As we look into the future of crypto finance, wrapped tokens are like superheroes in disguise, while synthetic assets will cater to the needs of a wider group of users. Synthetic assets do not rely on an actual asset. This means that crypto synthetic assets are catalogued, sold, and transferred online rather than being held by investors.
That said, this post will through more light on all you need to know about both wrapped and synthetic tokens.
What Is Wrapped Token?
Wrapped tokens are tokenized versions of one cryptocurrency that are issued on a different blockchain. It is pegged 1:1 to the original asset and guaranteed by reserves stored in smart contracts or vaults.
Wrapped tokens retain the value of the original coin, even when they migrate and function on a different network. Wrapped crypto coins enable cross-chain interoperability by connecting blockchains that would not otherwise operate together.
For example, Bitcoin was not designed to be compatible with Ethereum’s decentralized finance apps. Users can wrap BTC into Ethereum and utilize it for trade, lending, or yield farming while maintaining its original worth. The procedure uses a lock-and-mint approach, in which a custodian locks the native asset and creates an equivalent wrapped version on the new blockchain.
What Are Synthetic Assets?
Synthetic assets, or crypto synths, are simply tokenized derivatives. Let us illustrate tokenized derivatives with an example. Consider a derivative whose value is linked to another asset by contract. In such situation, we can trade the movement of that value utilizing trading instruments such as futures.
In conventional finance, derivative value is calculated using an underlying asset, such as a stock or bond. These derivatives enabled traders to bet on the price swings of an asset without actually purchasing it. However, crypto synths, also known as tokenized derivatives, expand on the concept of derivatives by allowing them to be recorded on the blockchain and generating a cryptocurrency token.
Crypto synthetic assets are gaining popularity in the crypto sector because they allow investors to profit from the fluctuations of numerous tokens without actually owning any of them. These digital assets are becoming widely preferred for investing purposes. This is for two primary reasons: security and traceability. Trades are recorded on a distributed ledger, which ensures trader anonymity and security.
How Wrapped Crypto Works?
Understanding wrapped tokens begins with determining how they work. They lock an underlying asset—such as BTC or ETH—on one chain and create a corresponding token on another, typically utilizing the ERC-20 Token Standard. Let’s look at each stage of the process in further depth.
1. Locking Mechanism
First, native coins are placed in a secure collateral reserve, which is administered by a custodian. The tokens remain locked until the wrapped versions are redeemed. This locking technique is a critical component of how wrapped tokens ensure that each asset is fully backed and pegged 1:1 to the original.
2. The Wrapping Process: Minting, Burning, and Redeeming
After the assets are locked, wrapped tokens are produced and distributed to the user on a distinct blockchain network. To liberate the original, the wrapped tokens must be burned, which removes them from circulation. Only then may the custodian withdraw the native asset from the reserve. This
3. Roles of The Custodian and Token Issuer
The cycle is enabled by two key actors: the custodian, who owns the underlying assets, and the token issuer, who typically operates via a cross-chain bridge. The bridge secures the coins and distributes wrapped versions that adhere to the ERC-20 standard, allowing for cross-chain interoperability.
4. Security Measures: Proof of Reserves and Multi-Signature Wallets
Proof of Reserves confirms that every wrapped token is matched with a genuine asset, which is frequently verified through cryptographic audits, in order to increase user trust. Multi-signature wallets provide an additional precaution by demanding numerous permissions before funds may be transferred. Together, these approaches maintain transparency and reduce risks, making it safer to manage wrapped tokens for both custodians and users.
Why Are Synthetic Assets Important?
The DeFi world is relatively new, and the variety of financial products remains limited. In the traditional finance world, investors have access to a wide range of financial products. They have the opportunity to use a variety of techniques by combining different financial instruments.
Crypto synthesizers seek to increase the accessibility of financial products and investment methods in the DeFi sector. Synthetic assets in DeFi are supposed to improve risk management, trading volume, and liquidity.
Synthetic asset protocols are also helping to minimize the problems caused by ineffective cross-chain communication methods. Users can trade assets without actually owning them through these tokenized derivatives. Furthermore, it has been observed that cryptocurrency trading is restricted to crypto aficionados or persons who are aware of DeFi.
Synthetic assets are also aiming to overcome this constraint. This is accomplished by enabling anyone to invest and participate in the traditional market without leaving the blockchain ecosystem. Thus, the use of synthetic assets will increase the overall user base for cryptocurrency.
These aren’t the only benefits these assets offer; there are plenty others. Let’s look at their primary qualities and why they’re gaining traction so quickly.
1. No Counterparty Involved
Synthetic assets are created through the minting procedure, which includes securing a higher amount of cryptocurrency as collateral. When these assets are traded against one another, the “sold” asset is destroyed, and an equal amount of the “buy” asset is created.
This approach enables the exchange of value between synthetic assets without the requirement for a physical transaction or a counterparty. As a result, order books, which are venues where buyers and sellers of an asset can meet at a predetermined price, are not required for synthetic assets.
Instead, the value of the assets can be directly transferred using the minting and burning processes. This can improve the trading process and make it more efficient for investors.
2. Decentralized
Synthetic asset exchanges can create an almost limitless supply of any asset as long as it is adequately collateralized. This means that the exchange can issue as many tokens as it likes as long as the collateral has an equivalent value to the total worth of the tokens.
Synthetic asset exchanges are non-custodial, which means they do not keep assets for their users and do not use brokers or know-your-customer (KYC) procedures. This can make synthetic asset exchanges a more decentralized and cost-effective way to trade, as these platforms have extremely low costs.
3. Increased Flexibility
Synthetic assets enable investors to acquire exposure to a diverse variety of assets, such as stocks, bonds, commodities, and currencies, without directly acquiring the underlying assets. This enables investors to personalize their portfolios and adjust their assets to meet their individual financial objectives.
4. Enhanced Risk Management
Synthetic assets can be used to protect against market risks, including currency and commodity price changes. This can assist investors to secure their portfolios and lower the total risk of their assets.
5. Lower Transaction Costs
Since synthetic assets are formed through financial contracts rather than real acquisitions, they can frequently be exchanged at a lower price than traditional assets. This may make them an appealing alternative for individuals wishing to lower the costs associated with their investments.
6. Increased Liquidity
These assets may provide more liquidity than traditional asset exchanges and lower underlying costs for dealers. This is because synthetic asset exchanges do not have the same price spreads or trading fees as traditional asset exchanges, making it easier for traders to purchase and sell assets while potentially profiting.
Synthetic assets might be an appealing choice for traders who want to bet on the movement of asset values without paying hefty fees or spreads.
7. Greater Accessibility
Investors who do not have enough funds to buy the underlying asset directly can purchase synthetic assets. This can help investors with modest budgets acquire exposure to a broader choice of assets.
Differences Between Wrapped Tokens and Synthetic Assets
Wrapped Coins are synthetic assets, although not all synthetic assets are wrapped coins. Synthetic Asset is a broad category, and “Wrapped Token” is a specific variety within it. Here’s an explanation of the distinction:
1. Synthetic Assets (The Broad Category)
A Synthetic Asset (or “Synth”) is a tokenized derivative—a digital token created to imitate the price and performance of another asset without requiring direct ownership of the underlying asset.
The goal is to provide consumers with price exposure to an asset that they would otherwise be unable to use on a particular blockchain.
| Type | Underlying Asset | Purpose | Example |
| Wrapped Tokens | Another Cryptocurrency | Enables interoperability (cross-chain use). | Wrapped Bitcoin (WBTC) tracks BTC price on the Ethereum network. |
| Synthetic Stablecoins | Fiat Currencies | Creates a stable store of value on-chain. | sUSD (tracks USD) or DAI (a decentralized stablecoin). |
| Real-World Assets (RWAs) | Stocks, Commodities, Indices | Allows crypto users to gain exposure to traditional finance. | sTSLA (synthetic Tesla stock) or sGold (synthetic gold). |
2. Wrapped Tokens (A Specific Type of Synthetic Asset)
A Wrapped Coin is a synthetic asset backed 1:1 by a reserve of the native coin, intended specifically for interoperability.
- Mechanism: The original coin (e.g., Bitcoin) is locked in a smart contract or maintained by a custodian, while an equivalent wrapped token (e.g., WBTC) is created on a different blockchain (e.g., Ethereum).
- Key Feature: The 1:1 backing allows you to always “unwrap” the token and redeem the underlying asset.
Key Difference Summary
Wrapped tokens have a 1:1 backing from their original asset, whereas synthetic assets track the value of an item without actually having it in reserve. This is how they compare.
| Feature | Wrapped Tokens | Synthetic Assets |
| Backing | Collateralized 1:1 by the underlying asset (e.g., WBTC backed by BTC). | Not backed directly, but by collateral and code that tracks price (e.g., sBTC on Synthetix). |
| Main Purpose | To bring non-native assets into a different blockchain (e.g., BTC on Ethereum). | To give exposure to asset prices (crypto, stocks, commodities) without ownership. |
| Custody Model | Relies on custodians or bridges to hold the original coins. | Managed by code and collateral pools, with no direct custody. |
| Risk Profile | Custodial or programming risk; depends on issuers and bridge security. | Higher contract and collateral risk; vulnerable to oracle issues. |
| Use Cases | DeFi trading, liquidity pools, lending, collateral for stablecoins. | Price speculation, derivatives, and hedging across asset classes. |
| Examples | WBTC, WETH, renBTC. | Synthetix (sUSD, sBTC, sETH), Mirror Protocol assets. |
Top Synthetic Asset Protocols
As the need for synthetic assets has grown, more decentralized finance (DeFi) solutions have emerged to satisfy it. Synthetic asset exchanges, which allow traders to purchase and sell synthetic assets, are gaining popularity on multiple blockchains.
Synthetix is a well-known synthetic asset exchange that was one of the first to focus on trading tokenized derivatives. Other popular synthetic asset exchanges include MakerDAO. This exchange provides traders with a variety of purchasing and selling alternatives for synthetic assets, as well as lower gas expenses and greater flexibility.
1. Synthetix
Synthetix is a DeFi protocol that allows for the creation and trade of synthetic assets on the Ethereum network. Synthetic assets, like traditional financial derivatives, derive their value from cryptocurrency and physical assets. Synthetix’s native token, SNX, may be used as collateral against synthetic assets and serves to protect the Synthetix network through staking.
The Synthetix protocol enables users to construct a wide range of synthetic assets by collateralizing their existing assets. Traders can then use Synthetix’s decentralized exchange (DEX), Kwenta, to exchange these synthetic assets for other crypto and real-world assets like gold. Synthetix, which is built on the Ethereum blockchain, requires users to deposit their tokens on DeFi platforms such as Curve or Uniswap.
In 2020, Synthetix’s governance was transferred from a non-profit foundation to three decentralized autonomous organizations (DAOs). Synthetix, a premier synthetic asset protocol, promises to provide users with censorship-resistant access to a diverse variety of assets.
2. UMA
UMA is a decentralized platform for financial contracts that uses smart contracts and a “provably honest oracle” mechanism to allow any two parties to enter into financial contracts on their terms. On the platform, investors can use ERC20 tokens to establish their own tokenized derivatives, similar to exchange-traded funds (ETFs), which provide short, long, or leveraged exposure to real-world assets.
One of UMA’s goals is to increase the use of cryptocurrency in the derivatives market by allowing retail investors to purchase synthetic assets representing the underlying value via a transparent, open-source protocol.
UMA uses Ethereum’s smart contracts and incentive mechanisms to provide a secure and trustworthy means for users to construct unique financial contracts and launch ERC-20 tokens on the Ethereum blockchain, eliminating the need for legal frameworks or intermediaries.
3. Abra
Abra is a decentralized investment platform launched in 2014 that has pioneered the use of synthetic assets in the cryptocurrency market. It enables users to buy, sell, and hold alternative cryptocurrencies by generating synthetic assets. Abra converts fiat dollars into crypto assets. This conversion procedure entails linking the crypto asset to another asset type, such as fiat currency.
4. MakerDAO
MakerDAO, like Abra, enables investors to get exposure to the value of traditional assets, such as the US dollar, by utilizing cryptocurrency as collateral. In the case of MakerDAO, investors can use Ethereum as collateral to create the synthetic asset DAI. DAI is an Ethereum-based stablecoin that is tied to the US dollar’s value.
Users can produce DAI by using the MakerDAO platform’s smart contract to collateralize their cryptocurrency assets. The DAI’s value is then maintained by an automatic process known as the “Stability Fee,” which adjusts the DAI supply in response to changes in market conditions. This approach allows Ethereum holders to benefit from US dollar price changes.
Risks of Wrapped Tokens You Should Know
Wrapped tokens provide DeFi options, but they also introduce dangers related to bridges, custodians, and code. Here are the major ones to watch:
- Smart Contract Exploits: Wrapped tokens rely on code, and bugs can be disastrous. In 2022, a glitch in Wormhole allowed hackers to create 120,000 WETH (worth ~$320M) from thin air, emptying the protocol’s collateral.
- Bridge Attacks: Wrapped tokens frequently cross blockchains, making bridges great targets. The Ronin Bridge hack in March 2022 resulted in the theft of roughly $600 million in ETH and USDC.
- Custodial Risk: Many tokens, such as WBTC, rely on centralized custodians who store the original asset. If a custodian, such as BitGo, were ever hacked, declared bankrupt, or compelled to freeze funds, every WBTC holder would lose access to their holdings.
- Operational Errors: Even when solutions exist, delays in implementing them might be costly. Wormhole’s exploit was possible because engineers failed to distribute a patch to address the problem.
- Regulatory Pressure: Since custodians are major points of control, they are subject to laws and regulations. If authorities order them to cease redemptions or freeze assets, wrapped token holders may find themselves abruptly stranded.
Take Home
Wrapped tokens are an excellent choice if you prioritize functionality over speculation. They are not, however, moonshots; rather, they are the passport that allows your cryptocurrency to move across blockchains and connect to decentralized finance (DeFi). Use them for lending, liquidity, or cross-chain trade while keeping the risks in mind. Ultimately, they are tools rather than treasures.
Synthetic assets, in general, are a more flexible and versatile version of classic derivatives. While derivatives offer personalized exposure to a variety of assets, synthetic assets allow investors to trade nearly anything.
In addition to their numerous applications, synthetic assets and the algorithms that drive them have the potential to transform finance by allowing investors to trade traditional assets and derivatives within the digital ecosystem. They also use the benefits of decentralization to create new chances for thousands of investors.
As the market value of crypto synthetic assets rises, they are likely to become more popular among investors looking to reduce risk and deploy a variety of investment methods across a diversified set of assets. This tendency is likely to expand the amount of crypto trading and entice traditional investors to the world of decentralized finance.
