Imagine how simple global finance would be if there were just one currency in the world. A system where money could flow across borders without worrying about exchange rates, conversion fees, or delays. Transactions would be instant, frictionless, and universally accepted.

In traditional finance, this idea is difficult to achieve because of geographical boundaries. However, in the world of cryptocurrency, this vision feels much closer to reality. While crypto removes geographical boundaries, it introduces a new kind of separation called blockchain isolation. To tackle this isolation, this is where the wrapped token concept comes into play. To move value across different blockchains without losing its original form?

What Is a Wrapped Token?

A wrapped token is the systematic design mirror or copying of another cryptocurrency or token that lives on another blockchain. This token holds the same 1:1 value as their original token. When a token is wrapped, the original asset is locked or held in reserve, and a new token is created on another blockchain that represents that asset. This new token maintains a 1:1 value with the original.

The concept behind wrapped tokens is to enable a native token to be used on a different blockchain. For instance, Bitcoin operates on its own network, which makes it difficult to directly utilize within ecosystems like Ethereum or BNB Chain. This limitation prevents Bitcoin holders from accessing a wide range of decentralized applications, especially in areas like DeFi. So wrapped tokens solve this problem while still maintaining their original value.

Wrapped tokens allow holders to retain exposure to their coin, e.g., Bitcoin, while accessing features available on other blockchains. Instead of selling their Bitcoin, users can utilize its wrapped version to participate in activities like trading, lending, or yield generation.

These wrapped tokens can be traded across both decentralized exchanges and centralized exchanges. In the case of centralized platforms, users often don’t need to go through the manual wrapping process themselves, as exchanges typically handle the conversion process.

How Do Wrapped Tokens Work?

Wrapped tokens follow a fairly straightforward process, but behind the scenes, it involves coordination between custodians, smart contracts, or cross-chain bridges. Bridges are basically protocols connecting two separate blockchains to transfer data.

In many cases, a trusted custodian or organization (such as a DAO) manages the wrapping process through a combination of smart contracts and reserve systems. When a user wants to acquire a wrapped token, for example, Wrapped Bitcoin (WBTC), they must first deposit their original Bitcoin into this smart contract. Once the Bitcoin is deposited, it is securely locked and can't be moved or used until the user decides to redeem it. After the deposit is confirmed, an equivalent amount of wrapped tokens is minted on the target blockchain and sent to the user’s wallet. The value of the wrapped token is always pegged 1:1 to the underlying asset, ensuring that 1 WBTC always equals 1 BTC.

The custodian plays a critical role until the user redeems their original asset. They are responsible for securely holding the underlying cryptocurrency. Most importantly, custodians guarantee that for every wrapped token in circulation, there is an equivalent amount of the native asset held in reserve. This backing is what maintains the 1:1 peg and ensures that wrapped tokens can always be redeemed for their original value. When a user wants to convert back to the original asset, they simply need to unwrap the token. This involves sending the wrapped tokens back to the custodian. Once the tokens are received, they are burned (destroyed), and the equivalent amount of the original cryptocurrency is released back to the user. Burning the wrapped tokens is a critical step in this process. It ensures that the circulating supply of wrapped tokens always matches the amount of the underlying assets held in reserve.