Blockchains have brought about a lot of developments:
Sending money in under 10 seconds ✅
Taking a loan without going through all the paperwork ✅
Eliminating intermediaries (banks) and reducing the risk of fraud ✅
But there are still many challenges they face, one of which is the lack of interoperability.
Interoperability refers to the ability of two different systems or blockchains to interact together seamlessly. This is something that blockchains are currently struggling with.
Think of it like going to a grocery store where you speak English, but the attendant speaks Mandarin. You really can't communicate or make any exchanges.
The same applies to different blockchains with varying functionalities and codes.
Wrapped tokens help solve this issue. They're tokens wrapped to function on another blockchain. For example, because Bitcoin and Ethereum aren't compatible due to their differences in standards and codes, to solve this BTC is wrapped into WBTC for use on the Ethereum blockchain.
How do you create one?
Creating a wrapped token involves three entities:
1. You, the user,
2. The token or funds to be wrapped, and
3. The custodian.
Here's how it works:
1. You send your funds to the custodian, which acts like a vault with codes and functions. It's responsible for turning your token into its wrapped version.
2. You send your token to the custodian. It then creates a wrapped version of your token and locks away the original in a vault. Meanwhile, it sends the wrapped token to your wallet.
3. You can now use the wrapped token for whatever you need. If you decide you don't want it anymore, you send it back to the custodian.
4. The custodian then destroys (burns) the wrapped token and gives you back the original token from the vault.
What are the advantages of wrapped tokens?
One of the advantages is enhanced functionality. Let me break this down: gas fees on Bitcoin can be pretty high at times. Recently, data shows that they rose up to $80 this week.
Imagine if you were to make a transaction of $20, you'd be paying gas of $80 (check this out if you don't know the meaning of gas).
So, if you wrap your Bitcoin to Ethereum or Polygon, you can essentially bypass the gas fees that have been paid on the Bitcoin network and leverage the lower transaction fees of the network.
Another perk of wrapped tokens is the access they provide to decentralized applications (dApps) and lending platforms.
Before wrapped tokens came into play, Bitcoin users couldn't access Ethereum's features like lending, borrowing, or tokenization due to their differences in codes and functionalities. But now, with wrapped tokens, they can tap into these features by converting to wBTC.
What are the disadvantages of wrapped tokens?
One of the drawbacks is the reliance on the custodian. If you look at the whole process of wrapping the token, the custodian plays a significant role in both wrapping the token and custody, and this contradicts the whole idea of decentralization in blockchain, where you ought to have control over your funds and activities.
With that being said, the advantages outweigh the disadvantages and in the long run, we're bound to see more upgrades to Blockchain networks that deal with the issue of interoperability.
Image Credit - ZeroCap
And that's it for today. Thanks for reading. Have a blessed weekend, and don't forget to touch grass 🌱.
P.S. You can collect this edition as an NFT for ($0 + gas fees) by tapping on the collect button below.
