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In the ever-evolving landscape of cryptocurrency and decentralized finance (DeFi), new concepts and innovations emerge at a staggering pace, reshaping the way we interact with digital assets. Among these transformative developments, one concept gaining significant traction is that of wrapped assets. As the name suggests, wrapped assets represent a unique bridge between traditional and digital finance, offering a novel approach to tokenizing real-world assets on blockchain networks.
Two key categories of tokens that play pivotal roles in blockchain networks are native tokens and ERC-20 tokens. Understanding the distinctions between these token types is essential for grasping the underlying mechanics and functionalities of blockchain ecosystems.
Native tokens are the foundational assets native to a specific blockchain network. They are integral to the operation and governance of the network, serving various functions such as transaction fees, network security, and incentivizing validators. Examples of native tokens include Bitcoin (BTC) for the Bitcoin blockchain, Ether (ETH) for the Ethereum blockchain, and ADA for the Cardano blockchain.
Native tokens typically have specific utilities within their respective ecosystems. For instance, Ether is used to pay for transaction fees and computational services on the Ethereum network, while also serving as the fuel for executing smart contracts and deploying decentralized applications (DApps).
ERC-20 tokens, on the other hand, are a standardized token format based on the Ethereum blockchain. ERC-20 stands for "Ethereum Request for Comments 20," which is the Ethereum Improvement Proposal (EIP) that introduced this token standard. ERC-20 tokens adhere to a set of rules and interfaces, enabling seamless interoperability and compatibility with a wide range of Ethereum-based applications, wallets, and exchanges.
To understand the wrapped assets better let's stick with the simple example of ETH vs wETH.
In the Ethereum ecosystem, Ether (ETH) serves as the native cryptocurrency and fuel for executing transactions and smart contracts on the network. However, alongside ETH, another concept has gained prominence: Wrapped Ether (WETH). Understanding the differences between ETH and WETH is crucial for navigating decentralized finance (DeFi) protocols and tokenized ecosystems on Ethereum.
As already discussed Ether (ETH) is the native cryptocurrency of the Ethereum blockchain. It functions as digital cash within the Ethereum network, used to pay for transaction fees (gas) and to deploy smart contracts. ETH is also a store of value and is traded on various cryptocurrency exchanges. Moreover, it serves as a unit of account for pricing assets and executing financial transactions within DeFi applications.
Wrapped Ether (WETH) is a tokenized representation of Ether on the Ethereum blockchain. WETH is an ERC-20 compliant token, meaning it adheres to the Ethereum Request for Comments 20 standard, which enables it to be easily traded and integrated with other Ethereum-based applications.
The process of wrapping ETH involves depositing Ether into a smart contract, which then mints an equivalent amount of WETH tokens. These WETH tokens can be freely traded, transferred, and utilized within the Ethereum ecosystem like any other ERC-20 token. Conversely, WETH can also be unwrapped back into ETH by redeeming WETH tokens for the equivalent amount of Ether.
Native vs. Tokenized: ETH is the native cryptocurrency of Ethereum, while WETH is a tokenized version of ETH represented as an ERC-20 token.
Interoperability: While ETH can be directly transferred and utilized within the Ethereum network, WETH's ERC-20 compatibility enables seamless integration with DeFi protocols, decentralized exchanges (DEXs), and other Ethereum-based applications.
Enhanced Functionality: WETH's ERC-20 format allows for additional functionalities compared to native ETH, such as trading on decentralized exchanges, collateralization in lending protocols, and inclusion in automated market maker (AMM) pools.
Decentralized Exchanges (DEXs): WETH is commonly used as a trading pair on decentralized exchanges like Uniswap, enabling users to trade ETH against other ERC-20 tokens.
Lending and Borrowing: WETH can be utilized as collateral in DeFi lending protocols like MakerDAO or Aave, enabling users to borrow other assets while leveraging their ETH holdings.
Liquidity Provision: WETH can be deposited into liquidity pools on decentralized exchanges or liquidity protocols, earning fees and providing liquidity to the ecosystem.
In summary, while ETH serves as Ethereum's native cryptocurrency, WETH provides enhanced interoperability and functionality within the Ethereum ecosystem through its tokenized representation. Whether used for trading, lending, or providing liquidity, both ETH and WETH play integral roles in facilitating value transfer and innovation within decentralized finance and tokenized ecosystems on Ethereum.