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What Are Wrapped Tokens and Why Should You Invest In Them?

·3 min read
D-Keine / iStock.com
D-Keine / iStock.com

Just when you thought you had a grip on Bitcoin, other cryptos and altcoins, there’s a new kid in town that’s about to shake things up: Wrapped Bitcoin and wrapped tokens.

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CoinMarketCap explains that Wrapped Bitcoin (WBTC) is a fairly new innovation that effectively brings Bitcoin to the Ethereum blockchain. One of the main use cases for WBTC lies in decentralized finance, as it gives the owners of digital assets freedom to explore other blockchains.

“A large chunk of the DeFi ecosystem (and DApps) are based on the Ethereum network rather than the Bitcoin blockchain. This can be extremely frustrating for Bitcoin owners, as this means it’s near impossible for them to get involved unless they sell their crypto assets or buy others,” according to CoinMarketCap.

“Imagine you’re already familiar with Bitcoin and really keen to start using DeFi applications. But there’s a problem! There isn’t much of a cryptocurrency bridge connecting Bitcoin and Ethereum. Wrapped BTC helps to solve this problem and deliver some much-needed liquidity to DeFi protocols,” CoinMarketCap explains.

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WBTC.com explains on its website that “with Wrapped BTC, users experience increased liquidity and participation. The Ethereum network processes transactions faster than the Bitcoin network, but Bitcoin holders don’t have to wait anymore. With WBTC, moving Bitcoin between exchanges is much faster.”

Eric Bleeker, technology analyst at The Motley Fool, told GOBankingRates that Bitcoin has value because it was the first cryptocurrency, but even its biggest fans will admit it has drawbacks.

“For example, Bitcoin can only handle about 4.6 transactions per second, and its energy expenditure per transaction is very high,” he said. “This is why wrapped tokens are so interesting. They effectively allow you to place a cryptocurrency like Bitcoin into a digital vault that allows a wrapped version to be created on another blockchain.”

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What’s the practical benefit of this? Bleeker noted that $2.5 trillion worth of Ethereum was transacted in the second quarter, which is about the same volume as all Visa purchases in the same timeframe. Bleeker added that while it would be great to trade an asset mirroring the value of Bitcoin on the fast-growing decentralized finance, or DeFi, apps on Ethereum, “Wrapped Bitcoin (WBTC) is a tokenized version of Bitcoin on Ethereum, allowing you to trade an asset pegged to the value of Bitcoin on the Ethereum blockchain.”

Bleeker added that there are some limitations and that it might be confusing.

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“For example, I talked about that digital vault earlier. That effectively means users must put their trust in a custodian pegging the value of a wrapped token. That’s an idea that’s antithetical to the decentralized idea of cryptocurrencies,” he said.

At the end of the day, wrappers are an intriguing way to trade tokens pegged to the value of Bitcoin and other tokens on other blockchains, he added.

“However, bear in mind that they’re just one way to increase interoperability between blockchains. Projects like Polkadot continue pushing the boundaries of blockchains connecting to each other in the years to come, so expect a lot of innovation in this market!” Bleeker said.

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This article originally appeared on GOBankingRates.com: What Are Wrapped Tokens and Why Should You Invest In Them?