Bitcoin pulse, guides and news: Cross-chain Demand in Booming DeFi

Wednesday, June 16, 2021

Cross-chain Demand in Booming DeFi

As we all know that the outbreak of DeFi has made an over crowded Ethereum, thus other smart chains with higher performance have become the first choices for many newborn projects, even for some leading applications. The blockchain ecology has been gradually evolving from Bitcoin and Ethereum’s oligopoly towards the co-prosperity of multiple chains, such as Ethereum, Huobi Eco Chain, and Binance Smart Chain. And more new smart chains like Polygon and Solana are also emerging. The data on DeFi Llama（defillama.com）shows that the Total Value Locked (TVL) of DeFi on Ethereum has reached $100 billion, and the sum of TVL on BSC, Solana, Polygon has also exceeded $35 billion.

Smart chains like BSC can provide faster transaction service with lower gas fees, so users will naturally transfer some behaviors outside Ethereum; however, after a series of movements, many people will finally return value back to the latter. After all, assets need a universal application environment to maximize their value, and Ethereum always plays the role of a safe hub. Each public chain has its own self-positioning and mission, thus users hold different expectations on various chains in different functioning. To achieve mutual prosperity, it is not cutthroat competition for users and applications that ecosystems should be in, but cooperation to meet different aspects of user demand.

Such shift in user behavior has foster the demand for cross-chain: users tend to play with their assets on multiple chains according to the features of each chain and the allocation of varying applications, choosing the most suitable chain in each segmented demand. Currently the distribution of applications is already set, what needs more is breaking the wall among these diverse islands. However, the exclusivity of the public chains makes it impossible for users to integrate assets on each individual chains by themselves, since the consensus mechanism, the ledger, and the underlying technology are incompatible. This dilemma is bringing the data-isolation problem to the surface, booming the demand for cross-chain.

This demand can be understood from two aspects:

To maximize the value of their assets, users need to participate in different kinds of financial activities on different chains at a cost as low as possible.
As for developers, the realization of cross-chain not only adds to the liquidity, but also makes it possible for more novel scenarios. Moreover, it can also attract extra users from other chains, increasing the exposure of projects. Especially for those located outside Ethereum, since the congestion of a chain is positively correlated with the extent of prosperity, developers must think of how to bring in more users while enjoying the light traffic.

In terms of implementation, cross-chain means asset swap or transfer between two chains, i,e, either to swap CAKE on BSC to UNI and use it on Ethereum, or mapping CAKE to Ethereum. It sounds like a piece of cake but the underlying logic is quite sophisticated. One thing is to build mutual consensus to acquire and verify information from other chains; the other is to keep a high level of decentralization to guarantee the transparency and correctness of the data validation.

Decentralized cross-chain techniques and product types

It is still in the early stage for blockchain players to explore cross-chain solutions, which can be divided into three types according to different techniques: Notary schemes, Sidechains or Relay chains, and Hash TimeLock Contract.

Notary schemes introduce one or more credible entities who take the responsibility of data collection and transaction verification. Only when the intermediary confirms that a specific event has actually happened and signs for it will the asset be unlocked and sent. That is how the consensus is built.

Instead of depending on trusted intermediaries, relay chains take on this task by themselves in order to maintain a higher level of decentralization. A smart contract that is monitoring the block headers of chain A is set on chain B and can verify them with a standard procedure, which is accepted by chain A’s consensus. Once the block header is reported to be finalized, the relay can then authorize the transaction.

Hash TimeLock Contract refers to a series of predetermined trigger conditions set in a smart contract, including a hash lock (the hash of a random secret) and a time lock. Both ends lock their assets into the smart contract, and only when the correct hash value is provided within the time interval can the transaction be successfully carried.

As has been said, there is no perfect solution, and each type of chain interoperability above has its own drawbacks: Notary schemes raise the risk of centralization; relay chains are difficult to be implemented, while hash-locking has limited functions and only supports cross-chain asset exchange. Despite their imperfections, more developers are involved in blockchain interoperability and create more and more multi-chain applications that are worth attention and learning. According to application scenarios and product design, the current projects can be divided into the following three types: ecotypes, cross-chain bridge, and multi-chain aggregation.

Ecotypes

Represented by Polkadot and Cosmos, these cross-chain ecosystems provide a new substrate framework that allow chains/applications in the same eco to interact with each other.

Polkadot, given birth by Gavin Wood (one of the founders of Ethereum), uses a heterogeneous sharding structure and creates a new ecology where data and assets on different parachains under Polkadot can interact with each other in the help of a relaychain without further restrictions. However, there is a cost for renting a parachain slot, and projects need to bid for its right to use and lock a certain number of DOT (the native tokens on Polkadot). Polkadot aims to achieve cross-chain composability and scalability, but by ‘cross-chain’ it only means the chains that inhabit on Polkadot (pay for its slot).

Cosmos, created by Jae (the inventor of Byzantine consensus engine Tendermint), is a decentralized network which contains multiple parallel and independent blockchains that use BFT consensus algorithm. Similar to Polkadot, it also adopts the relay model. Hubs (analogous to the relaychain on Polkadot) play the role of sorting, verifying and sending oders from and to different Zones in Cosmos eco(analogous to parachains on Polkadot). Cosmos focuses more on assets transfer rather than the wider concept of blockchain interoperability; however, it wins Polkadot in openness, offering more freedom for developers to customize their projects and to build consensus.

As for such ecotypes, the risk lies in the uncertainty of the quantity and quality of projects in each ecology, since the initiative is held in latter (including existing public chains), who can determine whether to agree with their cross-chain protocols and to be a sebset of these ecos. Afterall, an ecology without enough apps is only an empty shell.

Cross-Chain Bridges

The second type is the cross-chain bridge, which provides a compatible channel between two public chains with different protocols and consensus. The essence of a cross-chain bridge is that a same asset circulates on numerous chains, so that it can be minted and used on chain A, and be burnt on chain B to achieve a rebalance.

At current stage, cross-chain bridges mainly function via mapping assets. For example, suppose that a cross-chain bridge deploys a smart contract on both Binance Smart Chain and Ethereum, when a user wants to transfer UNI from Ethereum to Binance Smart Chain, it can be managed by the following steps:

The user deposits and locks UNI to/in the smart contract on Ethereum.
The smart contract verifies the change in state and send it to a companion on BSC.
On BSC, the smart contract receives this information, and mints the same number of UNI-BEP20 (the mapping token of UNI on BSC, while BEP20 is the token standard on BSC).
The user acquires the mapping assets and can use them on Binance Smart Chain.

The advantages of cross-chain bridges are that they are not only easy to implement, but also maintain high decentralization. For users, cross-chain bridges can meet their needs with a cheap and friendly user experience; and for developers, the underlying logic and coding are relatively simple to build such a bridge, thus most cross-chain projects on the market are based on this model, represented by:

Anyswap: a Biance-founding project that supports seven public chains namely Ethereum, Huobi Eco Chain, Binance Smart Chain, Fantom, Fusion, xDAI and Polygo, with a gross transaction volume over $10 billion.

Chainswap：Launched by ANTIMatter and with a strategic funding of $3 million, Chainswap has been deployed in 5 public chains (Ethereum, Huobi Eco Chain, Binance Smart Chain, OKEx、Polygon) and supports 61 cryptocurrencies, with TVL exceeding $100 million.

Multi-Chain Aggregation

While the core of cross-chain bridges is mapping assets, the concept of multi-chain aggregation protocals as its name implies, is to aggregate the liquidity of multi-assets on different chains and to create a cross-chain pool, which makes it possible to achieve cross-chain transaction rather than simply token transfer. Based on this main idea, there are some disparity in the way of implementation. Taking O3 Swap as an example, if a user wants to swap CAKE on Binance Smart Chain for MDX on Huobi Eco Chain, the steps are as follows:

The user initiates an exchange request to O3 Swap and lock CAKE to its smart contract on BSC.
CAKE is swapped into BUSD, a stable currency on BSC.
BUSD is swapped into HUSD, a stable currency on Huobi Eco Chain, in O3’s cross-chain pool (which contains various stablecoins on different chains).
HUSD is swapped into the targeted MDX.
The User receives MDX in a Huobi Eco Chain wallet

A different solution is to introduce an intermediate token as a joint that replaces stablecoins on different chains. Taking THORChain as an example:

The user initiates an exchange request to THORChain and lock CAKE to its smart contract on BSC.
THORChain swaps CAKE into equivalent numbers of RUNE (the native currency of THORChain).
THORChain swaps RUNE into equivalent numbers of MDX.
The user received MDX.

Steps 2 to 4 in the example of O3 Swap and steps 2 to 4 in the example of THORChain are performed behind the scene, meaning that users do not need to execute these steps by themselves. Multi-chain aggregation is just a conceptual idea, on top of which there are more than one practical solutions. Moreover, multi-chain aggregation has made it possible for one-chain applications to provide multi-chain experience (for example, pledging idle UNI for BUSD so that to mine on BSC), thus achieving the interoperability of assets on different chains at the application level and solving the problem of data isolation in real sense.

Expectations

2020 has witnessed the booming of DeFi, but it just begins, with huge potential and more application scenarios in the future. This is bound to drive a greater demand for cross-chain. As for the latter, there is no denying that the goal of each stakeholders remains the same, i.e., connecting all ecosystems and realizing the seamless finance across chains. The exploration of cross-chain technologies also leads to the positive collision of different projects, which pushes the development of this segmented demand in mutual learning.

At present stage, to land the solutions mentioned above requires sophisticated knowledge in mathematics and cryptography, as well as strong coding capability of developers; it is also a must for a project to achieve great user experience, friendly and readable codes, openness, and commercial implementation; while user experience can also be digged deeper into aspects like easiness of operation, transaction speed, waiting time for transaction finality, transaction fees, and so on.

By far, it can be said that the users’ demand for the most basic cross-chain functions is already met. However, in the level of product design, how to provide a faster, cheaper and more convenient user experience is still to be explored. In analogy with the evolution of mobile phones, cross-chain is a basic function as dialing, but on top of that, blockchain interoperability has made it possible for more creative DeFi applications like facetime and online shopping, realizing the revolutionary progress from landline phone to PHS, and finally to the smart phone.