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How do Wrapped Tokens work?

How do Wrapped Tokens work?

A wrapped token is a synthetic version of a cryptocurrency token that enables it to function on a separate blockchain while maintaining a price peg of 1:1. 

Though that definition is accurate, it doesn’t make much sense without understanding a little bit about how blockchains work. So let’s step back and provide more context.

Bitcoin is both the first cryptocurrency and the first example of a blockchain. The Bitcoin blockchain (usually written with a big ‘B’) is a ledger of balances of the cryptocurrency bitcoin (usually written with a little ‘b’) maintained by a distributed network of global independent computers.

Along with a record of the Bitcoin blockchain, those computers - known as Nodes - run a piece of software - the Bitcoin Protocol - that includes all the rules for maintaining accurate balances of Bitcoin known as addresses, creating new bitcoin at a pre-programmed rate (through what is known as a consensus method) and enabling wallets to transact bitcoin.

This all happens without any central authority, which is the magic of decentralisation. You can read about How Bticoin works in more detail elsewhere in the Learn Crypto knowledge base, but the key element to understand is that bitcoin the cryptocurrency, works based on a very specific set of rules, the Bitcoin Protocol.

Those rules are open source, so there are numerous examples of copy-cat versions of Bitcoin, which follow the same basic principles but tweak a certain element.

Bitcoin also inspired a whole host of new cryptocurrencies that follow different rules, with their own consensus methods and different approaches to recording balances. The most well known is Ethereum. 

Ethereum is a blockchain-based system that supports an ecosystem of digital platforms that are interoperable because Ethereum is Turing Complete, with a specific language for writing Smart Contracts. It also includes a very specific set of standards for transferring value. You have probably heard of them: ERC-20, the most common standard for an Ethereum-based token, or ERC-721 for NFTs.

These standards are really useful because any Ethereum wallet can support any ERC-20 token, making transactions and exchange simple. This standard-based system is one reason why the Ethereum ecosystem has grown so fast because all the elements are composable; they can fit together like Lego blocks.