Wrapped Tokens are a type of cryptocurrency, whose value is pegged at a 1:1 ratio to another cryptocurrency. Wrapped tokens are most useful when we need to move a currency created on one blockchain network onto a different blockchain network, and transact with it there. This is of great advantage as it allows users of distinct blockchain networks the ability to operate across networks and have broader financial experiences.
Wrapped tokens work by ‘wrapping’ or locking the original currency into a smart contract on its native network. Then, an equivalent representation of this currency, known as its wrapped version, is created on the second blockchain network, wherever desired. The entire process of wrapping the original currency and creating the new, wrapped currency is handled by smart contracts, whose function is visible to the public. Such smart contracts can be published by any type of individual or organisation (such as a DAO).
The unwrapping process takes place in the reverse order of wrapping. First, the wrapped tokens are requested to be 'burnt' on the second blockchain. Once the burn is verified, the original token in the wrapper smart contract on the first blockchain is released to the address of its owner. The wrapping and burning processes are extremely sensitive, as an error here can lead to the circulation of duplicate assets. Such duplication can greatly decrease the value and trust of the wrapper and render it useless, just like the minting of counterfeit banknotes is harmful to the economic system of a country.