Blockchain networks were initially built independently. However, the crypto industry has evolved to become an interconnected web of ecosystems. As such, it’s important that blockchain networks communicate. One of the first steps if understanding blockchain interoperability is learning about blockchain bridges and wrapped tokens.
Blockchain bridges are mechanisms that facilitate the transfer of digital assets between different blockchain networks. They enable interoperability and connectivity among disparate blockchains, allowing assets and data to move across them seamlessly. Blockchain bridges are vital in enabling cross-chain communication and facilitating the exchange of tokens and information.
What is a Blockchain Bridge?
- A blockchain bridge connects or links two or more blockchain networks.
- It enables the transfer of assets, tokens, or data from one blockchain to another.
- Blockchain bridges typically consist of a set of smart contracts or protocols that facilitate the secure transfer and verification of assets across different networks.
Why are Blockchain Bridges Important?
- Blockchain bridges enhance interoperability by allowing assets to move between different blockchains.
- They enable cross-chain decentralized applications (dApps) and facilitate the exchange of tokens across multiple networks.
- Bridges enhance liquidity by connecting fragmented markets across different blockchains.
- They support scalability by offloading transactions from one blockchain to another, relieving network congestion.
Types of Blockchain Bridges
- Relay Bridges: These bridges operate by relying on a set of validators or oracles that verify and facilitate the transfer of assets between blockchains.
- Tokenized Asset Bridges: These bridges focus on transferring ownership of real-world assets, such as fiat currencies or physical commodities, onto a blockchain network, enabling their representation as digital tokens.
- Hybrid Bridges: These bridges combine features of relay and tokenized asset bridges to enable the transfer of both native and tokenized assets across blockchains.
How Does a Blockchain Bridge Work?
- Step 1: Locking Assets – When transferring assets from one blockchain to another, the assets are “locked” in the original blockchain by a user or a smart contract.
- Step 2: Verification – The bridge protocol verifies the locked assets’ validity and initiates the transfer process.
- Step 3: Cross-Chain Communication – The bridge protocol communicates with the receiving blockchain and creates a corresponding representation of the locked assets on the target blockchain.
- Step 4: Unlocking Assets – Once the representation is created, the locked assets are “unlocked” on the target blockchain, allowing users to utilize or trade them.
Wrapped tokens are digital assets that represent other cryptocurrencies or assets on a different blockchain. They are created through a process called “wrapping” or “tokenization” and enable the transfer and use of assets across different blockchain networks.
What are Wrapped Tokens?
- Wrapped tokens are tokens that are pegged to the value of another asset or cryptocurrency on a different blockchain.
- They act as a bridge between different blockchains, allowing the representation of an asset from one blockchain to be used on another blockchain.
- Wrapped tokens maintain a fixed or variable value ratio to the underlying asset they represent.
How do Wrapped Tokens Work?
- Step 1: Locking the Original Asset – The original asset is locked in a custodial wallet or smart contract on its native blockchain.
- Step 2: Minting the Wrapped Token – The corresponding amount of wrapped tokens is minted on the target blockchain, typically following a predetermined ratio or formula.
- Step 3: Redemption – When a user wants to redeem their wrapped tokens, they initiate the process by burning the wrapped tokens on the target blockchain.
- Step 4: Unlocking the Original Asset – After burning the wrapped tokens, the user can claim the original asset from the custodial wallet or smart contract on the original blockchain.
Use Cases of Wrapped Tokens
- Interoperability: Wrapped tokens enable the transfer of assets between different blockchains, enhancing cross-chain interoperability.
- Liquidity: By wrapping assets, they can be used on platforms that support the target blockchain, thereby increasing liquidity and accessibility.
- DeFi Applications: Wrapped tokens play a significant role in decentralized finance (DeFi) applications, allowing users to leverage assets from different blockchains for lending, borrowing, and trading.
Popular Examples of Wrapped Tokens
- Wrapped Bitcoin (WBTC): A wrapped token representing Bitcoin on the Ethereum blockchain.
- Wrapped Ether (WETH): A wrapped token representing Ether on the Ethereum blockchain.
- Wrapped Tezos (wXTZ): A wrapped token representing Tezos on the Ethereum blockchain.
Understanding blockchain bridges and wrapped tokens opens up new possibilities for cross-chain compatibility and asset utilization. However, it’s important to consider the trustworthiness, security, and reputation of the bridge or wrapping protocol being used. Conducting thorough research and relying on trusted platforms are crucial to ensure the safe and efficient usage of blockchain bridges and wrapped tokens. Keep watching Fintech Express for more beginner and advanced-level guide articles.