Cryptocurrencies are linked to their respective blockchains and therefore cannot be transferred to another blockchain. This siled structure creates the need for a solution that allows users to transact in one cryptocurrency on another crypto’s blockchain. This is where blockchain bridges come in. These are cross-blockchain applications that allow operators to move assets between blockchains.
To introduce this interoperability, receiving blockchains use a process called “wrapping” to create compatible tokens. In this process, the native cryptocurrency of the first blockchain is locked and a proportional amount of wrapped currency is minted on the second blockchain.
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Wrapped tokens are akin to stablecoins – their value is tied to the original blockchain crypto. For example, 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?
Linking two blockchains unlocks a plethora of benefits for users. Here are a few:
1. Efficient transactions: The blockchain on which a token is wrapped can be faster and cheaper than the old blockchain. For example, high gas fees and slower transaction speeds on the Ethereum 1.0 proof-of-work blockchain discourage users from participating in decentralized finance (DeFi) services. Wrapping Ether and porting it to other blockchains proves advantageous in such cases.
2. Sustained liquidity: Layer 2 blockchains like Polygon, which are built on top of the Ethereum layer 1 blockchain, can transfer ERC-20 tokens at surreal speeds and minimal gas fees. This is done without destroying the underlying Ether that is enveloped.
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 is accessible via wrapped Ethereum (WETH).
4. Scalability: When transaction volume is extremely high, bridges can help offload some of the burden from 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 take advantage of two different protocols and are designed to meet various purposes. Some bridges only allow tokens to be wrapped in another token, but not the other way around. For example, you can wrap Bitcoin and harness the power of the Ethereum blockchain, but not the other way around. These are called “one-way blockchains”.
On the other hand, some protocols like Wormhole and Multichain are “two-way” protocols where native tokens from either blockchain can be wrapped to fit the other blockchain. For example, Ether (ETH) can be wrapped for use on the Solana blockchain and vice versa.
In any case, blockchain bridges can be built in two ways depending on the functionality they want to achieve:
1. Federation bridges (or trust-based bridges):
Centralized protocols like WBTC involve locking up a certain amount of BTC, which is placed in the custody of the merchant whose wallet you are using. This wallet is controlled on the merchant side and forces users to depend on a central entity. The locked BTC is released by the merchant as soon as the wrapped Bitcoin is unwrapped. It is therefore a “trust-based” solution.
2. Bridges without trust:
As the name suggests, in this case, users do not need to trust a central authority, but the underlying mathematics that is rooted in the code of the blockchain. When many transaction authenticators (or nodes) distributed across a global network jointly agree on the validity of transactions, the truth is established. This is called a “consensus mechanism”, which is encoded in the blockchain protocol.
This structure promotes decentralization because no government authority is required to function as a mediator or certifier of truth. The client software ensures that “consensus” equals truth. It also eliminates the possibility of abuse of power by the central authority, thus “without confidence”.
Some of the most popular blockchain bridges:
As of this writing, $34.03 billion worth of cryptocurrency is 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). The second largest network at $6.55 billion in TVL is the Multichain network, the largest cross-chain bridge supporting 14 blockchains.
(Edited by : Jomy Jos Pullokaran)