Part 1: The Case for Cross-chain DeFi
This is a multi-part series which describes the motivations and characteristics behind the Cross-chain Loans Protocol.
The Cross-chain Loans Protocol is a non-custodial, trustless, decentralized, and multi-chain system of smart contracts that enables frictionless interoperability between different blockchains. The primary use case is to enable market participants to borrow and lend assets that exist on different blockchains which do not have direct and trustless communication and interoperability between one another.
Decentralized Finance in a Multi-Ledge World
Distributed ledger technology has potential to make the world more open and connected by allowing participants of a particular blockchain to transfer value in a trustless and disintermediated way, yet this ability is governed by the consensus and protocol rules implemented by a specific network; limiting, in many cases, its capacity to interoperate with other networks.
Due to its innate inability to interact with external systems, blockchains operate as incommunicated fiefs or kingdoms where its economy and community depends mostly on centralized parties to communicate and interact with its neighbors. Thus, the vast majority of interoperability solutions require inhabitants of blockchains to give up custody of their assets, actions, and messages by having to trust centralized intermediaries that can steal, distort, or lie at any moment.
Due to the absence of trustless cross-blockchain interoperability solutions, liquidity and ecosystem growth has concentrated on Ethereum’s blockchain despite its current scaling limitations. In times of heavy transaction loads, Ethereum’s gas costs have increased considerably, making it costly and slow to interact with smart contracts when this happens; arguably limiting innovation, adoption and growth.
Even though there have been advancements in blockchain scalability solutions, the vast majority of DeFi applications, protocols and smart contracts still operate uniquely on Ethereum’s blockchain. Legacy and more advanced blockchains alike, have struggled to import liquidity, applications, community and growth to their respective blockchains and ecosystems.
Decentralized Finance Beyond Ethereum and the chicken-and-egg dilemma of Layer 1 blockchains
The DeFi ecosystem is trapped in a dilemma where the scope and performance of decentralized applications and smart contracts are limited by the current technical limitations of Ethereum, and on the other hand, there are not enough incentives for migrating existing projects, or for launching newer ones, on more scalable blockchains.
Newer blockchains with more throughput capacity are practically sub utilized as their ecosystems still lack community, protocols, applications, tokens and other types of assets required in order to generate incentives for the DeFi ecosystem to grow beyond Ethereum.
In this way, we can argue that there are no incentives in general to develop decentralized protocols and applications on newer blockchains if there is not an existing layer of infrastructure in the form of fungible, and non-fungible tokens and other types of digital assets that represent, or create value, with which these decentralized protocols could work and interact.
Without this first layer of tokens and assets, it is not possible for developers to create a great variety of financial applications that require multiple assets (besides the native token of a particular blockchain) to operate and function. On the other hand, without protocols, applications and innovation, entrepreneurs do not have enough incentives to mint tokens on blockchains beyond Ethereum, where the majority of current decentralized applications are deployed.
This is the chicken-and-egg dilemma of layer 1 blockchains: there are no incentives to develop complex DeFi protocols, if there are no tokens on a given blockchain. On the other hand, token minters do not have incentives to mint tokens on these isolated blockchains because there are no decentralized applications and protocols to use and interact with.
One could argue that if blockchain is about openness and decentralization, then we should aim at creating a trustless and interconnected blockchain ecosystem. This means expanding the DeFi space to more blockchains, creating trustless cross-chain solutions, removing centralized points of failure, and creating the incentives for other blockchains and communities to thrive and grow.
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