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What Is Wrapped Ethereum (wETH) and How Does it Work?

Wrapped Ethereum (wETH) explained

In their standard forms, most blockchains are not interoperable with each other. As a result, you can’t move your coins from one DLT network to another without using the services of an intermediary like a crypto exchange.

However, as the industry matured, blockchain interoperability has become more significant than ever. For that reason, developers and cryptocurrency projects have found ways to transfer digital assets between two separate chains, such as Bitcoin and Ethereum.

One method to achieve the above is utilizing a wrapped token, a coin that has its value tied to an underlying cryptocurrency to represent the latter on another blockchain, network, ecosystem, or application.

Wrapped Bitcoin (WBTC) is an excellent example that allows users to move BTC from the Bitcoin blockchain to Ethereum by wrapping the token via either trusted custodians or smart contracts in a decentralized way.

But today, we will explore a cryptocurrency that developers created to achieve interoperability, not between different chains but decentralized applications (dApps) within the Ethereum ecosystem. In this article, you will learn what Wrapped Ethereum (wETH) is, how it works, and what benefits it provides for crypto market participants.

The Compatibility Issue Between ETH and ERC-20 Tokens

Before we deep-dive into what Wrapped Ethereum (wETH) is, let’s first see a quick recap about ETH and ERC-20 tokens.

ETH is the native token of the Ethereum blockchain that is utilized to cover gas fees for all kinds of transactions, including simple user-to-user value transfers to deploying, interacting, and executing smart contracts (e.g., DeFi token swaps, NFT minting).

As a side note, while ETH has no cap on the number of coins that can be created, the London hard fork in August added a deflationary burning mechanism to make the cryptocurrency more attractive to investors.

On the other hand, ERC-20 is a fungible token standard on Ethereum that was proposed by co-founder Vitalik Buterin back in 2015 to offer a seamless and standardized way for developers to launch their coins and integrate them with dApps in the smart contract blockchain’s ecosystem. With thousands of coins launching on top of Ethereum, it’s safe to say that ERC-20 is among the most successful token standards in the cryptocurrency industry.

However, there’s a catch. ETH was created before the ERC-20 token standard. For that reason, and due to the fact that developers haven’t yet rolled out a tweak around this field, ETH is not compatible with the ERC-20 standard and the coins that use it.

The lack of compatibility between the native coin and the ecosystem’s primary fungible token standard led to quite some complexity for developers. Instead of using a single interface, they had to create two separate (one for ERC-20 tokens and another for ETH) in smart contracts.

As you may already know, a smart contract is computer code that represents a self-executing digital agreement between two or more parties that is widely utilized in dApps, decentralized finance protocols, as well as NFT and blockchain gaming solutions.

Smart contracts are among the most “delicate” components of blockchain applications. While they require expertise from developers to program, one small mistake in the code can lead to grave consequences. The infamous Poly Network hack is a great example, where the attacker (or a white hat hacker) exploited a smart contract-related vulnerability to steal $610 million from the protocol (which he had since returned).

As you can see, creating two interfaces in smart contracts increases the complexity of the code, which opens up more room for mistakes that could lead to financial loss. However, unless they use this method, developers can’t (natively) exchange between ETH and ERC-20 tokens without using a trusted intermediary.

What Is Wrapped Ethereum (wETH) and How Does it Work?

Fortunately, Wrapped Ethereum is an effective solution to execute transactions between ETH and ERC-20 tokens while reducing the complexity of smart contracts and avoiding the need to utilize an intermediary.

wETH is a wrapped coin that features a 1:1 pegged ratio to ETH and uses the ERC-20 token standard instead (or another token standard like BEP-20 if it’s present on another blockchain).

Interestingly, wrapping Ethereum doesn’t affect its value at all. For that reason, 1 ETH will always be worth 1 wETH (and vice versa) without the risk of major price differences between the two coins.

Unlike in the case of Wrapped Bitcoin (WBTC), where funds have to be moved from the Bitcoin blockchain to Ethereum, wrapping and unwrapping wETH is a relatively straightforward process that can be easily done without any intermediaries.

For example, you can use the Uniswap decentralized exchange (DEX) to wrap ETH via the following process:

  1. Head to Uniswap’s DEX interface and connect your wallet
  2. Select ETH as the first and wETH as the second token from the list
  3. Click “Wrap” and confirm the transaction via your wallet

You can unwrap wETH any time. Simply select wETH as the first and ETH as the second token on Uniswap (or any other DEX), click “Unwrap,” and use your wallet to execute the transaction.

It’s important to note that there are many versions of wETH present across Ethereum, which is why developers are working together to create a canonical wETH standard, so they can make the application development process more seamless, avoid confusion, and reduce friction when users move the asset across multiple dApps.

wETH and Blockchain Interoperability

In addition to reducing the risks of smart contract bugs, Wrapped Ethereum enhances interoperability not just between decentralized applications (via seamless transactions between wETH and ERC-20 tokens) but also across different blockchains and scalability protocols on top of the second layer.

For example, Polygon automatically wraps ETH into wETH when the digital asset is moved from Ethereum’s mainnet to the layer-two (L2) scalability protocol.

This way, users can basically utilize their ETH holdings in the Polygon ecosystem (or in another high-throughput network) to access low gas fees and instantaneous transactions. This comes in handy for smart contract-powered dApps (where transfer costs are the highest due to the massive amounts of gas used), such as in the DeFi and NFT sectors.

Service providers within the cryptocurrency space have already identified this opportunity to improve the user experience for their customers.

For example, the Austria-based Bitfly’s Ethermine mining pool started to offer miners payouts in wETH on Polygon alongside ERC-20 tokens. Since transaction fees are inexpensive on the layer-two scalability solution, the pool covers gas costs for those who choose to receive their revenue in Wrapped Ethereum.

As you can see, this is a significant benefit for miners. Before the option to get paid in wETH came about, pools charged hefty transaction fees for withdrawals due to Ethereum’s high gas costs (that stand at $9.95 and $30.81 on average for ETH and ERC-20 transfers, respectively, as of November 19).

While large miners could wait until they accumulate more profits, it hurts the profitability and the operational flexibility of small miners. On the other hand, both parties can leverage wETH to withdraw their earnings with inexpensive fees and quick settlement.

And Bitfly is not the only company that integrated Wrapped Ethereum into its platform. Recently, AAX has become the first cryptocurrency exchange to support direct wETH deposits and withdrawals via the Polygon network.

In addition to miners, traders, investors, DeFi users, NFT collectors, and all other cryptocurrency market participants can utilize AAX’s LSEG-powered platform to deposit wETH and convert it between a wide variety of digital assets via a competitive fee structure. In addition to withdrawing the funds, users also have the option to subscribe to the exchange’s high-yield savings product to boost their earnings and generate a passive income.

At the same time, since you can seamlessly move your ETH (or wETH) between different blockchains (AAX supports Ethereum’s mainnet, Binance Smart Chain, and Polygon for ETH deposits and withdrawals), AAX also acts as a bridge for dApp users.

wETH: a Temporary Yet Effective Solution to Ethereum’s Compatibility Problems

wETH is a super useful tool to limit the risks of smart contract mistakes and make coding more seamless for developers.

In addition to developers, crypto market participants like miners, traders, investors, and yield farmers can leverage wETH at service providers like AAX to access various blockchain ecosystems and avoid Ethereum’s high gas fees.

However, while it’s an effective solution to solve the compatibility issues between ETH and ERC-20 coins, it seems like wETH is only a temporary fix, as developers have already taken steps to update Ethereum’s codebase to make it compliant with the token standard.

At the same time, ERC-223 is in the works, which may replace ERC-20 with a more efficient and secure token standard in the future.

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