What is a Wrapped Token in Ethereum?
A wrapped token is a type of cryptocurrency that represents another asset on the Ethereum blockchain. Typically, this is used to represent cryptocurrencies that exist on different blockchains, allowing them to be utilized within the Ethereum ecosystem. The most notable example is Wrapped Bitcoin (WBTC), which is Bitcoin wrapped in an ERC-20 token format.
How Wrapped Tokens Work
Wrapped tokens function by creating a 1:1 peg with the original asset. When you want to wrap a Bitcoin, for example, you send your Bitcoin to a custodian who holds the Bitcoin in reserve. In return, the custodian mints an equivalent amount of WBTC, thus allowing the Bitcoin to be used on Ethereum-based applications. This process can be reversed: when you want your original Bitcoin back, you return the WBTC to the custodian, who then releases your Bitcoin.
Benefits of Wrapped Tokens
- Interoperability: Enables non-Ethereum assets to be used in Ethereum's decentralized finance (DeFi) ecosystem.
- Liquidity: Wrapped tokens can provide liquidity for decentralized exchanges and other financial services.
- Smart Contracts: They can be integrated into smart contracts, enhancing functionality and flexibility.
In summary, wrapped tokens play a crucial role in the cross-chain functionality of cryptocurrencies, significantly enhancing their usability and compatibility within various blockchain networks.