Introduction to Wrapped Tokens


In crypto, blockchains often operate separately. Wrapped tokens allow assets from one blockchain to be used on another, making ecosystems more interconnected. Wrapped Bitcoin (WBTC) and Wrapped ETH (WETH) are key examples that bridge Bitcoin and Ethereum with Ethereum's DeFi space.

What Are Wrapped Tokens?


Wrapped tokens represent cryptocurrencies from one blockchain that have been wrapped to work on another. For example, Bitcoin (BTC) is tokenised into WBTC to interact with Ethereum-based DeFi apps. This process locks up the original asset in a smart contract and mints an equivalent amount as a wrapped token.

Wrapped Bitcoin (WBTC)

  • What is WBTC?: WBTC represents Bitcoin on the Ethereum blockchain.
  • How It Works:
    • Locking: Bitcoin is locked in a contract.
    • Issuance: The equivalent WBTC is minted on Ethereum.
    • Redemption: To unlock Bitcoin, WBTC is burned, releasing the original BTC.

For example, WBTC allows Bitcoin holders to access Ethereum’s DeFi protocols like Aave (AAVE) or Compound (COMP), without having to sell their Bitcoin.

  • Scarcity of Bitcoin: With only 21 million BTC ever to be created, WBTC opens up new financial opportunities for Bitcoin holders, allowing them to use their scarce asset across DeFi platforms while maintaining exposure to BTC’s value.
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Photo by Jievani Weerasinghe / Unsplash

Wrapped ETH (WETH)

  • What is WETH?: WETH is a wrapped version of Ethereum’s native ETH token, created to improve compatibility with ERC-20 tokens.
  • Why Use WETH?:
    • Interoperability: WETH makes it easier for ETH to interact with ERC-20 tokens.
    • Smart Contract Use: ETH isn’t ERC-20 by default, so WETH allows ETH to function within Ethereum smart contracts.

For example, WETH is used extensively in liquidity pools on Uniswap (UNI) and SushiSwap (SUSHI), paired with other tokens like USDC for trading.

  • Supply of ETH: Unlike Bitcoin, Ethereum’s total supply isn’t capped. With the EIP-1559 burning mechanism and the transition to Ethereum 2.0, ETH’s supply has become deflationary, making WETH an increasingly valuable tool in DeFi.

Why Wrapped Tokens Are Used in DeFi

  • Interoperability: Wrapped tokens allow assets like Bitcoin to be used in Ethereum’s DeFi ecosystem.
    For example, Bitcoin holders can convert BTC to WBTC and lend it on platforms like Aave to earn interest.
  • Liquidity: WBTC and WETH bring additional liquidity to Ethereum’s DeFi protocols.
    For instance, WBTC is used in liquidity pools on Curve Finance (CRV), allowing efficient swaps between WBTC and other stablecoins.
  • Flexibility: Wrapped tokens let users leverage their assets in ways that wouldn’t be possible on their native blockchain.
    For example, while Bitcoin can’t be directly used in Ethereum smart contracts, WBTC can be used as collateral for loans or yield farming on Yearn.Finance (YFI).

Real-World Examples of Wrapped Tokens

  • Aave (AAVE): Users can lend or borrow WBTC for interest.
  • Uniswap (UNI): WBTC/ETH pairs are popular in liquidity pools.
  • Yearn.Finance (YFI): WBTC holders can optimise their yield across DeFi platforms.

Conclusion


Wrapped tokens like WBTC and WETH play a key role in connecting different blockchain ecosystems. They allow scarce assets like Bitcoin to be utilised in Ethereum’s DeFi protocols while preserving their original value. By offering liquidity and flexibility, these tokens are crucial for DeFi’s growth, enabling users to do more with their assets. Understanding how wrapped tokens work can help users maximise their potential in the broader crypto space.

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