If you’re a crypto user, you must be frustrated about the fact that your crypto coins or tokens from one blockchain cannot be easily transferred to or utilized on another. As for instance, you cannot use bitcoins on the Ethereum blockchain or vice versa. This is called the issue of interoperability which is one of the main limitations and challenges that blockchain networks face. And here is where wrapped crypto comes into play.
What is blockchain Interoperability and What does It have to Do with Wrapped Coins?
Basically a blockchain refers to a distributed ledger system consisting of a sequence of blocks (units) that contains digital information which is stored in a decentralized public database. Data stored in the blockchain is immutable; meaning it cannot be altered or changed and irreversible. Blockchain is the technology on which a cryptocurrency is created.
It is evident from the preceding description that in order for blockchain technology to achieve mainstream world wide, there must be a link or inter-blockchain communication and cross-chain transactions between multiple blockchains. Blockchain interoperability has been achieved by pioneer networks like Cosmos, Polkadot, and Harmony. In layman's terms, these blockchains must communicate with one another just like many websites on the internet can be connected. But the question is how do blockchains transfer value? The answer is wrapped coins.
What are Wrapped Coins?
Wrapped coins are a tokenized representation of a cryptocurrency that is pegged to its price which users create to operate on other blockchains than the original one. You may think of wrapped coins as stablecoins, as the only difference is that stablecoin are pegged to fiat or a commodity while wrapped coins are pegged to other cryptocurrencies. So for example, if you want to harness the Ethereum blockchain for transacting in bitcoins, you must create Wrapped Bitcoin or WBTC.
But How Does The Process of Wrapping Work?
There are 2 things that you need in order to wrap a coin: a merchant (the user) and a custodian. To make things clear, let’s say that you want to wrap BTC to use on the Ethereum blockchain. Firstly, the custodian, who is someone who keeps the equivalent amount of the coin as the wrapped amount, receives BTC from the merchant. After that, the custodian mints WBTC on Ethereum based on the amount of BTC the merchant sent and returns it back to the merchant. When done trading on the Ethereum blockchain and you want to unwrap your BTC, the merchant submits a burn request to the custodian when the WBTC has to be converted back to BTC, and the BTC is released from the custodian.
What’s the Point of Wrapped Tokens?
You must be wondering why we should do that? Well, diverse blockchains have different functions. Wrapped tokens are a way to make use of different functionality of various blockchains by circumventing the interoperability limitation by creating additional bridges between different blockchains.
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