What Are Wrapped Tokens?

Innovation continues to reshape the digital asset landscape, and one of the technologies enabling more flexible blockchain interactions is wrapped tokens. If you’ve seen tokens like WBTC or WETH on exchanges or DeFi platforms, you’ve likely encountered this concept in action.

Wrapped tokens are part of a broader effort to enhance interoperability — the ability for different blockchain networks to communicate with one another. While each blockchain is typically isolated in terms of technical architecture, wrapped tokens allow value to move between networks in a secure and verifiable way.

For Canadian users exploring decentralized finance (DeFi) or cross-chain applications, understanding how wrapped tokens work can offer important context for navigating multi-chain ecosystems. In this article, we’ll explore what wrapped tokens are, how they’re created, their use cases, and considerations for users engaging with them. 

Wrapped tokens are blockchain-based representations of cryptocurrencies that can be used on networks other than their native ones. However, some wrapped tokens—like WETH (Wrapped Ether)—exist on the same network as the original asset to provide compatibility with token standards (e.g., ERC-20 on Ethereum). In some instances, they are designed to mirror the value of the underlying cryptocurrency, enabling users to access blockchain ecosystems that would otherwise be incompatible with the original asset.

At a high level, wrapped tokens work by locking the original asset in custody—most commonly through a trusted third-party custodian (as with WBTC) or, less commonly, a smart contract—then issuing a new token on a separate blockchain that represents the same value.. For example, when 1 BTC is wrapped, a corresponding 1 WBTC (Wrapped Bitcoin) is minted on the Ethereum network. The wrapped version is meant to reflect the same value as the original BTC but is compatible with Ethereum-based applications and smart contracts. 

1. Minting Wrapped Tokens

Crypto assets are wrapped to enable compatibility with smart contracts, decentralized applications, and token standards, in some instances, within the same blockchain and in others, across different blockchains. To do this, the user initiates a process in which their original asset (e.g., BTC) is transferred to a custodial system — either a smart contract or a designated custodian.

Once the original asset is securely held in custody, an equivalent amount (minus any fees) of wrapped tokens is created (“minted”) on the destination blockchain. For instance, when 1 BTC is locked via a protocol that supports Wrapped Bitcoin (WBTC), 1 WBTC is created on the Ethereum network. The goal is to maintain a 1:1 correspondence between the wrapped token and the original asset, based on reserves.
 

2. The Custodian’s Role 

Custodians — which can be centralized entities, decentralized networks, or a combination of both — are responsible for holding the original asset in reserve. Their role is to provide transparency and assurance that each wrapped token is backed by the underlying cryptocurrency.

In the case of WBTC, the actual custody of the underlying BTC is handled by BitGo, a centralized custodian. The WBTC DAO, which includes merchants and other stakeholders, governs the processes for minting and burning wrapped tokens, but does not directly manage custody. The DAO follows procedures to ensure transparency in minting and burning, with multi-signature approval for these actions. However, the DAO does not directly control the underlying assets; actual custody is held by the centralized entity (e.g., BitGo) 

3. Burning and Redemption 

To convert a wrapped token back into its original cryptocurrency, a burn-and-release process is used. The user initiates redemption—typically through a merchant—by requesting to exchange wrapped tokens for the underlying asset. The wrapped tokens are then sent to the issuing protocol and burned, meaning they are permanently removed from circulation on the blockchain. Once this is confirmed, the corresponding amount of the original asset (e.g., BTC) is released from custody and returned to the user.

This process helps maintain a 1:1 backing ratio and ensures that the total supply of wrapped tokens on the destination chain never exceeds the actual amount of the original asset held in reserve. 

Wrapped tokens solve a key limitation in the blockchain ecosystem: the lack of interoperability between independent blockchain networks. Most blockchains operate in isolation, using their own consensus mechanisms, token standards, and protocols. While this provides security and autonomy, it limits the ability to move assets or interact across different ecosystems.

Wrapped tokens provide a workaround by enabling cross-chain asset mobility. For instance, a Bitcoin holder can convert BTC into Wrapped Bitcoin (WBTC), an ERC-20 token on Ethereum. This allows them to participate in Ethereum-based decentralized finance (DeFi) protocols while maintaining exposure to the price of Bitcoin.

By allowing assets like BTC to be represented on other chains, wrapped tokens increase liquidity across networks such as Ethereum, Avalanche, or Arbitrum. When BTC is wrapped and used on Ethereum, for example, it expands the capital base available to DeFi applications—supporting deeper liquidity pools, improved trading efficiency, and greater capital access for users.

Additionally, wrapped tokens can benefit from the performance characteristics of their host chains. For example, while native Bitcoin transactions may take around 10 minutes for final confirmation, transacting with WBTC on Ethereum or Layer 2 networks may offer faster settlement—though this is dependent on gas fees and network conditions at the time.

These performance and compatibility advantages can make wrapped tokens more suitable for certain use cases, including real-time trading, lending, yield farming, and collateralization within DeFi ecosystems. 

The wrapped token ecosystem includes a range of formats and designs, each tailored to meet specific technical, regulatory, or market requirements. While all wrapped tokens aim to represent the value of a native cryptocurrency on a different blockchain, they vary in how custody is handled, how tokens are redeemed, and the degree of decentralization involved. 

Redemption Models: Redeemable vs. Cash-Settled

Wrapped tokens can generally be categorized based on how redemption works:

• Redeemable Tokens: These tokens are backed 1:1 by the underlying asset and are designed to be redeemable. For example, WBTC (Wrapped Bitcoin) can be returned to a merchant, who coordinates with a custodian (like BitGo), to release the equivalent amount of BTC to the user—assuming all redemption criteria are met. This model prioritizes full backing and trust in the issuing mechanism.
• Cash-Settled Tokens: These tokens provide exposure to the price movement of an asset without offering direct redemption of the underlying cryptocurrency. Instead, they may settle in fiat, stablecoins, or other crypto assets. Synthetic asset protocols like Synthetix issue tokens that track the price of another asset (e.g., sBTC for Bitcoin price exposure). These synthetic tokens are not technically wrapped tokens, since they lack any 1:1 reserve backing and cannot be redeemed for the real asset.

Custodial Models

The security and decentralization of wrapped tokens are shaped by how the original assets are held. Custodial models differ in who controls the backing reserves and how transparent or decentralized that control is:

• Centralized Custodians: A trusted third-party entity holds the underlying assets. This model is used by projects like WBTC, where BitGo serves as the custodian. While operationally efficient, it introduces centralized trust assumptions and custodial risk.
• Decentralized Custodians: In this model, smart contracts or decentralized protocols (e.g., tBTC or Ankr’s cross-chain wrappers) manage custody without relying on a single authority. This approach aligns with decentralization principles but depends heavily on the security and governance of the smart contract infrastructure.
• Multi-Signature Custodians: This hybrid approach uses a group of trusted parties, where multiple approvals (signatures) are required to move the underlying assets. It distributes control to mitigate single points of failure and enhances transparency and operational integrity. WBTC’s DAO governance, which involves multiple merchants and custodians, is an example of this model layered on top of centralized custody. 

Understanding the difference between native and wrapped tokens is essential for users navigating multi-chain environments. Although both represent cryptocurrency value, they differ in terms of functionality, custody, and network compatibility — distinctions that can impact how they’re used in trading, decentralized finance (DeFi), and other blockchain applications. 

Native Token Characteristics

Native tokens are the original assets created to operate on their respective blockchains. They serve as the core units of value and utility within those ecosystems.

Examples include:

• Bitcoin (BTC) on the Bitcoin network
• Ether (ETH) on Ethereum
• Solana (SOL) on the Solana network

Common characteristics of native tokens:

• Used to pay transaction (gas) fees on their blockchain
• Power network security through mechanisms like proof-of-work or proof-of-stake
• Enable participation in governance, if the blockchain supports it
• Act as the primary store and medium of value within the native ecosystem

Wrapped Token Characteristics

Wrapped tokens are blockchain-based representations of native cryptocurrencies that may be issued on the same or a different blockchain. They are created by locking the original asset (or using a smart contract mechanism) and minting a compatible token that conforms to the standards of the host blockchain. Key characteristics include:

• Designed to mirror the value of their native asset, typically aiming for 1:1 parity
• Compatible with the target blockchain’s protocols, such as Ethereum-based DeFi apps (in the case of WBTC)
• Rely on custodial systems or smart contracts to hold the original asset and manage issuance/redemption
• Can typically be converted ("unwrapped") back into the native token if they are reserve-backed; synthetic or price-pegged tokens cannot be redeemed for the underlying asset 

Wrapped tokens unlock cross-chain functionality that expands the ways in which users can interact with the crypto ecosystem. By bridging value across blockchain networks, they enable a range of use cases—including decentralized finance (DeFi), trading, and portfolio management. 
 

1. Decentralized Finance (DeFi)
   One of the most prominent use cases for wrapped tokens is within the DeFi ecosystem, especially on Ethereum Virtual Machine (EVM)-compatible blockchains. Since many DeFi applications — including lending protocols, yield platforms, and decentralized exchanges — operate on Ethereum or similar networks, native tokens from other chains (like BTC) would otherwise be incompatible. 
    
2. Cross-Chain Trading
   Wrapped tokens make it possible to trade assets from different blockchains without relying on centralized exchanges. For example, decentralized exchanges can offer trading pairs like WBTC/ETH, allowing users to swap wrapped assets directly on decentralized platforms without the need for a centralized intermediary. 
    
3. Portfolio Diversification
   For Canadian investors and crypto holders seeking to diversify across protocols, wrapped tokens offer strategic flexibility. For instance, someone holding Bitcoin for its long-term value can convert a portion into WBTC to access DeFi tools or participate in other blockchain-based services. 
    

Wrapped tokens can offer increased flexibility and utility, but they also come with added risks compared to native cryptocurrencies. Wrapped tokens rely not only on the security of their host blockchain (e.g., Ethereum for WBTC) but also, and more importantly, on the security and transparency of the custodian or protocol holding the original asset. Custodian mismanagement, hacks, or protocol vulnerabilities represent the greatest risks.

The most significant risk lies in the custodial arrangement. Unlike native assets that users can hold directly in a self-custodied wallet, wrapped tokens depend on a custodian (centralized or decentralized) to hold the original asset in reserve. If the custodian mismanages, loses access to, or behaves maliciously with the underlying asset, the wrapped token could lose its value. As with any crypto asset, users should carefully evaluate the transparency, reputation, and security practices of the protocols and custodians involved. 

Wrapped tokens have emerged as a key innovation in the crypto space, helping to address limitations in cross-chain communication, liquidity, and interoperability. By enabling assets like Bitcoin to operate on chains such as Ethereum, they open the door to broader participation in decentralized finance and other blockchain ecosystems.

However, with these benefits come important trade-offs. Smart contract risk, custodian dependency, and system complexity mean that wrapped tokens are not risk-free. While they may play a growing role in the evolution of digital finance, user due diligence remains essential.