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Explained: Blockchain Bridges

Explained: Blockchain Bridges

Explained: Blockchain Bridges
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By CNBCTV18.com Apr 4, 2022 4:42:28 PM IST (Published)

To introduce this interoperability, the receiving blockchains use a process called ‘wrapping’ to create compatible tokens. In this process, cryptocurrency native to the first blockchain is locked in, and a proportionate amount of wrapped currency is minted on the second blockchain.

Cryptocurrencies are bound to their respective blockchains and therefore cannot be transferred to another blockchain. This siloed structure creates the need for a solution that allows users to transact in one cryptocurrency on a different crypto’s blockchain. This is where blockchain bridges come in. They are inter-blockchain applications that allow transactors to move assets between blockchains.

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To introduce this interoperability, the receiving blockchains use a process called ‘wrapping’ to create compatible tokens. In this process, cryptocurrency native to the first blockchain is locked in, and a proportionate amount of wrapped currency is minted on the second blockchain.
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Wrapped tokens are akin to stablecoins – their value is pegged to the crypto of the initiating blockchain. E.g., Wrapped Bitcoin (WBTC) is an ERC-20 token on the Ethereum blockchain but is pegged 1:1 with Bitcoin.
Why do we need blockchain bridges?
Bridging two blockchains unlocks a plethora of benefits for users. Here are some of them:
1. Efficient Transacting: The blockchain on which a token is being wrapped may be faster and cheaper than the former blockchain. For example, high gas fees and slower transaction speeds on the proof-of-work Ethereum 1.0 blockchain discourage users from participating in decentralised finance (DeFi) services. Wrapping Ether and porting it onto other blockchains proves advantageous in such cases.
2. Sustained Liquidity: Layer 2 blockchains like Polygon, which are built atop the layer 1 Ethereum blockchain, can transfer ERC-20 tokens at surreal speeds and minimal gas fees. This is done without destroying the underlying Ether that gets wrapped.
3. Interoperability: Wrapping also allows investors to access DeFi services that are only hosted on other blockchains. For example, the Popular DeFi service Orca is hosted on the Solana blockchain but can be accessed through wrapped Ethereum (WETH).
4. Scalability: When the volume of transactions is extremely high, bridges can help offload some burden of the parent blockchain by wrapping tokens and harnessing the power of more efficient chains without compromising the liquidity of the former.
What are the types of blockchain bridges?
Blockchain bridges allow users to leverage two different protocols and are designed to suit various purposes. Some bridges only allow tokens to be wrapped into another token, but not the reverse. For instance, you can wrap Bitcoin and harness the power of the Ethereum blockchain but not the other way round. These are called ‘unidirectional blockchains.’
On the other hand, some protocols like Wormhole and Multichain are ‘bidirectional’ protocols wherein the native tokens of either blockchain can be wrapped to suit the other blockchain. For example, Ether (ETH) can be wrapped for use on the Solana blockchain and vice versa.
Either way, blockchain bridges can be built in two ways depending on the functionality they wish to achieve:
1. Federation bridges (or trust-based bridges):
Centralised protocols like WBTC involve locking in a certain amount of BTC, which is placed in the custody of the merchant whose wallet you use. This wallet is controlled at the merchant’s end and requires users to depend on a central entity. The locked BTC is freed up by the merchant as soon as the Wrapped Bitcoin is unwrapped. It is thus a ‘trust-based’ solution.
2. Trustless bridges:
As the name suggests, in this case, users need not trust a central authority but the underlying math that is ingrained in the blockchain code. When many transaction authenticators (or nodes) spread over a global network jointly agree on the validity of transactions, the truth is established. This is called a ‘consensus mechanism,’ which is coded into the blockchain protocol.
This structure promotes decentralisation as no governing authority is required to function as a mediator or certifier of the truth. The software client ensures that a ‘consensus’ is synonymous with the truth. This also eliminates the possibility of power abuse by the central authority, hence ‘trustless.’
Some of the most popular blockchain bridges:
At the time of writing, $34.03 billion worth of cryptocurrency was locked across 17 bridge protocols, according to Defi Llama. Among them, the lion’s share belongs to Wrapped Bitcoin with $12.73 billion in total value locked (TVL). Following second at $6.55 billion in TVL is the Multichain network, the largest cross-chain bridge supporting 14 blockchains.
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