Cross-chain Interoperability

Welcome to the sixteenth issue of > alpha unhashed, aarnâ's fortnightly newsletter on a decentralised & intelligent financial future. In this edition, we explore:

•  🧩 blockchain ecosystem fragmentation

•  🔗 the importance of cross-chain interoperability

• ⚙️ bridge designs and consensus mechanisms

• 🔒 security challenges and future trends

• 🗞️ DeFi news roundup

Unlocking the potential of blockchain technology requires addressing a critical issue: interoperability. Unlike the seamless connectivity of the internet, blockchains often operate as isolated ecosystems due to varying use cases, governance models, and design choices. Consider Ethereum ($533bn in TVL), the leading DeFi blockchain with the most assets staked. However, this significant portion of DeFi capital is inaccessible to users on other blockchains like Solana ($4.5b in TVL) or Avalanche ($1.2bn in TVL).

With networks competing for marketing dominance rather than genuine innovation and user empowerment, blockchain networks function as "isolated internet ecosystems." So, cross-chain interoperability protocols serve as vital infrastructure for exchanging data and tokens across diverse blockchains.

The absence of interoperability stifles blockchain adoption by impeding data and value flow across networks. Developers encounter hurdles when deploying on various networks, leading to isolated backend contracts. For users, transferring tokens between blockchains becomes challenging due to multi-deployment, requiring third-party bridges and risking fragmented data, security breaches, and diminished user experience, alongside increased vulnerability to hacks and fund loss.

There are several use cases that require cross chain solutions such as:

> decentralised finance: in DeFi, platforms like DEXs, lending protocols, and yield farms span Ethereum, Binance Smart Chain, and Polygon. Cross-chain solutions enable seamless asset transfers, access to liquidity pools across chains, and execution of diverse trading strategies involving assets from different blockchains.

> tokenization:  businesses tokenize real-world assets on different blockchains to enhance liquidity. Cross-chain functionality enables trading tokens across markets, offering investors new opportunities and diversification strategies.> gaming: blockchain games utilise various blockchains for in-game assets and mechanics. For example, Ethereum for NFTs and Flow for transactions. Cross-chain compatibility enables seamless asset trading and gameplay across different gaming ecosystems.> supply chain management: blockchain-based supply chain solutions enhance transparency and efficiency. Cross-chain interoperability enables seamless data sharing and transaction tracking between disparate platforms, ensuring end-to-end visibility and integrity throughout the network.> identity management: blockchain identity solutions provide secure verification processes. Cross-chain interoperability ensures seamless verification across platforms, enhancing user privacy, security, and convenience in digital identity management.> DApps: DApps offer decentralised services across various sectors. Operating on multiple blockchains, they leverage specific features and cater to diverse needs. Cross-chain solutions facilitate interoperability, enhancing synergy between decentralised services and platforms.

To resolve DeFi's distributed liquidity over multiple chains, bridging infrastructure is crucial. These platforms facilitate seamless asset and data transfer between blockchain ecosystems, available in decentralised, centralised, or hybrid forms based on developer preferences and user control.

> trusted bridges: A trusted bridge, often called a "custodial bridge," acts as a link between two blockchain networks, facilitated by a third party. Users entrust this party with their transactions, which raises security concerns.Binance Bridge, controlled entirely by Binance, serves as a prime example of a trust-based bridge. Users rely on Binance's assurance against fund freezes, bankruptcy, or hacks.

> trustless bridges: A trustless bridge connects two blockchain networks without requiring a third party, relying on cryptographic techniques for security (trust in code). This approach offers users more control over their assets through smart contracts. However, trustless bridges are experimental and susceptible to vulnerabilities, risking asset loss if exploited. Trusted bridges, like Ethereum's Arbitrum and Polkadot's Snowbridge, offer potential insurance funds during cyberattacks, providing added security.

Consensus algorithms ensure transaction validity and ledger state agreement in blockchains. In hybrid blockchains, they foster consensus among public and private nodes, promoting integration and interoperability. Some popular consensus mechanisms used in cross-chain solutions include:

> proof of work (PoW) verifies transactions by solving puzzles, demanding significant computational power. Introduced in 2009 on Bitcoin, it addresses issues such as double spending, decentralisation, and fair rewards.

> proof of stake (PoS) verifies blockchains more sustainably and securely than PoW. It selects one miner at a time to confirm the blockchain, requiring them to lock up coins as collateral.

> practical byzantine fault tolerance (pBFT), introduced by Liskov and Castro in the late 90s, efficiently achieves consensus in asynchronous systems. It ensures agreement in distributed networks, even amidst node failures or misinformation, with applications in distributed computing and blockchains.

> delegated proof of stake (DPoS), developed by Daniel Larimer in 2014, improves upon PoS principles. Coin holders elect delegates to oversee key network decisions, like validation and protocol rules, addressing centralization concerns while boosting efficiency and scalability.

cross-chain challenges

> Cross-chain communication involves trade-offs in security, trust, or flexibility, unlike interactions within a single blockchain. Achieving compatibility between smart contracts on different blockchains means balancing these aspects.

> Cross-chain interoperability faces a challenge without standardised protocols and consensus. Initiatives like cross-chain bridges and atomic swaps aim to address this. For example, Polygon's bridge enables token transfers from Ethereum to Polygon.

> The challenge isn't technical complexity but user experience. Cross-chain processes often demand intricate setups, hindering adoption. True interoperability is achieved with simplified user experience.

> Cross-chain interoperability struggles with scalability, as transferring large data between chains is slow. Yet, sidechains and state channels hasten transactions, and sharding and off-chain computation enhance scalability.

> Cross-chain token bridges rely on finality to ensure funds are available on the destination chain after transfer. Without guaranteed finality, events like reversed transactions on the source chain could adversely impact the destination chain.

Cross-chain bridges play a vital role in DeFi but are susceptible to vulnerabilities. As central hubs for crypto transfers, they hold substantial assets. These protocols, less tested than blockchains like Bitcoin, often have weak points. Hackers can exploit vulnerabilities with open-source codes, and the unregulated DeFi space complicates legal action against them.

Here are some examples of security-related bridge hacks:

> smart contract exploitation: attackers identify and exploit vulnerabilities in the smart contracts governing the bridge, enabling them to execute unauthorised transfers or steal assets.

> oracle manipulation: hackers compromise the oracles providing external data to the bridge, allowing them to manipulate asset prices or transaction information and facilitate fraudulent transfers.

> front-running attacks: malicious actors observe pending transactions on the bridge and prioritise their own transactions ahead of legitimate ones, enabling them to manipulate prices or steal assets.

> cross-chain replay attacks: attackers intercept transactions on one blockchain and replay them on another, exploiting the lack of proper validation mechanisms between the chains to duplicate assets. 

> protocol exploitation: hackers exploit flaws or weaknesses in the bridge protocol itself, such as incorrect validation processes or insufficient authentication mechanisms, to gain unauthorised access or manipulate transactions.

Two types of bridge hacks exist: code attacks exploit smart contract vulnerabilities, while network design attacks often involve social engineering. These aren't unique to bridges but are part of the broader challenge of crypto hacking and phishing.

Unfortunately, crypto bridge hacks are numerous. In 2022 alone, over $2 billion in assets was stolen from token bridge exploits.

Various solutions are emerging to enhance cross-chain interoperability:

> Chainlink's Cross-Chain Interoperability Protocol (CCIP) aims to standardise communication, connecting numerous blockchains

> Wormhole facilitates token and message transfers between blockchains via Guardians overseeing message verification

> LayerZero ensures lightweight message passing between chains with ultra-light nodes, enhancing efficiency

> Other notable solutions include Hyperlane, Inter-Blockchain Communication (IBC), Avalanche Warp Messaging (AWM), BTC Relay, XCM on Polkadot, and Axelar's General Message Passing protocol. They enable cross-chain communication, interoperability, and secure token bridging across multiple blockchain networks.

future of interoperability

In 2024, expect a surge in interoperability solutions like cross-chain bridges and protocols to ensure fluid communication among diverse blockchain networks. Technological advancements driving the achievement of seamless interoperability and cross-chain solutions include: 

> Interledger Protocols (e.g., Interledger Protocol, or ILP) enable value transfers between different ledgers, acting as bridges for interoperability

> Sidechains and Bridge Protocols allow the creation of interconnected blockchains, with sidechains operating alongside the main chain and facilitating asset movement between them

> Smart Contracts automate agreements between different blockchains, leveraging their capabilities to enforce cross-chain transactions

> Oracles provide external data to smart contracts, enabling cross-chain compatibility by transmitting information between blockchain networks

wrapping up

As web3 becomes multi-chain, dApps spread across various blockchains, layer-2 networks, and app-chains. Yet, blockchains face limits in communicating with external systems or APIs, hindering integration with web infrastructure and interactions with other blockchains.Embracing the true potential of blockchain relies on seamless and secure communication across diverse chains. Without this interoperability, we miss out on the transformative benefits: genuine decentralisation, innovative applications, cost reduction, and ongoing evolution. In essence, bridging the divide between chains is vital for unlocking blockchain's full capabilities.

Bitcoin halving sparks market swings. Cross-chain interoperability facilitates agile asset transfers, helping investors optimise profits and manage risks

Polymer, an Ethereum rollup that is hoping to become Ethereum’s interoperability hub, has launched the Polyverse Testnet, becoming the latest team hoping to tackle blockchain interoperability.

LeverFi unveils OmniZK: Bitcoin validation protocol enabling DeFi innovation. Shifting complex logic to EVM networks, zkOracles relay verified outcomes, settling non-custodial contracts securely on Bitcoin.

top DeFi tweets

According to @antiersolutions DeFi bridges are the key to unlocking liquidity and making finance accessible to all

@ChainLinkGod is betting big on the future with CCIP (Cross-Chain Interoperability Protocol) for secure cross-chain action and DECO (Decentralized Oracle) for stealthy data handling in smart contracts.

@tuananhmmo explores cross-chain interoperability challenges like protocol mismatch and diverse consensus mechanisms, offering solutions such as bridges and decentralised exchanges to streamline blockchain connectivity.

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