What Is Wrapped Token?
A wrapped token is a representation of an asset from one blockchain on a different blockchain. The most well-known example is Wrapped Bitcoin (WBTC): real BTC is locked in custody, and an equivalent amount of WBTC (an ERC-20 token) is minted on Ethereum. This allows Bitcoin to participate in Ethereum's DeFi ecosystem — lending, trading on DEXs, providing liquidity.
How Wrapped Token Works
Wrapped tokens maintain a 1:1 peg with the underlying asset through a custodian or smart contract mechanism. Centralized wrapping (like WBTC) relies on a trusted custodian holding the original asset. Decentralized wrapping (like renBTC) uses smart contracts and decentralized custodians. The wrapped token can be redeemed for the underlying asset at any time by reversing the process.
Why It Matters for Traders
When using wrapped tokens, understand the trust model: who holds the underlying asset, and what happens if that custodian fails? WBTC is custodied by BitGo — a single point of failure. Decentralized alternatives distribute this risk. Also consider depeg risk: if the market loses confidence in a wrapped token's backing, it can trade at a discount to the underlying asset, creating both risk and arbitrage opportunity.
