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Wrapped token

A tokenized version of another asset that works on a different blockchain—crypto’s way of traveling abroad.

What is a wrapped token?

A wrapped token is a cryptocurrency token that represents another asset from a different blockchain, maintaining a 1:1 peg to the value of the original asset. Wrapped tokens enable assets to function on blockchains where they aren't natively compatible. For example, Wrapped Bitcoin (WBTC) represents Bitcoin on Ethereum, allowing Bitcoin holders to use their BTC in Ethereum's DeFi ecosystem.

The wrapping process typically involves locking the original asset with a custodian (either a smart contract or trusted third party) and minting an equivalent amount of wrapped tokens on the target blockchain. When users want to unwrap, the wrapped tokens are burned and the original assets are released.

Core characteristics of wrapped tokens:

  • Cross-chain compatibility: Enable assets to work on non-native blockchains
  • Value peg: Maintain 1:1 ratio with the underlying asset
  • Token standard compliance: Follow the target blockchain's token standard (such as ERC-20 on Ethereum)
  • Redeemability: Can be unwrapped to retrieve the original asset
  • Custodial requirement: Original assets must be held in reserve to back wrapped versions

Why wrapped tokens matter

Wrapped tokens address a fundamental limitation in blockchain technology: different blockchains cannot natively communicate with each other. This isolation creates barriers that prevent users from accessing opportunities across multiple networks.

Problems wrapped tokens solve:

  • Ecosystem access: Bitcoin holders can participate in Ethereum DeFi without selling their BTC
  • Liquidity expansion: Assets can flow between isolated blockchain networks
  • Cross-chain trading: Users can trade assets from multiple blockchains on a single decentralized exchange
  • Capital efficiency: Idle assets on one chain can be put to work on another
  • Speed and cost: Use faster, cheaper blockchains for transactions while maintaining exposure to assets from slower chains

For example, Bitcoin's blockchain is secure but slower and more expensive for transactions than some alternatives. WBTC allows users to maintain Bitcoin exposure while benefiting from Ethereum's faster transaction times and rich DeFi ecosystem.

Risks and limitations of wrapped tokens

Wrapped tokens introduce several challenges:

  • Centralization risk: Many wrapped tokens rely on trusted custodians to hold reserves
  • Bridge vulnerabilities: Cross-chain bridges have been major targets for hackers, with losses exceeding $2.5 billion in 2022
  • Smart contract risk: Bugs in wrapping contracts can lead to loss of funds
  • Liquidity fragmentation: Different wrapped versions of the same asset (WBTC from different bridges) are not interchangeable
  • Limited utility: Wrapped tokens may not have the same capabilities as native assets (such as paying gas fees or governance voting)

Polkadot’s approach to cross-chain assets

Polkadot takes a fundamentally different approach that reduces the need for wrapped tokens through native interoperability:

XCM (Cross-Chain Messaging)

Instead of wrapping assets to move them between chains, Polkadot uses XCM, a native cross-chain messaging format that enables direct communication between rollups (i.e., parachains). XCM allows chains to transfer native tokens without requiring wrapped versions or external bridges.

Key advantages over wrapped tokens:

  • No wrapping needed: Assets remain in their native form when transferred between Polkadot rollups
  • Trustless transfers: No reliance on centralized custodians or vulnerable bridge smart contracts
  • Native interoperability: Built into the protocol rather than added through external solutions
  • Reduced complexity: Users don't need to wrap and unwrap tokens or manage multiple token versions
  • Better security: Eliminates the "weakest link" problem of bridges that rely on trusted third parties

When assets do need to move between Polkadot and external networks like Ethereum or Bitcoin, Polkadot uses trustless bridges. However, within the Polkadot ecosystem, rollups can exchange native tokens directly through XCM, avoiding the liquidity fragmentation and security risks associated with multiple wrapped token versions.

This design reflects Polkadot's philosophy of solving interoperability at the architectural level rather than patching it on afterward, creating a more secure and efficient cross-chain ecosystem.


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