The crypto community has recently been flooded with misinformation about wrapped tokens, especially Wrapped Bitcoin (wBTC) and Wrapped Ethereum (wETH). In this article, we’ll cover what wrapped tokens are, where they come from, and if they risk depegging. (Short answer: not a snowball’s chance)
What are Wrapped Tokens?
Wrapped tokens, also known as token wrappers, are digital assets representing a token or coin on its non-native blockchain. These wrappers allow users to take advantage of the benefits of different blockchain networks, such as increased liquidity or access to different decentralized applications (dApps).
The simplest example would be BTC. Ethereum can’t process bitcoins and vice versa, so if you want to use BTC on the Ethereum network, you need to use the wrapped version of BTC, wBTC. So, you send your BTC to a wrapper contract, and it mints a wBTC and sends that wBTC back to you.
This allows a user who holds bitcoin to use a wrapped bitcoin (wBTC) token to interact with Ethereum-based dApps, or a user who holds Ethereum can use a wrapped Ether (wETH) token to access decentralized finance (DeFi) services. Wrapped tokens have become increasingly popular in cryptocurrency as they give users greater flexibility and versatility when managing their digital assets.
Where do they come from?
Wrapped Ethereum
Wrapped ETH was first developed and implemented by a group of Ethereum projects led by 0x Labs. This coalition of projects established a canonical ERC20-compliant wrapped Ether token to create standardization and maximize security across applications.
wETH was created to allow users to convert ETH to wETH without using a centralized party and then be able to use those wETH tokens on dApps in the Ethereum ecosystem. The first proposed canonical WETH contract was released in November 2017. The current deployed WETH contract can be found here.
Wrapped Bitcoin
wBTC, however, is a much different story.
It’s also backed by real Bitcoin, but the BTC is held in custody by BitGo. For every 1 WBTC in circulation, BitGo has 1 real Bitcoin.
Bitgo provides users with a Proof of Assets page where anyone can check the minting and burning activity occurring on-chain for wBTC.
The purpose of this asset is to create an Ethereum-compatible version of Bitcoin that can be used in different DeFi applications. Simply put, it’s an ERC-20 token pegged to the price of Bitcoin.
Whenever a user wants to “unwrap” their wBTC and redeem it for genuine BTC, they must go through a merchant (typically an exchange, for example). Doing this means destroying (or burning) that wBTC and withdrawing one of the Bitcoin from custody.
Can wETH depeg?
wETH cannot ever go insolvent. wETH will always be swappable 1:1 with ETH. The code and logic are quite simple. The contract is only 60 lines of code. Twitter user 0xCygaar goes over the core functions and their purpose in this informative thread.
Instead, the key risk here is smart contract risk. There is always a risk that the smart contract may contain a bug. However, the smart contract for wETH has existed and been highly utilized for so long that something like that would’ve already happened if there were some sort of bug.
How about wBTC?
While one wBTC should always be redeemable for one BTC through official merchants, the token also trades on open markets, which means its price relative to BTC can fluctuate.
Last week wBTC depegged in price from the underlying Bitcoin. Since FTX blew up at the start of November, wBTC has traded on exchanges at a minor discount to Bitcoin.
Alameda Research is the top wBTC merchant by the number of tokens minted, having created more than 100,000 wBTC. Rumors began to circulate that the underlying Bitcoin backing Alameda’s wBTC could be commingled with FTX’s funds or otherwise impacted by the recent insolvencies suffered by major crypto firms. This misinformation then began to affect the secondary market price of wBTC negatively.
Chen Fang, the COO of BitGo, has reassured investors that WBTC is safe. “If folks capitulate to fake news, the market makers win — every WBTC is 1:1 backed, verifiable on-chain,” Fang said.
Normally, when a discount emerges, market makers will swoop in and arbitrage the difference for profit by buying the cheaper WBTC and redeeming it for the real Bitcoin. In the absence of wBTCs largest market marker, Alameda Research, wBTC still has arbitrage opportunities available to smaller, less defunct market makers.
Closing Thoughts
Wrapped tokens bring standardization and utility and allow users to take advantage of the wide world of dApps. However, not all wrapped tokens are made equally. As always, make sure you do your research before committing to an asset, wrapped or otherwise.
