Wrapped tokens are cryptos pegged to the value of another asset. A wrapped token is like a stablecoin, except its value is pegged to an asset such as Bitcoin. Wrapped tokens are usually used for compatibility in cross-chain transactions, but they can also be held by investors.
Wrapped tokens work like stablecoins: a custodian holds the balance of the asset, keeping the same amount that is wrapped. The custodian can be a merchant, a DAO, or a smart contract.
Wrapped tokens are used to make cross-chain transactions, such as trading Bitcoin (BTC) on the Ethereum network. Since Bitcoin and Ethereum aren't compatible, the exchange could instead use Wrapped Bitcoin (WBTC), an Ethereum-compatible wrapped token pegged to Bitcoin. Wrapped tokens operate on-chain, so they incur gas fees. Investors have to pay gas fees to wrap and unwrap their assets.
Wrapped tokens are a good option for cross-chain transactions, but are they too risky to hold? Since the wrapped token software is operated by a custodian, there is additional risk compared to holding the native asset. The custodian could be hacked or rug pull the project.
Some assets, such as BTC and ETH, are easy to acquire and hold, so holding WBTC or WETH is likely an unnecessary risk. Other assets, such as Nexus Mutual (NXM) are more difficult to acquire due to KYC requirements, but there is a wrapped version available with no KYC requirements: Wrapped NXM (WNXM). Although there is considerably more risk to holding WNXM, investors may consider this acceptable due to the ease of swapping WNXM compared to the native NXM.
TLDR: A wrapped token gives you the option to more easily access assets (for example, avoiding Know Your Customer (KYC), though it adds more risk than directly holding an asset.