A wrapped token is a token whose value is pegged to an underlying cryptocurrency. It is called “wrapped” because the original asset is put in a wrapper, a kind of digital vault, which allows the wrapped version of a token to be created on another blockchain. 

You could think of a wrapped token as being similar to a stablecoin in that it derives its value from another asset. In the case of a stablecoin, this is usually fiat currency, while in the case of wrapped tokens, it is often an asset that exists natively on another blockchain.

What is The Goal of A Wrapped Cryptocurrency?

Each blockchain offers its own functionality and has specific capabilities. However, they are unable to ‘talk’ to one another because of their distinct nature. For instance, the Ethereum blockchain does not communicate with the Bitcoin blockchain since they both have separate networks. With wrapped tokens, a bridge can be created between different blockchains. This in turn increases the interoperability between these blockchains – since the underlying assets can go cross-chain (moving from one chain to another).

Interoperability between blockchains is a long-awaited feature that is expected to bring enormous amounts of new use cases to blockchain technology. These include, but are certainly not limited to, customizable web3 services (e.g. interoperable smart contracts), increased decentralization, and enhanced cross-industry collaboration. 

Custody Of Tokens

For a token to be wrapped and distributed on another blockchain, a custodian is often required to act as a middleman. The custodian is an entity that holds an equivalent amount of the asset as the wrapped amount. This custodian is often a merchant, a DAO, a multi-signature wallet, or even a smart contract (on enabled blockchains). In the case of Wrapped XRP (WXRP) the custodian needs to have 1 XRP for each 1 WXRP that is minted (created and linked) on another blockchain. 

The Wrapping Process

The wrapping process itself works like this: let’s say a trader sends Bitcoin for the custodian to mint on Ethereum. The custodian would have to mint WBTC on Ethereum in accordance with the amount of BTC sent by the trader. When the WBTC needs to be exchanged back to BTC, the wrapped tokens are requested to be burnt on the second blockchain. Once the burn is verified, the original wrapped tokens on the first blockchain are released from the reserves to the address of its owner. Wrapped XRP can be purchased on SushiSwap and staked in a liquidity pool.

Disclaimer

The views and opinions expressed by the author, or any people mentioned in this article, are for informational purposes only, and they do not constitute financial, investment or other advice. Investing in or trading crypto-assets comes with a risk of financial loss.