In this week’s edition of ‘The Cortex Connection,’ we’ll explore blockchain bridges, the key piece of tech that facilitates communication and asset transfer between blockchains. We’ll cover why they’re important, how they operate, and cover any risks associated with using them.
What is a Blockchain Bridge?
There are hundreds of public blockchains in existence, and each one operates independently often unable to natively communicate with one another. Blockchain bridges, sometimes called ‘network’ or ‘cross-chain’ bridges, serve as gateways that enable the transfer of assets and data across different blockchain networks while preserving their underlying properties. They facilitate cross-chain transactions and allow users to access a wider range of assets and liquidity options.
If John wanted to send Bitcoin to Dave, but Dave only accepts assets on the Ethereum network there is no native way to complete the transaction as the Bitcoin and Ethereum networks are not designed to communicate with each other. Blockchain bridges close this gap and act as the intermediary that will facilitate this transaction.
How do Bridges Work?
Blockchain bridges leverage a combination of smart contracts, oracles, and other supporting technologies to facilitate cross-chain transfers. There are 2 primary mechanisms that accomplish this:
Wrapped Tokens
Wrapped tokens are representations of assets from one blockchain network on another blockchain. These tokens are backed by a reserve of the original asset and can be redeemed at any time.
The most notable example of a wrapped token is Wrapped Bitcoin (wBTC) which is used for transferring Bitcoin (BTC) on the Ethereum network. When John wants to send 1 BTC to Dave, but Dave only accepts assets on the Ethereum network, John would lock up the BTC into a bridge, then the bridge would mint and release 1 BTC to John on the Ethereum network which he could then send to Dave.
If Dave wanted to transfer his 1 wBTC from the Ethereum network back to the Bitcoin network, Dave would send his 1 wBTC back to the bridge where it would be burned (destroyed) and the bridge would release 1 BTC to Dave on the Bitcoin network.
Liquidity Pools
Liquidity pools (LP) differ from wrapped tokens in that they serve as banks of available funds. Bridges that utilize LPs will typically have incentives for users to lock their assets into pools for periodic rewards that include platform fee share or via platform token emissions which can be sold.
For example, Synapse Protocol, a widely used cross-chain bridge, incorporates an LP method for bridging stablecoin assets. For example, Synapse has a USDC pool hosted on Ethereum and a separate USDC pool hosted on Arbitrum. When users of Ethereum wish to bridge USDC to Arbitrum, they would deposit their USDC into a smart contract on Ethereum and withdraw their USDC on Arbitrum utilizing the LP on the Arbitrum network.
The Benefits of Blockchain Bridges
Expanded Liquidity
Bridges unlock liquidity by connecting fragmented ecosystems. Users can access a wider range of assets, leading to improved price discovery and enhanced trading opportunities.
Improved Market Efficiency and Opportunity
Bridges promote market efficiency by enabling arbitrage opportunities across different ecosystems. Traders can take advantage of price disparities between platforms, leading to more efficient and liquid markets.
Risk Mitigation
Bridges offer risk management benefits by enabling asset diversification across multiple blockchains. By spreading investments across different networks, users can reduce the impact of smart contract vulnerabilities, network failures, or other risks associated with a single blockchain.
Understanding the Risks
While bridges offer exciting possibilities, we always want to acknowledge the associated risks of using them and supplying liquidity to them.
Smart Contract Vulnerabilities
Bridges rely on smart contracts to facilitate asset transfers between blockchains. Any vulnerabilities or coding flaws within these contracts could be exploited by bad actors, potentially leading to financial losses or manipulation of assets.
Centralized Points of Failure
Some bridges have centralized components, such as custodial wallets or bridges operated by a single entity. This introduces a central point of failure, as any compromise or malicious action by the custodian can result in the loss or manipulation of user assets.
Oracles and Data Integrity
Bridges often rely on oracles to obtain external data necessary for asset transfers or functionality. If these oracles are compromised or provide inaccurate data, it could lead to incorrect asset transfers or manipulation of bridge operations.
Regulatory and Compliance Concerns
This is a stretch but given the current regulatory environment, it’s worth mentioning. Bridges that connect different jurisdictions may face regulatory challenges and compliance issues. As regulations evolve, bridge operators may be on the hook to ensure compliance with applicable laws to avoid legal complications or disruptions to their operations, as they might be considered intermediaries that facilitate the transfer of securities which could put them under the scrutiny of regulatory agencies like the SEC.
Notable Blockchain Bridges
Multichain (previously Anyswap)
Multichain is a decentralized cross-chain bridge that allows users to swap tokens between different blockchains. It supports nearly 100 different blockchains, including Ethereum, BSC, Polygon, and Avalanche, and has over $1.5 billion in TVL and processed over $100 billion in volume.
Synapse Protocol
Synapse is a universal cross-chain liquidity network that connects blockchains by offering an extensible cross-chain communication protocol that can also integrate directly with smart contracts. They support fewer blockchains than their competitors but users report faster transaction completion times than other platforms.
Polygon Bridge
Polygon's bridge connects Ethereum with its layer 2 solution, allowing users to transfer assets between the two networks. Polygon's bridge plays a vital role in expanding Ethereum's scalability and interoperability.
Cosmos IBC (Inter-Blockchain Communication)
Cosmos utilizes the Inter-Blockchain Communication protocol to connect sovereign blockchains, fostering cross-chain communication and interoperability. IBC enables secure and reliable token transfers between different blockchains within the Cosmos ecosystem.
The Future of Bridges
As the industry matures, adoption rises, and builders continue to build here are a few trends to watch:
Enhanced Scalability
With the rise of layer 2 solutions and advancements in interoperability protocols, bridges will become even more scalable, allowing for high-speed, low-cost transactions across multiple networks.
Decentralized Oracles
Decentralized oracles will play a crucial role in ensuring the security and reliability of bridges. These oracles provide real-time data from different blockchains, enabling trustless asset transfers and reducing reliance on centralized intermediaries.
Interoperability Standards
The continued development of interoperability standards, such as the Inter-Blockchain Communication (IBC) protocol, will promote seamless cross-chain communication and collaboration between different blockchain networks.
Wider Asset Support
Bridges will continue to expand their asset offerings, enabling the transfer of a broader range of digital assets, including non-fungible tokens (NFTs), stablecoins, and other unique tokens, across various blockchains.
That's a Wrap!
Blockchain bridges enable the seamless exchange of value and data across diverse blockchain networks. As we witness the continued growth of the crypto industry, keep a close eye on the advancements in bridging technology and beware of the risks.
As always, we welcome any feedback or suggestions for improvement! If there are any topics related to DeFi that you would like us to cover in future issues, please feel free to visit our Discord channel to let us know! Your feedback and input will make sure that we’re providing content that you want to see.
Thank you for reading!