Ethereum. Solana. Avalanche. Terra. And several hundred more in the making. With every passing day, we’re witnessing new protocols emerging to tackle problems that grip mass adoption of blockchain technology and to make the whole ecosystem or part of it efficient and cheaper in what they do.

While these are exciting updates for most, they also create a lot of confusion for the newer folks who’re trying to make sense of these developments, and the obvious question for them to ask is:

‘Why can’t we use just one protocol to build everything on web3?’

Let’s try to answer this from a first-principles approach. They’re a famous analogy used by folks in space, and that is to look at Layer 1 protocols as cities.

When we think about how cities are built, there’s usually some overarching purpose or goal. One might be able to decide on which city to go to based on the idea that the city’s environment would help them achieve their objectives. While New York City can get you a shot at corporate finance, LA houses all record labels any artist can think of. There are also other cities built for agriculture, factories, energy, etc. Similarly, we’re witnessing an increasing amount of blockchains pop up. Each protocol is made for specific use cases that provide developers different options to build on depending on the use case for their project.

With that in mind, the idea of cross-chain interoperability is the infrastructure that enables cities to physically and virtually communicate with each other - think highways, planes, messaging, and calls. This might also help paint a clearer picture that blockchains are somewhat siloed and constrained without access to cross-chain communication. Also, since web3 is also a lot about tribalism, these protocols are restricted by their technical specifications and their ecosystem’s liquidity and network effects. This is because users are fragmented across chains either because of monetary reasons or their affinity toward the specific idea and technical specifications that the protocol is based on or promotes, among several other reasons.

Thus, as of today, it’s safe to say that no one chain can bring all of these users together. As more blockchains are being built for increasingly niche use cases, finite liquidity is fragmented, so there is a clear need to connect between chains.

As more sophisticated applications are built, there is an increasing demand for parts of the protocol to live on one chain and other components on another chain, based on use-case-specific requirements. For example, folks at the much popular play-to-earn game Axie Infinity built Ronin, an Ethereum sidechain designed for high throughput gaming because of the increasing need for throughput. Now their infrastructure can be optimized by leveraging the strengths of different blockchains:

  • NFT marketplace on Ethereum to solve network effects
  • Gameplay on Ronin to solve for speed

Existing Solutions

Using Centralized Exchanges: One can choose to send ETH from their MetaMask or Rainbow wallet to Coinbase, swap ETH/SOL on Coinbase and then send SOL to their respective Phantom Wallet.

Using Cross-Chain Bridges: Bridges are another vital creation of the crypto world to attain the larger goal of interoperability. Bridges allow for sharing of valuable data and traffic between the many blockchains and layers. With a bridge, someone in Chain A can receive data from Chain B and vice-versa. They help wrap a token like BTC and bridge it to ETH and then move that newly minted wrapped-BTC(wBTC) over to any DeFi protocol.

Understanding Bridges

The framework to understand how bridging from Chain A to Chain B works is structured so that the bridge locks the token on Chain A and mints a fresh one onto Chain B. The total amount of circulating tokens remains the same but is split between the two chains, in this case, Chain A and Chain B. If Chain A had ten tokens and then sent five over to Chain B, Chain A would still have ten tokens, but five would be locked, and an additional five tokens would be minted on Chain B.

If at any point, the holder of the minted tokens wants to redeem them, they can burn them from Chain B and unlock them on Chain A. Since Chain A always had a locked copy of the token, the token’s value stays consistent with the chain A market price. This lock-and-mint/burn-and-release process is how the amount and cost of the tokens sent between the two chains remain the same.

Credits: Dragonfly Research

Blockchain bridges can be divided into centralized or federated systems and trustless systems. The differences lie in how bridge transactions are confirmed and stored in locked-up assets.

In a federated system, a network of pre-selected validators tracks token deposits on the source chain, locks them up, and mints tokens on the target chain; an example is Binance Bridge or wrapped BTC (WBTC).

On the other hand, anyone can become a validator in a trustless system. For every bridging transaction, several validators are selected randomly from the pool to minimize manipulation risks. Such a trustless system will typically include some relay mechanism that listens to bridge-related events on the source chain, creates cryptographic proofs of these events, and transmits them to the bridge smart contract on the target chain. This way, the bridge ‘knows’ that tokens were submitted on the source chain and that it’s safe to mint tokens on the target network.

In both types of architecture, the nodes responsible for asset deposits sometimes have to submit collateral to guarantee that they won’t behave dishonestly. For example, the tBTC protocol, powered by Keep Network, has a 150% collateralization ratio in ETH, meaning signers (custodians) have to submit an equivalent of 1.5 BTC in ETH for every bitcoin deposited with them.

Types of Bridges

There are roughly four types of bridges:

1. Asset-specific: A bridge with the sole purpose of providing access to a specific asset from a foreign chain. These assets are often “wrapped” assets that are fully collateralized by the underlying, either custodial or non-custodial. Bitcoin is the most common asset bridged to other chains, with seven different bridges on Ethereum alone.

2. Chain-specific: A bridge between two blockchains that usually supports simple operations around locking & unlocking tokens on the source chain and minting any wrapped asset on the destination chain.

3. Application-specific: An application that provides access to two or more blockchains but solely for use within that application.

4. Generalized: A protocol designed explicitly for transferring information across multiple blockchains. This design enjoys strong network effects because of the complexity — a single integration for a project gives it access to the entire ecosystem within the bridge. The drawback is that some designs usually trade off security and decentralization to get this scaling effect, which could have complex unintended consequences for the ecosystem. One example is IBC, which sends messages between two heterogeneous chains (that have finality guarantees).

Understanding The Bridging Trilemma

Credits: Ryan Zarick

There’s a saying that if one looks close enough into decentralized systems, all would have their trilemma to solve. So, while various blockchain protocols are trying to tackle the scalability trilemma, their subsystems also have problems to solve.

First, let’s understand the three components that make an ideal bridge.

  1. Instant Guaranteed Finality guarantees funds on the destination chain when a transaction is successfully committed on the source chain.
  2. Unified liquidity is the shared access of a single liquidity pool between multiple chains.
  3. Native Assets are the destination chain’s user-desired assets (native or most liquid synthetic).

The problem here is that even though instant guaranteed finality can be achieved through the lock-&-mint/burn-&-redeem systems, users need to settle with wrapped versions of their native assets on the destination chain, which might not possess the same technical qualities and potency of the asset it’s trying to imitate.

On the other hand, when bridges are designed to serve multiple chains with pools of native assets to provide unified liquidity across chains, they create massive network effects due to the magnitude of capital efficiency they promise. But, it becomes costly and time-consuming to execute transactions as the access increases. Other chains might be able to put their transaction process request faster, thus not helping facilitate the transaction and making reversion of the request expensive and cumbersome. This way, instant and guaranteed finality cannot be achieved.

However, newer projects like Stargate are built on top of the LayerZero protocol, which claims to have solved this trilemma.

The problems with bridges

Bridging is associated with several types of risks:

1. Validators/custodians stealing deposited funds: This is a vulnerability in federated or centralized bridges. Although the general solution to make them submit collateral is a good check on misbehaviour, if the collateral is deposited in the bridge protocol’s tokens, there is an additional risk that their price might collapse for multiple reasons, in which case appropriating the more valuable token locked in by the users on the bridge’s smart contract like may seem like an attractive idea.

2. Validator unresponsiveness: If many validator nodes go offline, the bridge will slow down or stop working. To motivate validators, some bridges pay rewards in their native tokens, but this can have the same effect as yield farming: as users cash out their rewards, the token’s price falls, and so does the general trust in the bridge project itself.

3. Exploits: Hackers can target vulnerabilities in any bridge’s parts: relay, asset deposits, or the contract on the target chain. Unfortunately, not all bridges are correctly audited before launch, so the risk of theft is very real.

From a user’s standpoint, there’s still no all-encompassing cross-chain protocol. While there is much development around what is known as Layer 0 with protocols like Polkadot and its canary network Kusama, Cosmos and much like its namesake LayerZero that are trying to solve the problems of bridges.

These play around with the concept of maximising interoperability and we'll soon discuss them.

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