Back to Basics: Learn About Wrapped and Pegged Tokens

The post Back to Basics: Learn About Wrapped and Pegged Tokens appeared first on Coinpedia Fintech News

Have you ever heard of wrapped or pegged tokens and wondered, “What in the world does that even mean?” Don’t worry, you’re not alone! The crypto world has its own lingo, and it can sometimes feel like you’re learning a new language. 

But today, we’re going to break it all down together. No jargon, no complicated stuff. Just an easy chat about what wrapped and pegged tokens are and why they matter.

Starting with the Basics: Why Do We Need Wrapped or Pegged Tokens?

Say you have a ticket to a concert. This ticket works great at the concert venue, but what if you’re at a festival that accepts tickets from multiple events? 

Suddenly, your ticket isn’t valid everywhere, and you’re stuck. This is similar to how different blockchains work—they don’t always talk to each other.

Now, wouldn’t it be nice if there was a way to make your concert ticket usable at the festival? 

That’s what wrapped and pegged tokens do in the crypto world. They let assets move between different blockchain networks while maintaining their value. Pretty cool, right?

What Are Wrapped Tokens?

Wrapped tokens are like digital gift wrap for cryptocurrencies. They take an asset from one blockchain and make it usable on another blockchain. But here’s the key: the wrapped version always matches the value of the original asset.

How Does It Work?

Let’s use Bitcoin (BTC) as an example. Bitcoin runs on its own blockchain, but what if you want to use BTC in the Ethereum ecosystem? Ethereum doesn’t natively accept Bitcoin. That’s where wrapped Bitcoin (WBTC) comes in.

Here’s the process:

1. You send your Bitcoin to a custodian. This is a trusted entity that holds your BTC.
2. The custodian creates an equivalent amount of wrapped Bitcoin (WBTC) on the Ethereum blockchain.
3. Now you can use your WBTC in Ethereum-based apps like DeFi protocols.

The custodian keeps your original Bitcoin safe while you use its wrapped version. Whenever you want your BTC back, you can “unwrap” your WBTC.

Why Are Wrapped Tokens Important?

Wrapped tokens solve a big problem in crypto: interoperability. Different blockchains often operate in silos, and wrapped tokens act as bridges between these silos.

For example:

• You can use Bitcoin (via WBTC) in Ethereum’s decentralized finance (DeFi) ecosystem to earn interest, provide liquidity, or trade.
• You can access features and tools on other blockchains without selling your original asset.

Examples of Wrapped Tokens

1. Wrapped Bitcoin (WBTC):
   • Allows Bitcoin to be used on the Ethereum blockchain.
2. Wrapped Ether (WETH):
   • Ether (ETH) itself doesn’t follow the ERC-20 standard used by Ethereum tokens. WETH wraps ETH into an ERC-20-compatible form, making it easier to use in Ethereum applications.
3. Wrapped BNB (WBNB):
   • Lets Binance Coin (BNB) be used across different blockchains like Ethereum.

What Are Pegged Tokens?

Now let’s talk about pegged tokens. These are slightly different but just as fascinating. A pegged token is a crypto asset designed to maintain the same value as another asset—like a 1:1 ratio.

How Does It Work?

Pegged tokens are usually backed by reserves. For example:

• A stablecoin like USDT (Tether) is pegged to the US Dollar. For every USDT in circulation, there’s supposed to be $1 in reserve.
• This “pegging” ensures that the value of USDT stays close to $1, even if the crypto market is going wild.

Pegged tokens can also be backed by other cryptocurrencies or even algorithms. But the goal is the same: keep the value stable and predictable.

Why Are Pegged Tokens Useful?

Pegged tokens are popular because they bring stability to a volatile market. Imagine you’re trading crypto, and the market suddenly tanks. 

A pegged token like USDT gives you a safe place to park your funds without converting back to traditional fiat money.

Here’s where pegged tokens shine:

• Stability: Their value doesn’t swing wildly like most cryptocurrencies.
• Ease of Use: They’re great for everyday transactions.
• Cross-Border Payments: Pegged tokens like USDT or USDC make it easier to send stable value across countries without relying on banks.

Examples of Pegged Tokens

1. Tether (USDT):
   • Pegged to the US Dollar.
   • One of the most widely used stablecoins.
2. USD Coin (USDC):
   • Also pegged to the US Dollar.
   • Known for being transparent, with regular audits of its reserves.
3. DAI:
   • A decentralized stablecoin pegged to the US Dollar.
   • Maintains its peg using crypto collateral and smart contracts.
4. Lido Staked ETH (stETH):
   • Pegged to Ethereum but represents staked ETH in the Ethereum 2.0 network.

Wrapped vs. Pegged Tokens: What’s the Difference?

At this point, you might be wondering, “Okay, so what’s the difference?” 

Here’s a quick comparison:

Challenges and Risks

Now, nothing in crypto is perfect, and wrapped and pegged tokens have their challenges.

Wrapped Tokens

Centralization: Many wrapped tokens rely on custodians to hold the original asset. This adds a layer of trust, which goes against the decentralized ethos of crypto.

Fees:Wrapping and unwrapping assets often come with transaction fees.

Pegged Tokens

Trust Issues:For pegged tokens backed by reserves, there’s always the question: “Are the reserves really there?”

De-pegging Risks:In extreme market conditions, pegged tokens can lose their value temporarily. This is called “de-pegging.”

A Fun Fact to Wrap It Up

Did you know that wrapped Bitcoin (WBTC) has over $4 billion worth of Bitcoin locked in its system? 

That’s a huge testament to how much people value the ability to use Bitcoin in Ethereum’s ecosystem.

So, what did we learn today? 

Wrapped tokens help assets move across blockchains, while pegged tokens bring stability to the crypto world. They both solve unique problems and open up exciting possibilities for the future of finance.

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