Why Cross-Chain Interoperability is Important for DeFi
One vital factor that’s key to the explosive growth of blockchain and decentralized finance is interoperability. Since Bitcoin, blockchain has witnessed an unprecedented growth and received attention from different sectors. Its capacity to create a peer-to-peer framework and democratize the transaction of value is why it has been transformational for the finance sector.
Numerous blockchain platforms have been established over the years. All with aims to facilitate a more improved and advanced blockchain ecosystem. There are currently over 20 blockchain established platforms including Ethereum, Binance Smart Chain, Ontology and others, with each providing unique value propositions for their protocols. However, the crucial factor here is how these different blockchain platforms can integrate with one another seamlessly without causing the user much hassle when transacting across the different platforms.
Why Interoperability?
Although different blockchain projects and platforms exist today, the capacity for them to communicate and integrate with one another is still a fundamental challenge. Each platform has its own mode of operation, different services offered, type of transactions, consensus mechanisms or hashing. Most of these platforms are developed to address a specific need and most times operate an isolated ecosystem.
In addition, various institutions in finance for example, also run on different platforms with different governance and regulatory requirements. What this implies is, users who plan to transact across different platforms have to consider these differences and almost all of the time, would have to go through a long hectic process to effect such a regulatory compliant transaction.
The different blockchain platforms existing today inherently lack proper communication channels to facilitate cross-chain transactions. However, this is highly crucial if DeFi is to continue its increasing growth rate. There are missed opportunities to earn yield, borrow and trade digital assets if they cannot intercommunicate across different platforms, which is highly necessary in the current stage due to cost and speed issues. For example, assets on Ethereum can be utilized on another public chain which offers lower cost and faster transactions, however this requires proper cross-chain bridges.
Cross-chain technology helps to bridge the existing gap between these platforms. It allows the different blockchains to communicate with each other and enables them to share information across platforms. This way, finance institutions running on a particular network will not be limited to transacting only on their networks, but can also communicate with other networks as well.
Users on the other hand will be able to share and receive information from other platforms without going through a hectic process. For instance, users on the Bitcoin platform are able to transact with other users on Ethereum blockchain.
While cross-chain projects are still emerging, their relevance for the DeFi sector cannot be overemphasized. Incorporating cross-chain tech provides:
- Seamless transactions across various blockchain platforms
- Information sharing across different platforms
- Higher liquidity and exposure to untapped capital
- Advanced and smoother user experience
- Unlocking value across different chains for different end goals
Enter Cross-chain Technology
CDzExchange believes that for DeFi to truly gain mainstream adoption, there must be bridges between the existing protocols that allow for frictionless transfers of assets. Each blockchain architecture has its own perks and limitations, which makes users want to try out different platforms. However, with a proper cross-chain tech, it becomes easier to trade assets across the different protocols.
Here’s a typical scenario of how cross-chain works with Bitcoin and Ethereum blockchains as an example. The user sends BTC from the source chain to the destination chain by first sending BTC to a designated Bitcoin address linked to the cross-chain bridge. After paying the Bitcoin network fee, the transferred BTC is then wrapped into a synthetic “wrapped” representation of Bitcoin on the Ethereum, which is the destination chain. The native BTC is locked in a smart contract when the wrapped BTC is minted. The wrapped BTC, often denoted as ERC20-wrapped BTC on Ethereum, is then deposited into the user’s ERC20 wallet on the Ethereum network. Fees are also paid as gas to the Ethereum network. Finally, the user can then trade, do yield farming and conduct other transactions on Ethereum-based dapps.
The user can also get back the original native BTC initially deposited by following the same process in reverse. The wrapped ERC20 BTC is burned at the same time the original BTC is returned to the user, on the native Bitcoin blockchain.
Facilitating communication and integration of existing blockchain protocols is very important for the DeFi ecosystem as it facilitates an overall superior user experience and enhanced growth of blockchain adoption. Leading to greater overall liquidity and more opportunities to earn and borrow.
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