January 05, 2022 - 10 min read
Smart contract platforms are isolated, but powerful environments which operate based on their own consensus mechanisms and native chains. That is, they have thus far functioned reliably as closed networks. The consensus mechanisms of different networks offer advantageous use-cases by their varying degrees of decentralization, scalability, finality, network fees, privacy, and security. That is to say, that there is no universally perfect blockchain, though that does not necessitate concern if blockchains become interoperable with one another.
Though layer-1 networks have thus far operated primarily in siloed, closed networks, interoperability has been a focus for developers for quite some time. As a result, crypto assets and the networks they were designed for are now experiencing a new parabolic increase in their economic dynamism and composability. That is, their networks can be built upon each other and their assets are interacting synergistically.
In fact, the varying needs of people and the tradeoffs they will be content to make for different real-world applications suggests that the future will be characterized by cross-chain interoperability. In other words, there will be many winners in the ongoing battle royale for top smart contracts platform. As different use cases call for certain protocol attributes, developers will fill market niches as they emerge.
As evidence of this, there has been a proliferation of various layer-2 scaling solutions as well as token bridges developed in response to blockchain isolation issues. Token bridges act as gateways from one protocol to another, making digital assets even more portable than before. By tokenizing assets to make them compatible with another blockchain’s standards, token bridges increase financial liquidity, and add to the overall value of blockchain as a collective technology.
Oracles provide critical infrastructure that makes possible the movement of assets and other data across blockchains in real time via token bridges, bringing society even closer to realizing a world composed of the Internet of Things (IoT). Of course, IoT refers to a network of composable or at least interoperable hardware devices with cooperative computational and networking capabilities. That is, it is the basis for concepts like automated healthcare, self-driving vehicles, smart manufacturing and power grids, smart homes, and eventually smart cities.
IoT devices sense and collect data, communicating with relevant networks and nearby devices in order to ‘make decisions’ and interact with both physical and digital realities. To date, IoT development has primarily made use of centralized, cloud servers managed by trusted operators. As the development of Web3 technology continues its upward trend, interoperability and the realization of IoT may be traced back to token bridges, layer 2 solutions, and decentralized oracles.
Token bridges are essentially used to convert one asset into another, moving them to different blockchains in the process. To illustrate, let us use an analogy of travelers exchanging currencies at the airport before arriving in a new country; they must first visit a specific location which converts their primary currency and then documents the conversion in its ledger. They would receive an equivalent amount of the appropriate currency minus fees, as expected. The same basic concept applies to token bridges, but with even more nuance in the blockchain world.
NFTs, cryptocurrency coins, and real-world assets can be tokenized and moved across blockchains as financial interoperability comes into its own. For example, Wrapped BTC was the first tokenized Bitcoin asset to be made available on the Ethereum network. Users holding Bitcoin might want to take advantage of Ethereum’s faster transaction times, or perhaps make use of a financial product only available on Ethereum. Token bridges thus provide incredible value for the blockchain space in terms of interoperability, and consequently global asset liquidity once traditional assets begin making their way across token bridges with regularity.
Major exchanges do not always offer native cryptocurrencies, but use the ERC-20 tokenized version of various layer 1 coins. A coin, of course, operates on its native blockchain and can often be mined. Tokens, on the other hand, are assets operating on another blockchain in a compatible standardized form, such as ERC-20 on Ethereum.
For instance, purchasing Terra (LUNA) on exchanges like Coinbase does not give one the native LUNA coin, but instead the wrapped, wLUNA ERC-20 token. This is not necessarily common knowledge among retail users, and thus over time many have found reasons to migrate their tokens across token bridges and onto new destinations. Reasons for migrating assets could range from lower network fees, higher throughput for active trading or price arbitrage, higher yields on deposits, and many others.
Token bridges which port assets from one native blockchain to another generally use a process consisting of locking coins on blockchain A, and then minting tokens on chain B. If the user wants to move those assets back to their chain of origin, the tokens on chain B may be burned. The coins on chain A would then be released for spending once again. Of course, this makes token bridges at risk of becoming single points of failure (SPoF) or targets for malicious behavior. Consequently, their governance and consensus must also be rather robust.
There are two basic models of governance for token bridges: trustless, and federated. Essentially, a trustless token bridge uses a consensus model reminiscent of blockchains in which a decentralized network of nodes validate proposed transactions. These bridges allow users to maintain custody of their assets except for the moment of actual transfer. Federated token bridges, on the other hand, make use of trusted node validators (meeting strict criteria) which take custody of users’ assets as collateral before releasing the new asset on the destination chain.
Inevitably, users will demand more efficient portability of their assets as it becomes apparent that certain blockchains are advantageous for their specific use cases. For instance, users may prefer the security of Bitcoin, the flexibility of Ethereum, or the speed of Solana. With cross-chain interoperability, they can take advantage of each blockchain’s strengths, moving value across chains as their needs evolve over time. This, however, may not be as incredible as it sounds if each movement across a token bridge is considered a taxable event by local governments. In fact, regulatory ambiguity is likely to hamper cross-chain transfers to some degree until clarity can be provided in terms of tax implications.
Polygon (MATIC) was actually built as a scaling solution for Ethereum in response to high gas fees and network congestion. As it and other scaling solutions like Arbitrum or Bitcoin’s Lightning Network were meant to reduce network fees, the implications seem to be that these protocols will continue to complement each other rather than compete directly. This sort of cooperation amongst blockchains, as well as layer-2 solutions to address network challenges, may allow us to harness the superpowers of each native blockchain for specific purposes, making smart cities and the Internet of Things a reality within our grasp.
Composability is arguably one of the most important features of the Ethereum network and ERC-20 tokens which run its dApps, or decentralized applications. This has of course attracted developers to learn the language of Ethereum, Solidity, and invest their time and capital deploying novel blockchain applications and tokens running on Ethereum. As the network has grown, so has network congestion, driving up gas fees to near-unusable levels during times of high traffic. This scalability issue resulted in the development of novel blockchains with higher throughput limitations, and of course layer-2 scaling solutions, often called rollups.
Rollups allow for fast transactions to happen off-chain without sacrificing the decentralized security model of ETH’s mainnet. They are essentially siloed side-chain networks which periodically write their transactions on Ethereum’s mainnet in batches. For example, these L2 solutions might be useful for online gaming communities with their own internal economy, perhaps even with unique digital items minted as non-fungible tokens (NFTs).
Users could transact in-game and in real-time without paying the higher fees or slower confirmation time of the mainnet. If users were only able to make use of the ETH mainnet, the fees alone could make any reasonable use case economically untenable. Fortunately, layer-2 solutions open up a plethora of opportunities in the payments space as it takes advantage of the security of layer-1 blockchains while leveraging the speed of the layer-2 protocol.
While token bridges leverage the composability of smart contract platforms, users often have to deal with longer withdrawal times. In order to move assets across chains, the bridge must synchronize with the appropriate parties to ensure that the ledgers on both sides are prepared to transfer value. Of course, withdrawal times depend on how frequently the layer-2 protocol writes its updated, aggregated ledger data to the relevant first layer.
The data is then written onto the appropriate blockchain’s immutable ledger, thus finalizing the transfer of assets and recording the new totals. Once the data is secured on the ledger, the asset’s use is then released for trading on the intended protocol. This level of interoperability opens up the door for a parabolic adoption curve of crypto assets, and a giant leap forward in the direction of a world powered by the Internet of Things.
Just as the blockchain space has thus far existed as a heterogeneous amalgamation of data silos, so has automated devices and the Internet of Things as we currently know it. That could be changing soon as trustless cryptographic ownership layers emerge from the adoption of blockchain technology and the migration of new developers into the Web3 community.
Certainly, it is not clear which blockchains, layer 2 solutions, or decentralized applications will become ubiquitous and which will fail and become anachronistic. Nevertheless, the widespread adoption and implementation of an IoT world may depend entirely on the robustness and homogeneity of trustless interoperability through decentralized oracles.
Moreover, oracles which track real-world conditions and feed that information onto blockchains is another brick in the foundation of IoT. For instance, say a retailer located in a shopping district wanted to optimize her opening hours, store conditions, staffing, foot traffic, and other variables by employing data analytics.
Various smart devices could track these variables in real time, feed the relevant information to the blockchain’s ledger, and provide analysis and optimization services based on the dynamic conditions at the location. This might take the form of moderating the temperature, music volume, or ambient light levels, but may also provide complete staffing services to meet customers needs in the most efficient and sustainable ways.
As blockchain technology experiences a parabolic adoption curve, we have seen the tribal affinities each community displays for their chosen blockchains or dApps. However, for Web3 to realize its true potential, these communities will inevitably need to embrace one another in cooperation.
The ubiquitousness of this technology depends on the breaking down of blockchain silos in the form of true interoperability, coupled with a clean user experience which shields us from the complicated processes which underpin it. The metaverse illustrates quite clearly the potential value ready to be unlocked by Web3 interoperability and advancements in the security of digital ownership.
The trend towards automation, IoT, and smart cities may thus hinge upon blockchain developers’ ability to make these new networks compatible with one another. Having said that, the level of compatibility needed for IoT and the like must be seamless if they are to be adopted on a broad scale.
In addition, the oracles which networks rely upon for real-time, seamless communications must be robust and maintain network uptime at all times, even in the event of malicious attacks. If these things are not more or less assured, smart cities may remain in the imaginations of the tech-savvy until our ability to secure data and network uptime catch up with protocols’ functional capabilities at smaller scales.
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