But why go through all the hassle of wrapping up a crypto? Why not just use the crypto directly?
To understand how wrapped tokens work and why people go through the process of creating wrapped crypto, we have to understand that blockchain applications and cryptocurrency systems like Bitcoin and Ethereum are actually completely separate communication networks.
While they do use some lines of codes that may seem very similar, the way they are written and the rules they follow are completely different. Think of it as different languages: we may recognise some similar phrases or even exact replicas of words in a foreign language, but the grammar rules and vocabulary are so different that we couldn’t really use our native language rules to speak another language.
This difference and independence of blockchain networks are crucial to ensure that they are all able to preserve their own independence and reliability. However, it also creates a lot of difficulties when trying to communicate information to each other.
Although some blockchains like Ethereum do have a significant number of compatible networks and can communicate with these, most other major crypto networks can only transact within their own channel. The Bitcoin network can only communicate with the Bitcoin network, for instance. The same goes for Dogecoin or Litecoin.
The sector that is dedicated to solving this type of problem of inter-blockchain communication is sometimes referred to blockchain interoperability.
Blockchain interoperability has improved vastly over the past several years. Today, for example, it is quite common for people to move their Bitcoin and Ethereum between different blockchains that aren’t native Bitcoin or Ethereum networks.
This is especially useful for people who like to trade on decentralised exchanges or DEXs, where many different networks communicate with each other to buy, sell or even loan various types of digital assets across multiple different blockchain networks.
Without the wrapping solution, to borrow ETH with BTC, you’d have to move your BTC to an exchange and deposit it directly as collateral in exchange for ETH. But in DEFI, if you wrap your BTC, you essentially still keep your BTC, using your wrapped Bitcoin instead to borrow ETH. Once you’re doing transacting, you can always redeem back your wrapped Bitcoin and receive your Bitcoin back on the original blockchain.
Wrapped tokens have become a critical part of this form of decentralised finance (DEFI), effectively allowing people to move almost any kind of asset between blockchains, using them across a wide crypto ecosystem made out of many different types of networks.
Wrapped tokens were created as a solution to this problem. With wrapped tokens, you can effectively move assets between blockchains and use them across the crypto ecosystem.
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