16
If you’re at all familiar with decentralized finance, then the chances are good that you’ve heard an awful lot about the pressing need for greater interoperability in the industry.
Interoperability is necessary because the DeFi world is made up of hundreds of blockchain networks, and each one of those has to balance the “trilemma” of decentralization, scalability and security. Because of the trilemma, every blockchain has its advantages and drawbacks, which means DeFi users can benefit immensely from taking advantage of each one. Interoperability has always been a challenge, but with advances in cross-chain swaps from protocols like RocketX, it’s becoming apparent that users can harness all of the benefits of each network.
What is interoperability?
Let’s look at the world of fiat money, where we can make a purchase simply by swiping our credit card without even thinking about it. When you make a payment, you don’t know or even care what goes on behind the scenes. Regardless of your location, bank or the currency you’re using, the transaction just goes through. This is what interoperability is all about.
The complicated technology backend of the fiat financial system enables different institutions to interact with one another flawlessly, transferring currencies across the world in seconds. For instance, someone can fly to India and use their Canadian credit card to purchase a bottle of water priced in rupees easily. They simply swipe their card and the transaction is performed instantly, though the user will often have to pay a small fee for doing so.
It’s this seamless interoperability that DeFi currently lacks. If you want to transfer crypto from one blockchain to another, it usually involves going through a number of tedious processes that are way too difficult for the average user. In order for DeFi to become widespread, there needs to be a way for different blockchains to interoperate with one another with zero hassles for the end user.
If DeFi can achieve flawless interoperability across networks, users will be able to interact with any protocol on any chain. This would significantly boost the appeal of DeFi and attract more users to the industry. More users means more liquidity and greater opportunities for people to profit. It would also mean increased freedom for every DeFi user in terms of how and where their financial assets live.
How do we achieve DeFi interoperability?
Cross-chain bridges:
The most common method for transferring crypto across chains is the “cross-chain bridge”. Unfortunately, these are clunky mechanisms that enable the transfer of assets and data across decentralized ecosystems, effectively “bridging the gap” between blockchains. With cross-chain bridges such as Synapse Protocol or Wormhole, it’s possible to use assets from one chain on another, albeit in a roundabout kind of way.
The way cross-chain bridges work is that the native asset of one chain, say Bitcoin, is locked in a smart contract, enabling the user to mint a “wrapped” version of that token on the target blockchain. So the user deposits 10 BTC, locks it in a smart contract, and then the bridge will then mint 10 “wrapped BTC” on the second chain, where it can be used.
While cross-chain bridges help to increase liquidity and accessibility by enabling tokens from one chain to be used in DeFi protocols on another, they present challenges. For one thing, the process of using a bridge to wrap and mint assets is far from smooth. Cross-chain bridges can also be vulnerable to hacks. By their very nature, they are tempting targets for malicious hackers. Such concerns are very real, as the constant stream of headlines about cross-chain bridge hacks reminds us on a regular basis.
The other issue with cross-chain bridges is centralization. Many of these services rely on trusted custodians and validators to facilitate asset transfers across chains, and this does not sit well with one of blockchain’s most important principles – that of decentralization.
Cross-chain bridges have emerged to play a crucial role in DeFi interoperability because they get the job done, but they’re a cumbersome and risky solution that can only ever be a stop-gap until a superior alternative is found.
Atomic Swaps:
Atomic swaps have become popular as an alternative to centralized cross-chain bridges, providing a way for two parties to trade tokenized assets across blockchains without any intermediary. They’re an exciting area of development in DeFi. They are peer-to-peer exchange mechanisms where each party deposits an equivalent amount of cryptocurrency – for instance BTC and ETH – into a smart contract. The transaction is entirely automated and will only proceed on an all or nothing basis, which means that unless the two asset deposits are matched in value, the transaction will not be executed. In this way, the atomic swap smart contract acts as a kind of escrow account, protecting each user and ensuring nobody can cheat.
Atomic swaps use a special kind of smart contract known as Hashed Timelock Contracts, or HTLCs, which will only be executed upon the delivery of an agreed amount of digital assets. Both parties must acknowledge receipt of these deliveries within a specified time period.
Numerous protocols have implemented atomic swaps, including Komodo’s AtomicDEX and the wallet provider Rubix, which facilitates them through its non-custodial wallet. The major advantage they provide is to reduce counterparty risk by eliminating the need for an intermediary. They also help to provide deeper liquidity for cross-chain exchanges and less slippage. But although they’re an exciting development, atomic swaps are still not a perfect solution for DeFi interoperability. They remain cumbersome to use for most people, and because they’re peer-to-peer, transactions can be slow, with both blockchains required to complete a number of blocks to fully process the swap. The reliance on smart contracts means there’s always a risk of vulnerabilities that hackers may be able to exploit, too.
Smart-Order-Routing
Representing the latest evolution of DeFi interoperability is the novel Smart-Order-Routing Engine that’s able to leverage the combined liquidity of hundreds of different centralized and decentralized exchanges, aggregating this into a single pool. By using a proprietary smart-order-routing engine, newer protocols such as RocketX act as a kind of hybrid exchange platform that allows users to swap assets across almost any chain with optinal prices and lower fees.
RocketX offers a non-custodial solution that sources liquidity from more than 250 CEXs and DEXs through a single user interface. Users retain full control of their funds, there is no need for a deposit or collateral to be paid, no wrapped assets involved and no hidden fees, while the protocol automatically finds the best possible price. It obtains liquidity through an aggregated CEX pool, taking advantage of the fact that CEXs tend to retain asset pools on multiple platforms. When users transfer assets with RocketX, they always receive the native asset on the support blockchain. Swaps are consolidated into one-click transactions, and the complexity is abstracted away from the user. It means asset swaps can be performed with in seconds, while getting around the problem of liquidity fragmentation.
Although it’s still a relatively new solution, RocketX has shown that it can scale cross-chain interoperability to almost any network. Most recently it announced support for the MicroVision Chain, a promising Bitcoin sidechain with smart contract functionality. Through the integration, MicroVision Chain assets are now interoperable with more than 100 leading blockchain networks.
Interoperability To Liberate DeFi
The advent of smart-order-routing-based protocols like RocketX promises to significantly ease the process of moving digital assets across blockchains. As more DeFi protocols take advantage of this seamless interoperability, the entire ecosystem will become more interconnected, resulting in less liquidity fragmentation and better user experiences.
This is key because the mainstream adoption of DeFi is dependent on users being able to interact across chains with zero hassles. It will enable more optimal utilization of digital assets and resources, only this time it will be done in a decentralized way, liberating users in a way that’s simply not possible with traditional finance.
