putting a foreign currency note (like a US Dollar) into a special sealed wrapper that clearly states it contains $1. This wrapped dollar can now be used in a vending machine that only accepts the local currency (like Euros), because the wrapper guarantees its value. The wrapper is the wrapped token, the US Dollar is the original asset, and the vending machine is the other blockchain's ecosystem.
Definition
A cryptocurrency token pegged in value to another cryptocurrency or asset, existing on a different blockchain than the original asset. It allows assets from one blockchain to be used on another, often to participate in decentralized finance (DeFi) ecosystems.
Key Points Intro
Wrapped tokens facilitate cross-chain interoperability and asset usability.
Key Points
Enables the use of assets on blockchains where they aren't native.
Value is typically pegged 1:1 to the underlying asset.
Often requires a custodian or a smart contract mechanism to mint and redeem.
Widely used in DeFi to bring liquidity from other chains.
Example
wBTC (Wrapped Bitcoin) is an ERC-20 token on the Ethereum blockchain that is pegged to the value of Bitcoin. This allows Bitcoin holders to use their BTC value within Ethereum's DeFi applications, such as lending protocols or decentralized exchanges.
Technical Deep Dive
Creating a wrapped token typically involves locking the original asset in a vault or smart contract on its native chain, often managed by a custodian (centralized) or a decentralized network of participants. A corresponding number of wrapped tokens are then minted on the target chain. To get the original asset back, the wrapped tokens are burned on the target chain, and the original asset is unlocked from the vault.
Security Warning
The security and reliability of a wrapped token depend heavily on the trustworthiness and robustness of the wrapping mechanism or custodian. If the custodian is compromised or the smart contract has vulnerabilities, the peg can break, causing the wrapped token to lose value relative to the original asset.
Caveat
Wrapped tokens introduce counterparty risk if a centralized custodian is used, or smart contract risk if a decentralized wrapping mechanism is used. The peg is not guaranteed and relies entirely on the underlying system.
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