Three overlapping blockchain networks, with bright area in the middle denoting interoperability
DeFi and AMM Education

DeFi In The Future 5: Interoperability


TL;DR blockchains are independent and siloed by design, but frictionless cross-chain communication is vital for sharing liquidity and services across the Web3 ecosystem.

Not good. Overnight there's been an outbreak of COVID-26 in a neighboring building. Your own apartment block is now sealed off, buying you a few hours to act. As it happens, you had your eye on a new apartment anyway. Since you don't feel like stitching your lungs back together and reinserting them, it's time to expedite that process. But that's going to take just about all the funds you can lay your hands on.

You remember when you were a kid, back when people still used physical cash, and you really wanted that new toy, back when people still collected physical things made from nonrenewable resources. You'd grab whatever remained of the week's allowance. Then you'd search around the house for loose change, in all the places it could possibly be: Pockets in items of clothing you hadn't worn in months, under the sofa cushions, in the washing machine filter, your sister's piggy bank—everywhere. Put it all together, count it up, and use what you needed to make your purchase.

Crypto transactions work a bit like that nowadays, except it's a lot easier in the Web3+ age. Once upon a time, keeping track of your total balance could be a real headache, involving tracking large numbers of different private keys and seeds, wallets, blockchains, and layers, and then exchanging and bridging funds manually to the right chain, one transaction at a time.

Fortunately, it's all automated now. Today, all the major chains are seamlessly connected by various bridging protocols to the Transaction Execution hub and Crosschain Hyperglobal All-node Ecosystem, or "TEh CHAnE", as normies call it. Most people don't care or even know which specific chain they're using. When you make a transaction, the key decisions are made under the hood. And that's going to save you some precious time, money, and potentially body parts.

Ruby's DeFi In The Future series looks at the signal behind the day-to-day noise of Web3. Strip away the hype, the clickbait, the scandals, the volatility, dare we say it even the memes,* and what is the broad direction of travel for the blockchain industry?

Five years ago, crypto was still a relatively little-known set of technologies just starting to gain traction. In five years' time, it will be everywhere. And while, as Sarah Conner taught us, "The future's not set. There's no fate but what we make for ourselves", we now have enough information to make some reasonably informed guesses about how things might progress.

Read previous DeFi In The Future blogs: 1. Liquidity, 2. CeFi, 3. Keys, 4. Gas.

This time, we're looking at Interoperability.

* Ok, not the memes.

SpongeBob crying more than SBF when uncle Gary flips on him

The Blockchain Bubble

Blockchains are decentralized ledgers of user balances and operations. To minimize trust and single points of failure, they collectively maintain consensus between large numbers of nodes. These nodes must have an economic stake of one form or another in the network, whether that's energy-intensive mining (PoW), or maintaining a certain coin balance (PoS).

Consensus is established between these network members, and only these members, however they are defined (i.e., given the set of rules they have to follow). This means blockchain networks are entirely self-referential: They do not (cannot) take into account information from outside their network of nodes. In short, blockchains are designed to be internally consistent, and to ignore everything else.

Blockchain network separated from other computers
Each blockchain exists in its own information bubble, with no contact with the outside world.

Without additional software, that means they cannot engage with the outside world, including data on other blockchains. That poses a problem for communication between chains, including moving assets from one platform to another. At present, that process can be cumbersome, slow, and sometimes risky.

This has to change for Web3 to become more than a niche technology. When you make a phone call, you don't know or care which carrier networks are used to connect you. You just want to talk. Similarly, most users don't want to think about all the steps involved in using one or more blockchains. They just want to transact.

Bridges: Basic Interoperability

While there are still plenty of maxis around, it should be pretty clear that the future of Web3 is multi-chain. Multiple different blockchain ecosystems have built strong network effects, and it's unrealistic to expect loyal users and activity to leave those in favor of a single chain. What is worthwhile, though, is building interchain infrastructure, so that liquidity can move freely between networks.

As the number of blockchain platforms grows, interoperability—the free exchange of data between chains—is vital. Otherwise, tokens and liquidity will be siloed on their different networks, fragmenting the ecosystem. This is especially true of Layer-2 chains for Ethereum, since the whole purpose of L2 solutions is to scale the capacity of mainnet, not make it obsolete or replicate its limitations on other chains.

Interoperability has been an active area of research in the blockchain space for years, with atomic swaps—basic cross-chain trading—providing some of the first and simplest functionality. Early bridges then sought to enable the transfer of assets between chains. These started out as centralized services (a CEX can function as a kind of bridge), with more decentralized versions later being developed.

These bridges typically work by locking tokens on one chain and minting a proxy or "wrapped" token on the destination chain, or burning the proxy token and unlocking the original for return transfers. Alternatively, they may use a lock/unlock method, with liquidity pools on both chains.

While this may be secure in theory, bridges have proven to be a serious vulnerability for DeFi. Around half of all DeFi exploits in 2022 were cross-chain hacks, costing $2.5 billion up to the end of last year. According to Token Terminal, "These hacks can typically be attributed to smart contract loopholes (e.g. Wormhole & Nomad) or compromised private keys (e.g. Ronin & Harmony)."

Bridges Vs Full Interoperability

It's one thing to move tokens from one chain to another (and even that has proven difficult to do safely). It's another to enable not just the flow of liquidity, but the ability to view and exchange any kind of data securely, including making cross-chain contract calls. This is the holy grail of interoperability: Interaction with many chains via blockchain-agnostic dApps that maintain the same global state and liquidity across multiple networks.

One starting point for this is oracles, which deliver external data (including financial asset prices, weather data, the outcome of sporting events and elections, and much more) to the blockchain, for dApps to use. A problem is that any centralized data feed would introduce a single point of failure. Projects like Razor Network address this by delivering data via a decentralized network of oracles.

As well as feeding real-world data to smart contracts, oracles can be used to monitor other blockchains and pass information about them between networks. Chainlink has made progress in this direction, with their Cross-Chain Interoperability Protocol (CCIP). This enables the creation of multi-chain apps. The protocol is maintained by a decentralized network of nodes. However, this is unlikely to be as secure as the chains between which messages are being sent.

Two blockchain networks linked by a smaller decentralized oracle network
A decentralized oracle network reduces risk when connecting blockchains

Another approach is the creation of "Layer Zero" chains like Cosmos and Polkadot. These seek to address the problem of interchain communication by providing the infrastructure to enable developers to launch many chains from the same base chain, also allowing for cross-chain transfers and communication as a native feature, rather than one implemented as an afterthought by third parties.

SKALE takes a slightly different approach. There is no Layer Zero as such; SKALE chains are secured by Ethereum L1 but also have their own network of validator nodes. This allows for fast, secure interchain communication via the IMA Bridge. Within the SKALE network, cross-chain transfers and even contract calls are free.

The Layer Zero strategy only makes a difference for the chains launched from the same L0. It does not address the need for secure communication between existing L1 chains (for example, Bitcoin and Ethereum).

Layer minus one ancient aliens meme

The future for Web3 is therefore likely to look like a set of blockchain ecosystems (SKALE, Cosmos, Polkadot, Polygon, BSC, etc), within each of which operations are fast, frictionless, and as secure as the underlying network. Between these platforms, transfers and smart contract calls may be more complicated, slow, costly, and only as secure as the weakest element in the sequence—whether that's one of the chains involved, or (more likely) the cross-chain protocol used.

As these solutions become more secure and robust, however, it's likely that we'll see less and less emphasis on specific blockchains, and more and more on dApps, which will provide the interface to many different chains. Multi-chain wallets will track balances across platforms, and automated solutions will enable users to trade across multiple different AMMs and chains, without needing to know which ones they're connected to.

You connect your MetaMetaMask wallet to TEh CHAnE. Ramona, your AI personal assistant (sometimes very personal), scans through all the assets you own on every connected blockchain. She checks gas prices and the status of approved DeFi dApps.

Then—and this is the really cool bit—for all assets you've allowed her to access, she analyzes your main wallets, stray balances, dust, and forgotten coins, down to specific UTXOs where relevant; calculates how much it will cost to move them, including any DEX and bridge fees involved in converting them to the right currency on the right chain; selects the optimal combination across every chain and wallet; and pulls the resulting few dozen inputs together to create a single output of Salvadorean Bukeles (SBK) on ConciergeChain.

Success! You just squeak over the line, with enough to spare to order a ride for you and your stuff. Your new, rona-free apartment beckons. While Ramona books a drone to meet you on the roof in an hour, you get packing.

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