The basic variations in their algorithms do not permit to invest in Bitcoin and Ethereum to bond. They adhere to different functionalities and protocols. To sum up, it is impossible for them to exchange and information.
Now, however, the scenario has changed. The advent of wrapped tokens has made it possible.
What are Wrapped Tokens?
They are cryptocurrencies too, albeit with a difference. Wrapped tokens link to the values of other digital currencies.
They also link to, and represent,other assets. These assets include real estate, gold, shares, commodities, fiat currencies, collectibles, artworks, and stocks. Such bonding helps them to easily operate on decentralized platforms. Due to their friendships with other assets, wrapped tokens require custodians to take charge of them. The custodian may wrap or unwrap these tokens.
What exactly does wrapping mean?
To take an example, Bitcoin is an original token, or an original asset. This original token goes into a digital vault. In other words, it is wrapped into it. Its place is then taken by a newly-minted, or newly-created token. The newcomer has permission to function on other blockchains/platforms.
In Bitcoin’s case, the newcomer is WBTC (wrapped Bitcoin). WBTC is acceptable to the Ethereum blockchain. The ERC-20 token/coin is in alignment with decentralized smart contracts.
Other blockchains are also experimenting with wrapping of their respective tokens. They include Ethereum, Solana, Cardano, Polkadot, Terra network, etc.
Thus, wrapped tokens permit the usage of non-native assets on any blockchain. They also bring networks together, and initiate interoperability in the digital currency arena.
Different Kinds of Wrapped Tokens
Technically, Stablecoins may be viewed as the first wrapped tokens on the crypto landscape. However, they are not exactly like the well-established wrapped tokens.
To illustrate, Tether or USDT is a Stablecoin. It is equivalent to one U.S. dollar. Nevertheless, every USDT cannot claim to match the amount held by the physical USD. Then again, its reserves hold diverse types of assets. They include investments, repayments from loans taken, cash, cash equivalents, etc. Therefore, Stablecoins are not the original wrapped tokens.
Original wrapped coins may be of two types. They are redeemable and cash-settled. Redeemable tokens permit investors to make an exchange between a wrapped token and its underlying asset. Cash-settled tokens do not permit this exchange.
Blockchains, such as ZCash, Monero, etc., host wrapped tokens.
Operating Mode of Wrapped Tokens
As mentioned earlier, a custodian takes charge of wrapped tokens. Whenever a merchant wants them, a request is sent to the custodian, offer the original coins/assets in return. The custodian mints the requisite quantity of wrapped tokens on a decentralized platform. An example is the Ethereum blockchain.
Similarly, whenever a merchant wishes the conversion of wrapped tokens into the original coins/assets, the custodian enters the picture. The custodian releases the original coins/assets from the reserves.
The snag here is that the custodian is a third party or intermediary. This is a limitation for a decentralized platform. After all, decentralized blockchains represent peer-to-peer transactions without any interference of a third party.
At the same time, such a scenario is unavoidable, for everything boils down to trust. Wrapped tokens are operating on an alien blockchain. The alien blockchain cannot permit cross-chain transactions in a virtual space that thrives on anonymity.
Regardless, developers are working on the issue. The future may yet witness some decentralized options coming into display.
Investing in Wrapped Tokens
Investors are beginning to take a keen interest in wrapped tokens. Since decentralization is a welcome trend, they view wrapped tokens as excellent assets for hoarding and trading.
As usual, Bitcoin has become a kind of advertisement for this attraction. To illustrate, over $800 million Bitcoins were converted into Wrapped Bitcoins in a single year. It indicates that wrapped tokens have a great market capitalization.
There are several advantages to wrapped tokens.
To begin with, they enhance capital efficiency and liquidity. This is true for both, decentralized and centralized cryptocurrency exchanges. The reason is that wrapped tokens can travel across multiple chains. The original tokens/coins are victims of isolation.
Reduced fees and rapid transaction times are other benefits, immensely appealing to slow blockchains.
Wrapped tokens offer fractionalized ownership. It is possible for an investor to become the owner of just a fraction of the asset.