DeFi
September 28, 2022
What is Token Burn and it's effects on price
An A-Z guide on token burning and how it is largely impacting the cryptocurrency industry.
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The majority of cryptocurrency transactions happening on the internet are mostly for trading purposes and for most people cryptocurrencies are still assets to trade with. However, cryptocurrencies have proven that there’s more to them and slowly people are coming with real world use cases of cryptocurrencies.
The web3 revolution everyone is talking about has some different demands and the companies and apps developed need to fulfill specific requirements in order to work in the way they are designed to.
One such requirement is wrapped tokens. The DeFi space has begun to grow and there is a definite need for wrapped tokens. In this article, we will learn about what Wrapped tokens are, what their use cases are and how to wrap or unwrap a cryptocurrency.
A Wrapped Token is nothing but an asset that represents a tokenized form of another cryptocurrency, as the term goes, it is a wrapped Token. Quite often it is compared with the operation of Stable coin.
You can say it is similar to a stable coin, but the working is quite opposite. Stable coins are pegged to fiat currency for its value, where Wrapped tokens are assets which you can say natively lives on another blockchain.
If you know anything about blockchain or have worked on it, you may be aware of the system. There are literally no ways to move information between any blockchains, and hence, they are said to be proper distinct systems.
Wrapped Tokens bring the function of cross chain operations and allow information to go cross chain. This increases interoperability, and allows underlying tokens to work on other blockchains with the cross-chain compatibility.
For users who don't get affected by wrapping and unwrapping of the tokens process, there's no need to worry about anything and they can trade their wrapped tokens easily. Some of the wrapped tokens in the market are wBTC and wETH.
Let's first see the working of wrapped tokens to get a better picture of wrapped tokens.
The idea of fiat currency trading and Wrap Tokens, where there are tokens like Tether, which completely involves traditional currency and transactions in USD. Whereas, the concept of Wrap Tokens is totally different, only the exchange part is similar.
Starting with wBTC, users try to exchange or trade their wBTC on ETH blockchain, hence they can easily use BTC on the Ethereum Network. Before that, users should have a custodian, so their assets are stored or held at the same amount as the wrapped tokens.
For custodian, it can be anything from a DAO to a Merchant or a smart contract or Mutisig wallet. For the exchange to work you'll need 1 BTC to trade 1 wBTC, so here's the similarities between tether and Wrap Tokens.
The working is quite simple, the BTC is sent to be minted by a merchant. Later the wBTC is minted by the custodian on the ethereum network according to the amount of BTC sent. The merchant requests for Burn when they need to exchange the BTC again. The whole adding and removing process is done by DAO.
Now that we know what wrapped tokens or coins are, we will take a look at two major wrapped tokens starting with wrapped Bitcoin (wBTC).
wBTC is a ERC-20 version of bitcoin which is backed by Bitcoin itself with a ratio of 1:1. The standard Bitcoin works on the Bitcoin network whereas the wBTC works on Ethereum network. However, the value of wBTC is pegged to the price of Bitcoin.
As the wBTC fulfills the compatibility standards of Ethereum blockchain, this wrapped BTC can be used for a wide range of functions which the Ethereum ecosystem offers. Where the standard Bitcoin fails to be useful in the Ethereum ecosystem, the wBTC finds its utility in Ethereum's DeFi applications.
The wrapped Bitcoin is a joint-project of BitGo, Kyber Network and Ren and these same organizations allow you to convert your Bitcoin into wrapped Bitcoin and vice versa.
In order to convert your Bitcoin into wrapped BTC, you will need to use platforms like Kyber, Ren or DeversiFi. These platforms are called wBTC merchants who will then transfer your standard Bitcoin to a custodian who mints wBTC. The custodian then will store your BTC and will release the same amount of wBTC to your wallet.
Whereas when you want to convert your wBTC back to BTC, the wBTC merchant will send a request to the custodian to burn your wBTC. Then your stored BTC will be returned to your wallet address by the merchant.
Similar to wBTC, wETH is a wrapped version of Ethereum coin. This wrapped version is ERC-20 compatible and thus can be seamlessly exchanged with other ERC-20 compatible tokens using various dApps on Ethereum blockchain.
By converting native Ether to wETH, these tokens can now not only be used on Ethereum blockchain but also many other blockchains like FTM or AVAX. Thus wETH offers better flexibility and utility. However, you would still need the ETher to pay gas fees.
To convert your ETH into wETH, you would need to use DEX like Uniswap which allows users to wrap their Ether. Then you can simply trade your Ethereum for warped Ethereum and vice versa. During converting wETH back to ETH, the wrapped tokens are burned.
These wrapped Ethereum tokens are better than unwrapped Ethereum tokens when it comes to transaction speeds and gas fees. Also wETH is as secure as Ethereum as it would still work on the Ethereum blockchain.
Ethereum blockchain is one major network on which different dApps are built. Ethereum blockchain also acts like a host for a number of cryptocurrencies. However, there are still many cryptocurrencies which run on their own networks and these networks have their own standards for their native tokens.
In order to use a token on a blockchain different from its parent network, it is required to be wrapped. This wrapped token can then work on different blockchains as per standards set by their blockchain.
Wrapped tokens also aid in boosting liquidity of an asset. Instead of keeping the cryptocurrencies idle, they can be converted to wrapped versions and used on different networks to increase the liquidity.
Cryptocurrencies like Bitcoin are more secured but take longer to execute transactions and also charge higher gas fees. However, the wrapped Bitcoin can be transferred faster and with less gas fees.
The wrapped tokens need to be minted in proportion to the actual cryptocurrency. Thus, it requires some energy to be spent and in turn causes gas fees to increase. Therefore, you will need to pay higher gas fees to wrap your tokens and then enjoy the benefits of wrapped tokens.
Cryptocurrencies are meant to be operated in a decentralized manner. However, in order to wrap or unwrap your tokens, you would need a custodian as a middleman, who will burn your wrapped tokens or mint them. Thus, you have to trust a third party custodian with your funds.
By now, you must have a better understanding of what wrapped tokens are. We have also seen both positives and negatives of using wrapped tokens. If you want to make use of the benefits provided by various blockchains, you might have to convert your existing tokens into wrapped tokens.
You can check out various DEX which allow users to wrap their tokens. Do consider the risks associated with them and only use trusted and reliable services when surfing through dApps.
We hope this article helped you get better insights about wrapped tokens, especially with wBTC and wETH. If you have any more queries, feel free to reach out to us. Our HyperGrowth team will be happy to help you.
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