What are Wrapped Tokens in DeFi?
Wrapped tokens are digital assets that represent another asset on a blockchain. They are created to enable interoperability between different blockchain networks, allowing assets from one blockchain to be utilized on another. This concept is especially important in the decentralized finance (DeFi) space, where different protocols often operate on separate networks.
A wrapped token is typically backed 1:1 by the original asset held in reserve, ensuring its value remains stable. For instance, Wrapped Bitcoin (WBTC) is an ERC-20 token that represents Bitcoin on the Ethereum blockchain. Each WBTC is backed by one Bitcoin held in custody by a trusted custodian, integrating Bitcoin's liquidity and market value with Ethereum's smart contracts.
The process of creating wrapped tokens involves several steps: locking the original asset in a smart contract, issuing the corresponding wrapped tokens, and providing a mechanism for redeeming wrapped tokens back into the original asset. Users can participate in DeFi protocols more efficiently, enabling activities like lending, borrowing, or trading without needing to convert assets to a compatible format continuously.
In summary, wrapped tokens play a crucial role in bridging different blockchain ecosystems, enabling liquidity, and enhancing the DeFi experience for users across various platforms.