Wrapped Asset

The core function of a wrapped asset is to enable an asset to move between blockchains. A custodian or smart contract locks the original asset (e.g., Bitcoin) on its native chain and mints a pegged representation (e.g., WBTC) on a destination chain (e.g., Ethereum). This allows assets to be used in DeFi protocols, DEXs, and other applications on the foreign chain.

Wrapped assets are backed 1:1 by the underlying asset, secured through different trust models:

• Custodial (Centralized): A single entity (e.g., BitGo for WBTC) holds the locked assets. Users rely on the custodian's integrity and proof-of-reserves.
• Non-Custodial (Decentralized): The underlying asset is locked in a multi-signature or DAO-controlled smart contract, reducing single points of failure.
• Over-Collateralized: Some synthetic or wrapped assets use excess collateral (e.g., 150%) to maintain the peg, managed by algorithms.

By representing a native asset as a standard token (like an ERC-20 on Ethereum), it inherits the programmability of that chain. This enables:

• Integration into automated market makers (AMMs) like Uniswap.
• Use as collateral in lending protocols like Aave or Compound.
• Inclusion in yield farming strategies and structured products.
• Composability with thousands of other smart contracts in the ecosystem.

Maintaining a 1:1 peg with the underlying asset is critical. Mechanisms include:

• Arbitrage: If the wrapped asset trades below peg, arbitrageurs can buy it and redeem it for the underlying asset, driving the price up.
• Mint/Redeem Fees: Fees can be adjusted to incentivize minting or burning to correct price deviations.
• Oracle Price Feeds: Decentralized applications rely on oracles to verify the value of the underlying asset for accurate pricing and liquidation.

Prominent examples illustrate different approaches:

• WBTC (Wrapped Bitcoin): The largest wrapped asset, an ERC-20 token backed 1:1 by Bitcoin held by custodians.
• WETH (Wrapped ETH): A wrapper for native Ethereum, converting it to the ERC-20 standard for use in dApps.
• bridged Assets: Tokens like USDC.e (bridged from Ethereum to Avalanche) are a form of wrapped asset created by cross-chain bridges.
• Synthetics: Assets like sBTC (Synthetix) are synthetic representations, not directly backed 1:1 but by a pool of collateral.

Using wrapped assets introduces specific risks beyond the underlying asset's volatility:

• Custodial Risk: The entity holding the underlying assets could be hacked or become insolvent.
• Smart Contract Risk: Bugs in the minting/burning or bridge contracts could lead to fund loss.
• Bridge Risk: Cross-chain bridges are frequent targets for exploits, potentially breaking the peg.
• Regulatory Risk: The legal status of the wrapper or custodian may be unclear.

A wrapped version of native Ether (ETH) that conforms to the ERC-20 token standard. Unlike most wrapped assets, it bridges a native asset to its own ecosystem's token standard.

• Purpose: ETH itself is not an ERC-20 token. WETH allows ETH to be seamlessly used in ERC-20 based applications like decentralized exchanges (e.g., Uniswap) and lending markets.
• Mechanism: Users "wrap" ETH by depositing it into a public smart contract, which mints WETH.

The ERC-20 wrapped version of Polygon's native MATIC token on the Ethereum mainnet. It is the canonical bridge representation for moving MATIC to and from the Polygon PoS chain.

• Function: Serves as the primary liquidity representation of MATIC on Ethereum, allowing it to be traded on DEXs or used as collateral.
• Process: Created when users bridge MATIC from the Polygon network to Ethereum via the Plasma or PoS Bridge.

Wrapped tokens are essential for creating deep, cross-chain liquidity pools on decentralized exchanges. They enable trading pairs that would otherwise be impossible, such as BTC/ETH or SOL/USDC on a single chain. This aggregation of liquidity improves price discovery and reduces slippage for traders across the ecosystem.

• Example: The WBTC/ETH pool is consistently one of the largest on Uniswap.
• Mechanism: Acts as the bridge asset in multi-chain trading routes.

Wrapped assets are the output of cross-chain bridges and messaging protocols. They represent a claim on an asset locked in a vault or smart contract on the source chain. This mechanism is the backbone of interoperability, enabling asset portability between Layer 1s, Layer 2s, and sidechains.

• Core Components: Custodial bridges (Wrapped BTC), decentralized bridges (Multichain, LayerZero).
• Process: 1) Lock native asset on Chain A. 2) Mint wrapped representation on Chain B.

Wrapping enables the creation of yield-bearing or staked asset derivatives. For instance, stETH is a wrapped representation of staked Ether on Lido, which accrues staking rewards and remains liquid and tradable. Similarly, yield-bearing wrappers like cTokens (Compound) or aTokens (Aave) represent deposit positions that earn interest.

• Function: Unlocks liquidity for otherwise locked assets (e.g., staked ETH).
• Benefit: Enables "staking" while using the asset in other DeFi protocols.

Custodial wrapped assets like WBTC involve regulated entities (merchants, custodians) to manage the underlying collateral. This model provides a trusted on-ramp for institutional capital seeking exposure to DeFi while relying on known counter-party risk structures. It bridges traditional finance compliance with blockchain utility.

• Key Players: Merchant networks (BitGo for WBTC).
• Process: KYC/AML verification for minting and burning.

Wrapping is the first step in creating synthetic assets that track the price of real-world assets (RWAs) or other cryptocurrencies. A wrapped stablecoin like USDC.e on Avalanche is a bridge-based synthetic, while more complex synthetics use wrapped collateral as backing for minting assets like synthetic stocks or commodities on protocols like Synthetix.

• Extension: Wrapped collateral backs synthetic issuances.
• Goal: Bring off-chain asset exposure on-chain.

A distinction in wrapped assets based on issuance authority and redemption guarantees.

• Canonical (Official): The wrapped asset issued by the original protocol's authorized bridge (e.g., WETH on Ethereum, WBTC by the Wrapped Bitcoin DAO). It is the standard, universally accepted representation.
• Non-Canonical (Bridged): A wrapped version created by a third-party bridge (e.g., multichain.xyz's anyBTC). These may have different liquidity, security models, and redemption paths, creating fragmentation risk.

A data feed that provides external information, such as asset prices, to a blockchain. Oracles are critical for wrapped asset systems that use algorithmic or synthetic models instead of direct custody.

• Price Feeds: Ensure wrapped assets and synthetic derivatives maintain their peg to the underlying asset's market value.
• Security: A compromised oracle providing incorrect price data can lead to undercollateralization and protocol insolvency, as seen in multiple DeFi exploits.