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What are Wrapped Cryptocurrencies?

By June 24, 2022July 6th, 20224 minute read

Cryptocurrencies have become incredibly popular all across the world in recent years. Even though the industry has seen many ups and downs, individuals have demonstrated their faith and trust, which has enabled the sector to expand at a tremendous rate. However, as time goes on, more and more individuals are interested in learning about technology and other forms of digital currencies, like wrapped bitcoin.

Bitcoin and Ethereum are cryptocurrencies that utilize blockchains. Now, several blockchains have various features, functions, and protocols. Unfortunately, they are not able to communicate with one another as a result of this discrepancy. While this improves the security of a blockchain-based digital asset, it makes it extremely difficult to build an interoperable exchange that allows for data transfer from one cryptocurrency into another.

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Why wrapped cryptocurrency idea was born?

There were issues with the native tokens for Bitcoin and Ethereum. However, information exchange between cryptocurrencies is essential for Decentralized Finance (DeFi) to exist. Therefore, the industry needs to resolve the communication problem between the oldest and largest cryptocurrency networks, like Bitcoin and Ethereum, for Decentralized Exchanges (DEXs) to handle such transactions efficiently. Although, some recent blockchains, like Polkadot, have attempted to address the interoperability issue.

Introduction to wrapped cryptocurrency

Here comes wrapped cryptocurrency into play. Simply put, a wrapped token symbolizes a cryptocurrency built on a different blockchain with the same value as the original cryptocurrency. Still, it may be used on non-native blockchains and afterward redeemed for the original cryptocurrency.

To put things into context, Wrapped Bitcoin (WBTC) is a digital token with the same value as one Bitcoin that is based on the Ethereum blockchain and can therefore be used in the Decentralized Finance (DeFi) ecosystem, which is primarily based on the Ethereum blockchain technology. It is also based on the ERC-20 standard.

What makes wrapped cryptocurrency unique?

Interoperability across blockchains is provided through wrapped cryptocurrencies like WBTC, allowing users to move assets quickly and use other blockchains’ functions and applications. These benefits might include quicker transaction times, reduced fees, or increased potential for farming.

Bridges, a technology that enables you to wrap your cryptocurrencies to transfer them across blockchains, have been growing as the number of wrapped cryptocurrencies like WBTC in circulation has been continuously rising.

How are wrapped cryptocurrencies (like WBTC) produced?

The WBTC DAO’s governing members decide on significant protocol updates and modifications, as well as who can take on the duties of the merchants and custodians who oversee the system.

Users must communicate with merchants to exchange their BTC for WBTC. By carrying out authentication processes to verify consumers’ identities, merchants start the process of minting or burning WBTC tokens. The real tokens are minted and burned on the Ethereum blockchain by custodians, who also retain the BTC that is being wrapped.

The custodian gives BTC back to the user when WBTC is burnt. When a new WBTC is created, the custodian takes BTC from the user and stores it.

How does the wrapped cryptocurrency work?

Wrapped cryptocurrencies are generated and eradicated by a process called “minting” and “burning.” The underlying asset, in this instance BTC, is transferred to a custodian who holds it in a virtual safe to mint a wrapped cryptocurrency like WBTC. A comparable quantity of WBTC can be minted when the underlying BTC has been secured.

This process is also known as “wrapping.” A smart contract is being used to “wrap up” the underlying asset in a digital vault, and a new wrapped asset is minted to be used on another blockchain.

A similar process is used, but in reverse, to burn WBTC. The corresponding amount of BTC is released from the online vault and put back into circulation in place of the WBTC, which is taken out of circulation.

Burning wrapped tokens may be compared to “unwrapping” the underlying item, just as minting wrapped cryptocurrency can be compared to “wrapping” the underlying asset to generate a token of comparable value for usage on another blockchain.

Final thoughts: What does the future look like?

The industry has a hurdle in achieving interoperability across various blockchains.

One issue is that when more blockchains are developed, the number of bridges required to ensure that assets on one blockchain may quickly move to every other blockchain exponentially rises, as was mentioned in the section above.

To attempt to make bridging assets across blockchains more straightforward and more effective, solutions are being created.

In the near future, at least bridges and wrapped cryptocurrencies are anticipated to be a vital component of the interoperability solution.

Disclaimer: Cryptocurrency is not a legal tender and is currently unregulated. Kindly ensure that you undertake sufficient risk assessment when trading cryptocurrencies as they are often subject to high price volatility. The information provided in this section doesn't represent any investment advice or WazirX's official position. WazirX reserves the right in its sole discretion to amend or change this blog post at any time and for any reasons without prior notice.
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Harshita Shrivastava

Harshita Shrivastava is an Associate Content Writer with WazirX. She did her graduation in E-Commerce and loved the concept of Digital Marketing. With a brief knowledge of SEO and Content Writing, she knows how to win her content game!

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