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Risks Associated with Wrapped Tokens & Flash Trade Solutions

October 31, 2023

By wrapping assets, cross-chain bridges have made it possible to address the limitations caused by the unreliable connection between blockchains. With wrapped tokens, users can access specific products and services without having to trade their crypto assets, which opens up new opportunities for holders to trade, stake, and access DeFi services.

Wrapped tokens are similar to stablecoins in that they represent the value of another crypto asset. However, unlike stablecoins, which are pegged to fiat currencies, wrapped tokens are pegged to a different cryptocurrency. Moreover, there can be several variations of such wrapped cryptocurrencies. For instance, Bitcoins can be wrapped to work on multiple chains, giving holders greater flexibility when managing crypto portfolios, participating in trading, staking, etc. Additionally, wrapped tokens can be traded on exchanges like any other token, providing even more options to their holders.

Learn more about wrapped tokens by reading this post on cross-chain bridges and this post on wrapped tokens.

Risks of Wrapped Tokens

Using wrapped tokens as a cross-chain solution has allowed users to transfer their crypto assets across blockchains. However, this solution has also created several critical problems and aggravated some existing ones. The primary issue with wrapped tokens is their vulnerability to hacker attacks. Despite the increasing robustness of blockchain technology, cross-chain bridges are still prone to malicious actions that often lead to the partial or complete loss of funds.

Another disadvantage of wrapped tokens is the lack of decentralization, which, again, highly affects their security. Many bridges are managed by companies that store user assets themselves, thus taking huge responsibility for their safety. Such custodianship of assets, unfortunately, often increases the chances of successful attacks.

Wrapped tokens also have two problems related to liquidity. Firstly, there is frozen liquidity, where original assets often get stuck in a smart contract during the wrapping process, making it unusable. Although this phenomenon may not affect widely used crypto assets, it can damage the liquidity of less popular tokens, causing substantial price volatility. Secondly, wrapping a coin through different bridges for use on other chains can divide its liquidity between those versions and, consequently, networks, negatively affecting the market.

Lastly, minting new wrapped tokens can sometimes be disadvantageous due to high gas fees and possible price slippages. As a result, users can lose more than expected, making the process uneconomical.

Flash Trade Solutions

The new version of the Kinetex dApp called Flash Trade will enable users to move native liquidity directly, thus eliminating the need for wrapped tokens and fear of the consequent risks. 

Such an approach allows for a far more secure and quick trading experience. First of all, since market makers (also called resolvers in the Kinetex system) bring their own liquidity, either bridging it from CEXes and DEXes or using their funds, Kinetex can eliminate any risks connected to attacks on liquidity stored on DeFi platforms. 

By choosing not to aggregate liquidity and surpass this task to resolvers, Kinetex also allows liquidity to move freely between platforms and networks without being frozen, fragmented, or otherwise lost. As a result, Kinetex helps the blockchain industry to work towards a more liquid and stable crypto market. The more projects will move towards similar solutions, the more we can expect changes liquidity-wise.

Next, resolving will ensure that Kinetex users will receive the best deals possible. Unlike wrapping tokens, which may be costly sometimes, trading directly with market makers via the Kinetex dApp will be highly beneficial. It is possible due to the high competition between resolvers, motivated by collateral and arbitrage opportunities. Before being able to fill orders, resolvers have to deposit collateral, which serves as an extra security for both users and Kinetex itself. Collaterals will motivate resolvers to fill orders in a timely manner and discourage possible dishonest market makers from entering the process. Another incentive is arbitrage trading. Kineetx will enable resolvers to build their own smart bots and try different trading strategies while filling orders. 

The only disadvantage of direct trades with market makers offered by Flash Trade is the loss of original assets. However, given all the above advantages, including security, speed, and advantageous rates, users can enjoy DeFi products and services and quickly swap their assets back to the original, if necessary.

Kinetex Network: Website | Kinetex dApp