Crosschain Innovation Is The Future Of DeFi

Decentralized Finance, also known as Defi, has grown massively since its beginnings in 2020. As this industry continues to grow, new innovations come into play and one innovation I want to focus on is the use of bridging protocols in the crypto space.

There are thousands of cryptocurrencies in circulation, with hundreds of them having their own, native blockchain networks. As these cryptocurrencies grow in popularity, they start to build their own communities and ecosystems, with users creating and using protocols and applications within these networks.

However, a lot of users like to use protocols across multiple networks, for example, a user might want to trade new, low-market cap coins on the Solana network via the Serum DEX, whilst also wanting to engage in yield farming on the Binance Smart Chain (BSC) network.

Traditionally a user would have to buy the network’s native tokens, transfer them to a compatible wallet and connect to the protocol on the compatible blockchain. Now, users can use bridges to transfer their assets from one blockchain network to another.

Before there was no way for coins and tokens that are native to one blockchain to be moved or utilized on another blockchain network. For instance, in the past Ethereum (ETH) and ERC-20 tokens were only usable on the Ethereum network and could not be moved to another blockchain. Thanks to bridging protocols, it is now possible to move ETH and other crypto-assets across different blockchains.

Bridging protocols enable users to transfer assets from one blockchain to another, from tokens to NFTs and stablecoins. Bridges work through decentralized applications (dapps) that are compatible with multiple networks. This allows the dapp to receive a token from one network and release an equal amount of the token on another blockchain. 

For example, the USDC stablecoin can be bridged from the Ethereum blockchain to Cardano. This works by users sending their ERC-20 USDC to a Cardano sidechain that uses an Ethereum Virtual Machine (EVM) to accept the tokens. The ERC-20 USDC is then held and the Cardano-native version of the stablecoin is released on the Cardano network.

Another example is Wrapped Tokens which is another form of bridge, where the token itself acts as a bridge. For example, Wrapped Ethereum is simply Ethereum on another blockchain network (BSC for example) that is equal to the value of the Ethereum network.

Let’s say you have 5 Wrapped ETH (WETH) on the BSC network, that 5 WETH is worth 5 ETH and can be redeemed for that amount at any time. It works similarly to stablecoins since wrapped tokens are pegged to the value of the original token that it represents.

Bridging protocols also give users access to multiple blockchains and the decentralized applications (dapps) that are hosted on these networks. This enables the Defi market to grow due to the increased use of dapps and protocols within the sector as well as additional funds being moved throughout the multiple blockchains.

There are two distinct categories of crypto bridges, referred to respectively as trusted bridges and trustless bridges. Trusted bridges are inherently centralized, which means that users are required to place their confidence in a single entity to handle custody and transactional duties.

Users of a trustless bridge do not need to have faith in any centralized organization in order for the bridge to function properly via the use of trade algorithms and smart contracts.

Whilst bridges allow users to send assets across different blockchains, there are some risks associated with bridging protocols. For example, the Ronin Bridge built by Axie Infinity was hacked and over $650m was stolen earlier this year.

Bridging protocols can have exploitable weaknesses in their code which malicious users can act upon so whilst they help to grow the Defi market, there is still some risk for users. However, this is not a common problem when it comes to bridges in the crypto space.

When consumers give their tokens and coins to a third party to be stored, they expose themselves to a risk known as custodial risk. Users run the danger of having their currencies censored when they store their cryptocurrency in a custodial account. 

However, there are certain users that would rather utilize trustless bridges because they are fine with the dangers involved. On the other hand, users of these bridges are not required to have faith in custodians or to be concerned about censorship. However, users are required to have faith in the smart contracts that are used to power the bridges.

The most damaging attacks in the history of cryptocurrency have originated from crypto bridges. This technology is quite new; even a short number of years ago, there was no consumer demand for cross-chain bridges on the market. 

However, as time goes on it’s a given that the safety of these bridges will become better as more people use them and as more of them are built. It is essential to keep in mind that bridges are still a developing technology, and in their present form, they do not provide a completely risk-free experience.