How and Why to "Wrap" A Cryptocurrency

in LeoFinance3 months ago

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If you are new to cryptocurrency, you might be confused when you hear someone mention “wrapping” a crypto. In this post, I will explain what it means to “wrap” a cryptocurrency, why someone would wrap a crypto, and how it works.

What is "Wrapping"

The most simple explanation I can give is that wrapping a cryptocurrency enables you to maintain ownership of the underlying asset while using it on a different blockchain. I realize that might not sound very simple, so let me explain a little bit.

Think of a blockchain like a gaming console. Gaming consoles can support a wide variety of games, but the software must be written in a way that the console can understand. I can’t simply take an Xbox game like Halo and put it into a PlayStation and expect it to work. In the same way, a single blockchain can support a wide variety of tokens, but only those tokens that meet that blockchain’s “token standard”.

I’m going to simplify a bit and explain the details later, but for now, know that wrapping a cryptocurrency is the process of modifying a cryptocurrency from one blockchain to ensure that it will be able to operate on another blockchain. For example, wrapping Bitcoin turns into "Wrapped" Bitcoin (WBTC) that can be used on the Ethereum blockchain.

Why Wrap?

Wrapping a cryptocurrency token allows us to use assets from one blockchain on another blockchain. Suppose that we are bullish on Bitcoin and we expect that the price will go up significantly. At the same time, we don't like simply holding it in our wallet and want to lend it on a decentralized financial protocol like Compound

However, we see that Bitcoin is not listed as an available option as Compound only supports Ethereum based assets. At this point, we could simply sell our Bitcoin for an asset on the Ethereum blockchain and then lend that asset, but by doing so, we would give up the underlying Bitcoin and would lose out on the potential price appreciation of BTC.

By Wrapping our Bitcoin, we are able to maintain ownership of the underlying Bitcoin while using said Bitcoin on a different blockchain. If the price of Bitcoin skyrockets and we later want to sell it, we can simply unwrap and sell the Bitcoin.

How does it work?

Remember when I said that wrapping a cryptocurrency means changing it so that it can be used on a different blockchain. That's not entirely correct, but we had to start with a simplistic definition to avoid getting bogged down. In reality, wrapping a cryptocurrency does not change the original cryptocurrency at all. Rather, the original cryptocurrency is placed with a custodian and “frozen” or “locked”. Once this happens, that custodian then “mints” a new cryptocurrency on the new blockchain. When you want to redeem the “wrapped” crypto from the new blockchain and take your assets back to the old blockchain, the process happens in reverse.

How Can I Wrap?

There are two simple ways of wrapping your cryptocurrency. The first way is simply trading your existing cryptocurrency for a wrapped version on a centralized exchange such as Coinbase Pro. The provided link will take you right to a trading page for trading BTC and WBTC. The second is by "manually" wrapping your coin.

Although I use Coinbase from time to time, some people may prefer a decentralized option like https://wbtc.cafe/ where you can “manually” wrap your BTC to WBTC. I’m not recommending either way over the other as they both have advantages. Coinbase will obviously require KYC documentation whereas wbtc.cafe will not. On the other hand, wbtc.cafe does have a few more steps to go through and could seem more intimidating for a newbie. Either way, the choice is yours.

Conclusion

To sum everything up, wrapping a cryptocurrency can be thought of as a way of “porting” a crypto and allowing it to function on a different blockchain. This allows you to retain ownership while enjoying the advantages that a different blockchain might offer.

As always, thanks for reading!

References

https://academy.binance.com/en/articles/what-are-wrapped-tokens

Image Credits

https://wbtc.cafe/

https://pro.coinbase.com/trade/WBTC-USD

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