Due to the widespread acceptance of the ERC20 standard and Ethereum’s preference as the go-to blockchain platform for Defi (decentralised finance) projects, Ethereum-based tokens have emerged as a significant asset class. The asset-backed token market has seen exponential development and enthusiasm recently, with advocates hailing them as the “holy grail” of cryptocurrency.
Asset-backed tokens (stablecoins) are digital tokens backed by traditional assets (such as gold or currency), and so reflect the price of the underlying asset. These tokens fall into one of two design categories:
1. Algorithmic — Token demand and supply are managed by a set of Ethereum smart contracts in order to keep the token’s price consistent with that of a fiat currency. The DAI token from MakerDAO is an example of an algorithmic stable-coin linked to the US dollar.
2. Centralized — assets are held by a custodian entity that publishes proof of reserves on a regular basis. Tether and TrueUSD are two examples of such tokens.
The Wrapped Tokens have arrived!
Wrapped tokens is a centralised asset tokenization architecture that spans many institutions. However, rather than relying solely on one institution, it relies on a group of institutions to play various functions in the network.
Wrapped tokens offer a means for multiple institutions in the cryptocurrency sector to work together to solve common problems with current stablecoin implementations. As a result, a new generation of stablecoins will be able to leverage Ethereum in a much more trustless fashion to enable global liquidity, lower transaction fees, larger fractional ownership, and smart contract programmability.
WBTC (Wrapped Bitcoin), the first stablecoin based on the wrapped tokens framework, is an Ethereum ERC20 token backed 1:1 by Bitcoin, giving dApps native Bitcoin access. WBTC does not require any additional utility tokens, and there are no additional transfer costs other than the gas used for blockchain fees. WBTC employs a straightforward federated governance approach and prioritises usability.
Important Functions
The institution that holds the asset as well as the keys to create tokens is known as the custodian. BitGo is currently serving in this capacity for WBTC.
The institution to whom wrapped tokens are minted and burned is known as the merchant. The distribution of the wrapped token is heavily influenced by merchants. Kyber Network and Republic Protocol currently serve in this capacity for WBTC. Each merchant has a key that allows them to start minting fresh wrapped tokens and burning old ones.
The holders of the wrapped token are known as users. Wrapped tokens can be transferred and transacted in the Ethereum network just like any other ERC20 token.
Member of the WBTC DAO — A multi-signature contract governs contract amendments and the addition or removal of custodians and merchants. As part of the WBTC DAO, institutions own the keys to the multi-sig contract. The WBTC DAO, on the other hand, accepts members who are neither custodians nor merchants.
Distribution of WBTC
Custodians and traders trade assets for wrapped tokens. This is accomplished through two distinct transactions: minting (the generation of wrapped tokens) and burning (reducing the supply of wrapped tokens). These transactions are public and may be examined using a block explorer by anyone.
1. Minting
The process of minting involves the creation of fresh wrapped tokens. A custodian must mint in the wrapped framework, but a merchant must “initiate” the process.
2. Burning
Burning is the process of exchanging bitcoins for WBTC tokens. Wrapped tokens can only be burned by merchant addresses. The sum is deducted from the merchant’s WBTC balance, and the WBTC supply is decreased as a result.
Merchants want to have a buffer of wrapped tokens after the initial exchange so they can swap them with users. Because minting and burning are both time-consuming processes, the two-step minting process helps consumers acquire wrapped tokens faster.
The Wrapped Framework’s trust model
Custodians serve as trusted mediators in the wrapped structure to some extent, as assets may be stolen or the one-to-one backing may not be honoured. The wrapped framework, on the other hand, seeks to address this issue in several ways:
i. External third-party audits every quarter to ensure that all wrapped tokens generated have a same amount of assets kept across all custodians. Proof of reserves can be demonstrated in the instance of WBTC by posting signatures from the addresses where bitcoin is held.
ii. Custodians are unable to mint tokens on their own; instead, they must seek the permission of a merchant. As a result, both the custodian and the merchant are involved in the creation of new tokens.
iii. A set of merchant institutions protects the user from engaging with the custodian. Individual merchants do not need to be trusted; rather, all merchants must be trusted collectively.
iv. All institutions engaged with the framework’s credibility are at risk.
Wrapped Tokens are stored in cases.
1. Tokenization of assets
The act of tokenizing assets has the potential to:
Increase transaction speed – Ethereum blocks are formed every 15 seconds, and it is possible to have a reasonable amount of trust in the irreversibility of a transaction in under 5 minutes. When compared to many other assets such as Bitcoin, gold, and fiat currencies, this speed is faster than trading locally.
Increase transparency – Anyone may observe the total quantity of tokens, token creation transactions, token removal transactions, token holders, and transfer rules on a public block explorer.
Increase usability – A huge number of organisations and products have implemented the ERC20 standard. Users can utilise a number of exchanges, wallets, and Dapps to manage their tokenized assets as a result of this. They can also transfer tokens rapidly and at any time.
Enhance security — Tokenization gives users complete control over the asset’s private keys. Users who do not want to hold keys can move them from exchanges to a security-focused custodian to reduce counterparty risk.
2. Fiat-backed stablecoins, which allow traders to maintain their funds in a cryptocurrency without worrying about price volatility.
3. The wrapped framework makes it simple to represent any cryptocurrency, such as Bitcoin, on the Ethereum blockchain, allowing you to take advantage of all of Ethereum’s features.
4. Tokenization gives you a way to enforce policies on the blockchain. On-chain policy enforcement makes rules more transparent and prevents them from being manipulated by relying on a single party to enforce them.
5. In centralised exchanges, the majority of ERC20 trade is done with BTC rather than ETH, while most decentralised exchanges exclusively offer ETH/Token trading pairs. Wrapped tokens can help close the gap and provide liquidity on decentralised exchanges.
Questions for Discussion:
Q1. Does Wrapped tokens solve an age-old problem persistent across all markets?
Q2. When a token is unwrapped, then is it essentially “burnt” as the underlying asset is taken out?
Q3. Did the foreign entity’s shares really change when they were traded on the NYSE?
Q4. Why do blockchains need interoperability, and if they do, why are they incapable of it naturally?
JIMS, Kalkaji
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