Wrapped Tokens and Crypto Interoperability

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Interoperability is a concept which all of us are aware of, to a greater or lesser extent. Running a Windows game on a Mac or using an Android app on an iPhone – these will not be feasible without the interoperability feature which makes it possible to use applications across different systems, software, specifications etc. Applying the same concept to cryptocurrency, what happens when we try to trade Bitcoin on the Ethereum blockchain? It is technically feasible, thanks to a concept called wrapped token. Let’s look at some instances of how wrapped tokens work and its potential applications in the crypto world going forward.

Wrapped Bitcoin

The most popular wrapped token is called wrapped bitcoin (wBTC) – an ERC-20 version of bitcoin. As of Febuary 2022, the token has a market capitalization of over $10 billion and is secured by crypto custodian BitGo. Wrapped bitcoin dominates 81% of the market for wrapped tokens; the next largest token, renBTC, has a market capitalization of $672 million.

Wrapped bitcoin is useful because it allows bitcoin investors to plug their asset into decentralized finance (DeFi) protocols on Ethereum. This unlocks the potential to turn bitcoin into a yield-bearing asset, one that can earn returns from something like liquidity pools on Uniswap or Yearn Finance, for example. To acquire wrapped bitcoin, one can wrap one’s BTC by finding a wBTC merchant such as DeversiFi, Kyber or Ren. The merchant sends the bitcoin to a custodian for safe crypto storage who mints newly wrapped bitcoin at a 1:1 ratio and stores the deposited bitcoin. While redeeming the wBTC for bitcoin, the merchant will send a burn request to the custodian who will then destroy the wBTC and return the bitcoin back to the owner. WBTC isn’t a perfect solution, since it introduces a degree of centralization into the mix. If you hold wrapped bitcoin, you’re entrusting BitGo with your money.

Wrapped Ethereum

Another prominent wrapped token is wrapped ether (wETH,) launched by 0x labs in 2017. Unlike wBTC, whose sole purpose is to port bitcoin onto non-native blockchains (currently it supports Ethereum and Tron), one of the main purposes of wETH is to trade synthetic ether right on the Ethereum blockchain. That’s because wETH converts ether (ETH) into an ERC-20 token – a tradable version of ETH that’s compliant with decentralized finance protocols. ETH, the native token of Ethereum, doesn’t conform to the ERC-20 standard.

One can think of token standards as a set of rules a token must follow to ensure it is compatible with other Ethereum-based services and platforms. Different token standards are used to create different subsets of assets that are compatible with particular services, such as non-fungible tokens (NFTs) or fungible tokens.

Wrapped ETH opens up multiple opportunities in the world of decentralized finance for ETH holders. With wETH, holders can trade directly with other Ethereum-based altcoins and pledge funds to DeFi protocols. Unlike wBTC, ETH is not actually “wrapped”. To acquire it, ETH is simply traded for wETH through a smart contract, or on a digital wallet like MetaMask. The team behind wrapped ether hopes that the token will eventually be phased out once Ethereum’s code base is updated to make ether conform with the ERC-20 token standard.

Conclusion

As can be observed, it’s easier to trade wrapped tokens on different blockchain networks rather than wrapped individual cryptocurrencies. This interoperability will allow upcoming cryptocurrencies to develop the “wrap” feature on their own networks which should lead to a globally connected decentralized trading system. This is highly related to DeFi and is likely to improve transparency, reduce redundancy and decrease operating costs across crypto networks. The future of “the future of finance” awaits!