A “wrapped token” is a type of financial derivative representing a 1-1 claim on another token, the “underlying.” The most common use of wrapped tokens is to allow for the value represented by a token to be represented across multiple blockchains or DLT networks. However, there are examples of wrapped tokens that exist on the same network, such as Ethereum. Wrapping is a key service enabling interoperability and transfer of liquidity between blockchains and other types of DLT networks.
There are generally two types of “wrapped tokens”:
- Custodial: where the underlying token is held in custody by a centralized entity, and a wrapped version of the token is issued.
Wrapped Bitcoin (WBTC) is an example of this, where the company BitGo holds custody of BTC and issues WBTC as an ERC20 token on Ethereum. This allows Bitcoin to be represented and traded on the Ethereum network.
- Non-custodial: where the underlying token is locked on one network, and a wrapped version of that token is then issued automatically on the other network. This requires synchronization between the locking and issuance on the two networks, which is difficult to do safely and sometimes involves using synchronized smart contracts or an intermediate network, like REN protocol. If the wrapped version of the token is then returned by a user (“redeemed”), it is typically burned and the original underlying token released.
Wrapping should not be confused with:
- Tokens such as USD Coin (USDC) or Tether (USDt). USDC is a tokenized form of the US dollar, with every USDC backed 1-1 by a treasury of US dollars held by the company Circle. The concept is similar to wrapping but involves a non-blockchain asset as the underlying.
- Synthetic tokens that peg or track the price of an underlying. While these are also derivatives and may behave similarly to a wrapped token, their construction is very different. An example of a synthetic asset is the Frax stablecoin, whose price algorithmically matches its underlying asset - the US dollar - but it is not backed by US dollars anywhere and thus cannot be swapped for the underlying token like a wrapped token.