The virtual asset that is equal to the value of the cryptocurrency in the blockchain network at a ratio of 1: 1 and can operate on a different blockchain network is called a Wrapped Token.
Wrapped tokens have been developed so that the cryptocurrency can be processed outside of the original blockchain network to which it belongs.
The wrapped token is indexed to the value of the original asset and can be traded on the value of the original currency at the time of execution. They are similar in structure to stablecoins that get their value in fiat units.
While Stablecoin gets its value from fiat units, the Wrapped Token value is indexed to the digital asset running on a different blockchain.
Thanks to its wrapped structure, it is possible to switch between blockchains, as well as the original token to move on more than one blockchain.
What is the difference between Bitcoin and Wrapped Bitcoin?
There is no difference in terms of price and working principle. Wrapped Bitcoin (WBTC) is an ERC-20 token that has the ability to run on different blockchain networks such as Ethereum, while Bitcoin (BTC) only runs on its own blockchain network.
As it is known, the blockchain structure is similar to a long registry with its own registration system. In the blockchain system, which does not work in a typical database logic and where the transactions are sequenced, data is archived in a closed circuit logic.
Under normal circumstances, data in the Bitcoin network cannot interact with those in the Ethereum (ETH) network. However, thanks to WBTC, which is exactly equal to the original BTC price, there is a chance to directly participate in transactions on the Ethereum network.
Wrapped token acts as a bridge between multiple blockchains.
The fact that decentralized finance (DeFi) protocols work largely on blockchain networks such as Ethereum and Binance Smart Chain (BSC) has created the need for Bitcoin to be used in this field. Consequently, it was possible for Bitcoin to be included in transactions by using WBTC currency in both Ethereum and BSC networks.
How does Wrapped Token work?
A safe deposit box is required when creating the wrapped token. Wrapped tokens are given in the amount corresponding to the cryptocurrency paid to the custodian. The party we refer to as “custodian” here may be a service provider, a multi-signature wallet or a Decentralized Autonomous Organization (DAO).
Going from the Bitcoin example, if 1 BTC is transferred to make transactions on the Ethereum network, this amount is processed into a smart contract in accordance with the Proof of Reserve (PoR) algorithm and 1 WBTC is created and transferred to the user.
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The terms of the smart contract work in reverse whenever the user wants to convert their WBTC deposit back into BTC after completing the transaction. While BTC placed in the safety deposit box is released to the user, the relevant WBTC is destroyed by burning.
Pros of wrapped tokens
In addition to its ability to be used in different blockchain networks, Wrapped tokens can provide both liquidity and capital efficiency for cryptocurrency exchanges, regardless of whether they are centralized or decentralized.
It may allow the occurrence of transaction pairs that cannot be created under normal conditions and the realization of new transaction possibilities.
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Transaction costs and transfer times can also be improved with the Wrapped token. For example, since transactions in the Bitcoin network process over 10-minute blocks, they are performed slower and with higher transaction fees than alternatives. These problems are likely to disappear with alternatives such as Wrapped Bitcoin.
Cons of wrapped tokens
Absolute trust must be given to the custodian party in clearing transactions. Because these tokens are based on the principle of creating a version that works in the alternative network, instead of performing cross-chain transactions. In other words, a custodian must be found.
On the other hand, the token creation process can cause price fluctuations. Sometimes high gas fees can become more expensive than usual.
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