What are Blockchain Bridges and why are they Important for DeFi?

Introduction

Public blockchains, including the two most popular, Ethereum and Bitcoin, are digital ledgers visible to all. But while all on-chain data is transparent, the infrastructure of a blockchain serves a self-contained ecosystem. By design, blockchains are isolated, and for good reason: To maintain the consensus that underpins the security and accuracy of a shared ledger. Only miners who meticulously follow the rules of each network can verify and write transactions to the blockchain.

The system is incredibly effective, but the siled nature of blockchains is possibly holding DeFi back, locking DeFi users into a single network when the blockchain space as a whole offers a world of functionality and opportunity. At a time when the Lego-like compositional ability of decentralized finance applications (dApps) is changing the face of financial services, it is more important than ever for independent blockchains to “communicate” with one another.

While comprehensive cross-chain infrastructure solutions such as Polkadot, Cosmos, and Avalanche are gaining in popularity, many users simply want to move digital assets from one chain to another and use dApps and other services more efficiently.

What are Blockchain Bridges and how do they work?

Blockchain bridges enable interoperability between very different networks, such as Bitcoin and Ethereum, and between a parent blockchain and its child chain, called a sidechain, which operates under different consensus rules or inherits its security from the parent blockchain. This interoperability could include the transfer of tokens, data, and even smart contract instructions between independent platforms, allowing users to:

  • Deploy digital assets hosted on one blockchain into dApps on another.
  • Perform fast, low-cost transactions of tokens hosted on chains that are otherwise less scalable.
  • Run dApps on more than one platform.

While some blockchain bridges are centralized, others retain the important decentralization that helps ensure the security and openness of DeFi protocols.

Block and Coin: The Axis of Decentralized Bridges

When a user transfers assets from one blockchain to another using a decentralized bridge, those assets are not literally relocated or “shipped” anywhere. Instead, the functionality is leveraged through a two-stage process.

  1. Assets are locked or “frozen” in the blockchain where they live using a smart contract or, if smart contracts are not supported, another mechanism.
  2. New tokens of the same amount are then created or “minted” on the receiving blockchain. When the user wants to redeem the assets, the equivalent tokens are burned and then the original assets are unlocked.

This process prevents assets from being used in any way on both chains at the same time.

Image Source: Harmony

Shown above is a visual representation of how a Blockchain Bridge works, specifically Harmony’s Ethereum bridge. From this image, we can see that a bridge is a multi-stage process that includes both the locking/unlocking and minting/burning functionalities.

Trust-Based Solutions

More popular than any decentralized blockchain bridge is a centralized initiative that allows Bitcoin (BTC) users to take advantage of the benefits of Ethereum: Wrapped Bitcoin (wBTC). Users deposit a desired amount of Bitcoin via partners called “merchants” into a wallet controlled by a trusted (centralized) custodian, institutional digital asset firm BitGo, which stores BTC securely and then mints wBTC tokens from equal value in Ethereum. Because all wBTC is backed 1:1 by BTC, the two tokens are roughly equivalent in value. Also, and most importantly, since wBTC is an ERC20 token, unlike Bitcoin, it can be used as collateral in popular Ethereum dApps such as Uniswap, Compound, Aave, and the Maker Protocol.

Wrapped Bitcoin and similar projects, such as imBTC and HBTC, each provide a simple and effective solution to the problem of moving value through siled blockchains.

Side Chain Bridges

Unlike a bridge linking two completely different blockchains, a sidechain bridge connects a parent blockchain to its “child.” Because the parent and child operate under different consensus rules, communication between them requires a bridge.

For example, the developers of the popular blockchain game Axie Infinity created a dedicated Ethereum-pegged sidechain called Ronin to allow the game to scale beyond what was possible on the Ethereum mainnet. Ronin’s Ethereum Bridge allows users to deposit ETH, ERC20 and NFT tokens into a smart contract, which is picked up by Ronin validators and transmitted to the sidechain.

Another popular example is xDai, also an Ethereum-based sidechain. Like Ronin, xDai is protected by a set of validators other than the miners that maintain the main Ethereum blockchain. Two bridges, the xDai Bridge and the OmniBridge, connect the xDai chain to the Ethereum mainnet, allowing easy transfer of tokens.

Image Source: TokenBridge

Shown above is an image of the the xDai bridge and how it would look for a general user.

The Benefits of Blockchain Bridges for DeFi Users

Interoperability between blockchains, including between a mainchain and sidechain, allows users to access the benefits of each without sacrificing the advantages of the mainchain or initial chain. This has several implications and use cases:

  • Collateral between chains. Bridges allow users to transfer digital assets from a blockchain that has significant value but few dapps of its own, like Bitcoin, to one that has a mature DeFi ecosystem, like Ethereum, and a need for additional liquidity.
  • Scalability. Bridges designed for large transaction volumes allow for greater scalability, without forcing developers and users to give up the liquidity and network effect of the original chains. This is particularly important as congestion issues persist on Ethereum prior to the full release of Ethereum 2.0.
  • Efficiency. Users can make and receive micro-transfers quickly and without paying high transaction fees, enabling better gaming and e-commerce experiences.

By: Michell García, Defy Trends; Jack Nelson, Defy Trends

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Disclaimer: This article is for educational purposes only and must not be treated as financial or legal advice.

Please conduct due diligence and manage your risks accordingly.

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