00:00Welcome back to Decentralized News. Today is just a quick explainer. Somebody asked me to do a quick video just talking about wrapped tokens and why they are so essential to the cryptocurrency market.
00:14So wrapped tokens are effectively, if you want to put it in simple terms, smart contracts that represent locked collateral of the original asset on a separate blockchain. So they indeed do provide liquidity to this booming DeFi ecosystem, if you want to put it like that.
00:37So the way to think about wrapped tokens effectively is, let's look at wrapped BTC, for example. It's a smart contract that represent locked collateral in the original asset, right, which is Bitcoin in this instance with wrapped BTC and does that on a separate blockchain.
00:57So they are used to provide liquidity to a expanding market in DeFi. And so you want to more or less think of them as an IOU, right? So instead of paper representing a promise to buy back your BTC, inside is an actual live feed to a vault that contains every Bitcoin and also the outstanding wrapped Bitcoin.
01:26So just a few things to keep in mind. So just a few things to keep in mind is DeFi needs cross-chain liquidity for global adoption effectively. So wrapped tokens do provide a solution with the mechanism of wrapping a token requires three parties, a merchant, a custodian and an investor.
01:51So wrapped tokens carry what we call inherent liquidity and market contagion risks. And the value of wrapped tokens is not necessarily equal to that of their original counterparts.
02:05So you saw that with staked ETH recently and that whole debacle where, you know, people, you couldn't get that parity.
02:16And so if we just think of the importance of wrapped tokens, so we stay on course with this video.
02:22So this solution that they bring to the DeFi ecosystem is very essential because cross-chain liquidity is pretty much the fabric of it.
02:34And so if you think of each blockchain and its native asset token as a silo, so demand for that specific token is contingent on the applications built on that specific network.
02:47So decentralized finance and its complex credit and lending ecosystem as well needs immediate settlement technology that works across all blockchains and without this technology, blockchains can't really benefit from the entire growth of the market.
03:08So wrapped tokens, what they do in this case is sort of break down those silos by offering native tokens, utility outside the actual blockchain.
03:20And this innovation is what unlocks floods of capital efficiency and also enable a diverse investment across most chains.
03:31And so let's again focus on wrapped Bitcoin in this instance.
03:37So all users access wrapped Bitcoin third-party merchants, for example, you're looking at a decentralized money market like Aave or Maker.
03:48And when a user requests they wrap Bitcoin in exchange, the merchant takes their BTC and sends it to a custodian like BitGo, for example, managing the wrapped BTC DAO.
04:06And so the vault actually containing every Bitcoin and wrapped Bitcoin that we spoke about earlier represents the custodian.
04:15And once, let's say, let's say BitGo receives the Bitcoin from the merchant, it then means the equivalent in wrapped Bitcoin, which can be, in this case, an ERC-20 token on the Ethereum blockchain.
04:30And this token is a smart contract representation or an IOU briefcase of the original Bitcoin.
04:38And the custodian then sends the wrapped Bitcoin to the merchant where the user actually finalizes the transaction.
04:47Typically, there aren't any merchant fees in this transfer because they only charge fees for exchanging wrapped BTC for BTC.
04:58So the user will be responsible for any gas fees used in transferring wrapped BTC onto the Ethereum blockchain, for instance.
05:07So because this exchange requires trust from multiple parties, BitGo has also partnered with Chainlink to provide an automated trading system.
05:20If you want to know more about Chainlink, which provides these Oracle services, then you can go to our main site.
05:28We've done a review of Chainlink and other decentralized applications in the Ethereum ecosystem.
05:33Also use this protocol to monitor BitGo's balance sheet when accepting wrapped BTC as collateral in exchange for the equivalent.
05:44So if BitGo were to actually mint more wrapped Bitcoin than BTC, that it actually holds in reserve, every application using Chainlink's protocol would stop receiving wrapped BTC.
06:00So what is the difference between a pegged and a wrapped token?
06:05So the value of a pegged token or currency can be linked to that of another asset, digital or physical, using a variety of different approaches because custodians actually link wrapped tokens to the value of other crypto assets.
06:23They do fall under the pegged currency classification and they do not classify stable coins such as USDT as a wrapped token because it pegs to the value of the US dollar in off-chain cash reserves.
06:42And unlike wrapped tokens, these tokens or these reserves are not audited through an automated protocol.
06:49So that's the difference.
06:50So if you just want to put it down to a final conclusion, the wrapped token is not the same as the original token.
07:02So wrapped Bitcoin is not Bitcoin.
07:05It should not be considered a fundamental equivalent to BTC.
07:11This common misconception is why many lose money in liquidation crisis events, such as some of the ones that we've seen recently.
07:20And so the value of the actual briefcase IOU depends on three things.
07:28Like we said, the quality of the live stream and the integrity of the vault and the briefcase holding it together.
07:34And wrapped tokens in this way actually require three layers of trust that the original tokens do not.
07:42So it may seem that the two have equivalent value for a time.
07:47But when the market does turn bearish, the perceived value of the wrapped tokens can drop faster than that of the originals.
07:56And this is how our wrapped tokens can lose their peg through their balance, though even their balance is still one to one.
08:05So, yeah, you know, be careful of our market contagion and being caught up in some of these situations.
08:14But let me know what you think of this review of our wrapped tokens, what you guys want us to talk more about on this channel.
08:23Also make suggestions and also don't forget to check out the links in the description, of course, to my books, Tokenized, Trillions and Blockchain Applied.
08:32If you are interested in learning more about real world asset tokenization on the blockchain and like, share, subscribe, turn on that notification bell.
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