What are wrapped tokens?

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Takeaway

In order to use a cryptocurrency from one blockchain (e.g. Bitcoin) on a different blockchain (e.g. Ethereum), you need to use a wrapped token.

Wrapped tokens make it possible to use cryptocurrencies from one blockchain on a different blockchain. Because blockchains are separate systems, they can’t easily communicate with each other. It’s sort of like how different governments require different currencies: Just like you can’t spend your euros at a store in the US, you can’t use your bitcoin on the Ethereum blockchain.

Wrapped tokens solve for this incompatibility. Wrapping a coin allows it to be used on a non-native blockchain. Wrapping a token is essentially swapping one token for another token in an equal amount via a smart contract, or code on the blockchain that can store and send funds. Think of it like exchanging a dollar bill for four quarters. While they both represent the same value, quarters are compatible with a pinball machine, whereas the dollar bill isn’t.

How wrapped tokens work

You can buy wrapped tokens directly, or a merchant can convert your existing cryptocurrency into a wrapped token. The merchant sends your crypto to a custodian, who locks up your coin in a digital vault. Once the coin has been locked away, the custodian creates a wrapped token which represents your original coin, a process known as minting.

For example, if you wanted to use bitcoin on the Ethereum blockchain, your custodian would lock 1 BTC in a digital vault and mint 1 WBTC (a wrapped bitcoin token) on the Ethereum blockchain. You could then use your 1 WBTC—which represents a bitcoin locked away in a digital vault—on the Ethereum blockchain.

To exchange a wrapped token for its original unwrapped cryptocurrency, it must be destroyed. This process is called burning, where the custodian unlocks the original cryptocurrency and the wrapped token is destroyed.

Benefits of wrapped tokens

  • Interoperability: Wrapped tokens allow cryptocurrencies to be transacted on non-native blockchains, which might be faster or less expensive than their native blockchains. They also provide access to specific applications.
  • Liquidity: Wrapped tokens increase capital efficiency by allowing tokens to be used in different ways on non-native blockchains, as opposed to remaining locked on their native blockchain.

Limitations of wrapped tokens

  • Fees: There are possible financial benefits to wrapped tokens, especially if wrapping a token allows you to use it on a blockchain with lower transaction fees. However, the minting process itself may trigger fees.
  • Inequivalent value: While the wrapped token should theoretically have the same value as the original cryptocurrency it represents, in times of high volatility the value of a wrapped token could potentially be lower than the original coin.
  • Contagion: Contagion is the spread of a financial crisis from one cryptocurrency to the other. By increasing interdependence among currencies, wrapped tokens increase the risk of contagion.

The difference between wrapped tokens and stablecoins

Stablecoins are conceptually similar to wrapped tokens, but their value is generally tied to a more traditional type of asset, like the US dollar or gold, whereas the value of wrapped tokens are tied to cryptocurrency.

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This information is educational, and is not an offer to sell or a solicitation of an offer to buy any security. This information is not a recommendation to buy, hold, or sell an investment or financial product, or take any action. This information is neither individualized nor a research report, and must not serve as the basis for any investment decision. All investments involve risk, including the possible loss of capital. Past performance does not guarantee future results or returns. Before making decisions with legal, tax, or accounting effects, you should consult appropriate professionals. Information is from sources deemed reliable on the date of publication, but Robinhood does not guarantee its accuracy.

Options trading entails significant risk and is not appropriate for all customers. Customers must read and understand the Characteristics and Risks of Standardized Options before engaging in any options trading strategies. Options transactions are often complex and may involve the potential of losing the entire investment in a relatively short period of time. Certain complex options strategies carry additional risk, including the potential for losses that may exceed the original investment amount.

Commission-free trading of stocks, ETFs and options refers to $0 commissions for Robinhood Financial self-directed individual cash or margin brokerage accounts that trade U.S. listed securities and certain OTC securities electronically. Keep in mind, other fees such as trading (non-commission) fees, Gold subscription fees, wire transfer fees, and paper statement fees may apply to your brokerage account. Check out Robinhood Financial’s Fee Schedule for details.

Brokerage services are offered through Robinhood Financial LLC, (RHF) a registered broker dealer (member SIPC) and clearing services through Robinhood Securities, LLC, (RHS) a registered broker dealer (member SIPC). Cryptocurrency services are offered through Robinhood Crypto, LLC (RHC) (NMLS ID: 1702840). Robinhood Crypto is licensed to engage in virtual currency business activity by the New York State Department of Financial Services. The Robinhood spending account is offered through Robinhood Money, LLC (RHY) (NMLS ID: 1990968), a licensed money transmitter. A list of our licenses has more information. The Robinhood Cash Card is a prepaid card issued by Sutton Bank, Member FDIC, pursuant to a license from Mastercard®. Mastercard and the circles design are registered trademarks of Mastercard International Incorporated. RHF, RHY, RHC and RHS are affiliated entities and wholly owned subsidiaries of Robinhood Markets, Inc. RHF, RHY, RHC and RHS are not banks. Products offered by RHF are not FDIC insured and involve risk, including possible loss of principal. RHC is not a member of FINRA and accounts are not FDIC insured or protected by SIPC. RHY is not a member of FINRA, and products are not subject to SIPC protection, but funds held in the Robinhood spending account and Robinhood Cash Card account may be eligible for FDIC pass-through insurance (review the Robinhood Cash Card Agreement and the Robinhood Spending Account Agreement).

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