Wrapped tokens play a central role in today’s blockchain infrastructure. They allow assets to be used across blockchains that are otherwise not compatible - a crucial step toward interoperability and DeFi integration.
A wrapped token is a digital asset that represents the value of another coin or token on a blockchain where it does not originally exist. The most well-known example is Wrapped Bitcoin (WBTC) - a tokenized version of Bitcoin on the Ethereum blockchain.
In this process, real BTC is deposited with a custodian, and in return, an equivalent amount of WBTC is issued on Ethereum. The price of WBTC is generally pegged 1:1 to BTC.
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How do wrapped tokens work?
Wrapped tokens are typically based on smart contracts. The process usually works like this:
- A user sends, for example, 1 BTC to a trusted custodian.
- The custodian holds the BTC and issues 1 WBTC on Ethereum in return.
- If the user wants their real BTC back, the WBTC is burned and the BTC is returned.
The custodian can be organized either centrally (e.g., by BitGo) or in a decentralized way (via DAOs). What matters is that it can always be verified that enough real assets are deposited - transparency is essential here.
Wrapped tokens make it possible to integrate otherwise incompatible assets into DeFi ecosystems such as Ethereum or Solana. BTC can therefore be used in liquidity pools, lent out, or deposited as collateral. This increases capital efficiency and significantly enhances the usability of existing assets.
Wrapped tokens also carry risks - in particular trust risks with centralized custodians. If a custodian is compromised or becomes insolvent, the tokenized assets are at risk. Decentralized alternatives aim to minimize this risk but are still in their early stages.
