Today we start to see another crypto. As probably have you already read from the title, we will talk about Wrapped Ethereum (WETH)!
In the last review, I talked about Wrapped Bitcoin (WBTC), If you missed my last review, you can recover it here!
WETH is the Wrapped Ethereum version. Wrapped tokens, such as WETH or Wrapped Bitcoin, are tokenized versions of cryptocurrencies that are pegged to the value of the original coin. Almost every major blockchain has a wrapped version of its native cryptocurrency such as Wrapped BNB , Wrapped AVAX or Wrapped Fantom .
The mechanism of such coins is like that of stablecoins. Stablecoins are essentially "wrapped USD" meaning that stablecoins pegged to the dollar can be converted to FIAT dollars at any time. Similarly, WBTC, WETH, and all other wrapped coins can be redeemed for the original resource at any time. Wrapped coins solve a particular problem: because of the low interoperability of blockchains, native coins on one chain cannot be used on another chain.
For example, you cannot use Bitcoin on the Ethereum blockchain and you cannot use Ether on Bitcoin or Avalanche. Coin wrapping solves this problem by tokenizing them and applying the blockchain token standard to the tokenized version of the original cryptocurrency.
On Ethereum, almost all fungible tokens follow the ERC-20 standard developed in 2015. This token standard was developed to have a standardized set of rules for tokens on Ethereum, which simplified the launch of new tokens and made all tokens on the blockchain comparable to each other.
The mandatory rules that all ERC-20 tokens must follow are total supply, balance, transfer, transfer from, approval, and allowance. Unfortunately, Ether itself does not comply with the ERC-20 standard. Wrapped Ethereum was developed to increase 'interoperability between blockchains and make Ether usable in decentralized applications (dApps).
Image source: https://esmt.berlin/knowledge/blockchain-digital-disruptor
Wrapped tokens require custodians to hold the collateral. For example, if you want to wrap Ethereum, a custodian will hold your Ether and give you Wrapped Ethereum in return.
Custodians can be merchants, multi-signature wallets, or simply a smart contract. You send your collateral to the custodian and a wrapped version of your coin is minted. For example, with Wrapped Ethereum, you could simply go to a DEX like UniSwap and exchange your Ether for Wrapped Ethereum. The original Ether is converted to Wrapped Ethereum, but the value remains the same, like how stablecoins pegged to the dollar work.
On the Ethereum blockchain, Wrapped Ethereum is required to exchange tokens on decentralized applications. For example, some decentralized applications cannot work with Ether as collateral but only with WETH. While Ether is needed to pay for gas, WETH is an ERC20 token that can be exchanged with other ERC-20 tokens on DeFi applications. Other blockchains may have their own version of WETH, thus creating a mirror image of Ether on their blockchain.
In the OVERVIEW section, I introduced you Wrapped Ethereum (WETH) and I said that WETH is the Wrapped Ethereum version. Wrapped tokens, such as WETH or Wrapped Bitcoin, are tokenized versions of cryptocurrencies that are pegged to the value of the original coin. Almost every major blockchain has a wrapped version of its native cryptocurrency such as Wrapped BNB , Wrapped AVAX or Wrapped Fantom .
Wrapped tokens, such as WETH, WBTC, and others, allow tokens to live on multiple chains. For example, if an investor wants to hold Ether but use it on the Avalanche blockchain, he will need Wrapped Ethereum to have price exposure to ETH while not using the Ethereum blockchain. This increases the liquidity and capital efficiency of blockchains because it allows investors to wrap resources and distribute them on other chains.
Bitcoin is particularly popular in this regard because it is seen as a "digital gold" asset in the cryptocurrency space. Investors can store their Bitcoin but use it for farming or other DeFi assets by wrapping it. Coin wrapping can also reduce transaction time and fees. Ethereum suffers from high gas fees, so wrapping it on another blockchain allows investors to trade Ether at a much lower cost.
On the other hand, wrapping the coins means investors have to go through a custodian and take on additional risk that way. Decentralized exchanges can have smart contract risks, while custodians like Thorchain can be hacked. So far, there is no fully decentralized solution to wrap coins universally. Also, not every chain can wrap every token. Although versions of WETH exist on most major blockchains, the reverse is not always true.
Image source: https://www.coinmama.com/blog/defi-explained/
Creating a wrapped token has many more advantages for the target platform than the source platform, because a wrapped token steals liquidity from the other Blockchain. If we always take the case of BTC buying 1 Bitcoin the liquidity ends up in this same platform, buying instead 1 WBTC the liquidity spent goes to Ethereum and not to Bitcoins. In this way, people who want to invest in Bitcoin, that is, in a currency that follows that price trend, do so by buying, however, a cryptocurrency that works on the Ethereum platform and that increases to the detriment of BTC its liquidity volume.
Have you already used wETH into DeFi?
Next Sunday I’ll introduce to you a new cryptocurrency.
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