Solving Liquidity Fragmentation Across Blockchains

Conflux Network
Oct 2, 2020 · 9 min read

As it currently stands, nearly all layer-1 blockchains on the market have different characteristics, consensus algorithms, hashing algorithms, etc. that limit communication between other networks. Leading DeFi applications operate on one specific blockchain, DApps (decentralized applications) are restricted to transact using tokens native to their underlying blockchains, which isolates applications from the majority of liquidity in the crypto space that is offered on other blockchains.

A perfect example of this is Bitcoin. Because of the lack of smart contracts, and inability to upgrade the token, BTC is unable to move across the modern blockchain ecosystem efficiently, which means that 61% of the market capitalization of crypto is limited to the native Bitcoin chain. Blockchain asset interoperability is critical for DeFi to unleash its full potential and eliminate the huge barrier to mass adoption.

With over 61% of the total market capitalization in crypto dominated by Bitcoin, the need for cross-chain asset interoperability is higher than ever to propel the DeFi ecosystem. Source

The challenge of exchanging one asset for another exists even outside the crypto ecosystem. In traditional financial markets, sending money across borders and exchanging for local currencies has proven to be cumbersome. Legacy payment networks such as SWIFT are too expensive and obtuse to keep up with modern demand and globalization of business. Cryptocurrency provides an alternative solution to the siloed system currently offered for fiat currencies, but without open and interoperable protocols, the system has yet to live up to its promise.

What Are Cross-Chain Assets

At Conflux Network, we believe that creating native protocols that create seamless asset exchange between different networks is crucial to the long-term success of not only our native DApps but for the entire ecosystem of cryptocurrencies. Through implementing our cross-chain asset protocol — ShuttleFlow — we envision a permissionless system where liquidity ranging from high-cap coins like Bitcoin to low-cap tokens like NFTs can flow freely among the sea of blockchains.

Since the first wrapped Bitcoin experiment in November 2019, tokenized Bitcoin providers have surged, with over 100k BTC now wrapped off the native chain. Source

There are currently a few protocols that offer solutions to move Bitcoin and Ethereum across blockchains; the main trend that is common in all solutions is to offer a reserve smart contract or multi-sig wallet where users can store their underlying tokens, which will then mint the same amount of tokens on the desired blockchain as a “wrapped” token. A wrapped token is an asset hosted on a blockchain with a price that is pegged to another underlying asset, even if it’s not on the same blockchain. Wrapped Bitcoin (wBTC) is the most popular wrapped asset currently available, with over $969M worth of Bitcoin locked in to the protocol. This Ethereum token is always worth the same as one BTC at any given moment, as a smart contract algorithm reproduces its price in real-time and regulates the underlying fund with supply and demand information gleaned from user transactions. In exchange for their money, wrapped token users get an equivalent amount of value “wrapped up” in an asset that’s more easily mobilized by decentralized applications (DApps).

How Do They Work

The birth of cross-chain assets stemmed from popular fiat-backed stablecoins such as USDT, DAI, or USDC which essentially were the first cross-chain asset by wrapping assets from the traditional financial system onto the blockchain. The way cross-chain assets maintain their peg and operate is similar to stablecoins: both are backed accordingly via their reserves. For stablecoins this would be a bank account, but for wBTC this would be a multisig cold wallet on the Bitcoin Network which holds BTC according to the demand of online crypto exchanges and larger institutional investors who want to quickly exchange Bitcoin into wBTC and manage their money within a given platform.

Another popular cross-chain asset provider is pTokens, a network of validators operates the bridge between blockchains and monitors the minting and burning of tokens. Source

Atomic Swaps

Currently, there are not many alternatives to achieving cross-chain interoperability other than wrapped assets. For users who want to share liquidity of their tokens across blockchains without trusting a third-party for issuing wrapped assets, they are limited to a few options which are not optimal choices for true cross-chain composability. One of these examples is atomic swaps. An atomic swap is a smart contract that enables the exchange of one token for another without using centralized intermediaries, such as exchanges or cross-chain validators. Atomic swaps can take place directly between blockchains of different cryptocurrencies, or they can be conducted off-chain, away from the main blockchain by using hashed timelock contracts.

Although many would consider this an ideal solution as there is no wrapping of tokens and you receive the real digital asset, there are still significant problems that arise which cross-chain assets improve on. Because atomic swaps require a hash algorithm that is inherent to both assets and also expensive and non-scalable transactions, atomic swaps fail to keep up with the industry standard cross-chain asset solution of wrapping tokens. Recently, the technology has encountered another roadblock that cross-chain assets have capitalized on, DeFi.

Value In Cross-Chain Assets

The simplified minting and burning of wrapped assets in the modern blockchain ecosystem have introduced three key value-adds ​​to blockchain networks and their developers and users: increased liquidity, open collaboration, and diversification of collateral.

Increased Liquidity

The ability to tap in to any network and offer new use-cases for tokens such as Bitcoin presents the opportunity to accrue new liquidity in an alternate network. This initial challenge of developing and sourcing liquidity has been a problem in the blockchain ecosystem since its inception, this is especially true for newer blockchains who depend solely on native tokens and the development of new assets on their blockchain. Cross-chain assets can help tackle the initial roadblock of developing a substantial pool of liquidity to keep a network self-sustainable.

Open Collaboration

With every native token introducing its own unique features, the free flow of interoperable assets allows for the division of labour between blockchains. By allowing tokens to enter your network with their own purpose such as Bitcoin’s “digital gold” and Zec’s “privacy coin” distinctive characteristics, blockchains can now focus on developing their own value-adds. This helps develop the narrative of open-collaboration to better benefit the ecosystem, rather then the traditional narrative of introducing another competing smart-contract platform.

Diversification Of Collateral

The cross-chain assets currently flooding the blockchain market have allowed for some great application to DeFi protocols that were previously dependent on their native token and assets with strong correlation to their native token. For example, the MakerDAO platform that issues the stablecoin DAI was previously limited to Ethereum and ERC-20 assets as collateral, which, if faced with a bear market, poses the risk of liquidation for nearly all its users. The introduction of cross-chain Bitcoin allowed for new collateral types that diversified the portfolio ensuring that if some collateral drops, other native tokens can provide support. This also introduced the opportunity for DAI to operate on other blockchains such as xDAI and EOS.

Current Limitations

Majority of the cross-chain communication technologies such as multi-signature, light node proof, witness, side chain, relay, distributed key, atomic swap, etc are not new concepts. However, the impact of these technologies has not progressed at the same scale as the development has. Before DeFi, there was no true utility in bringing an asset off its native chain since there was a lack of uses on other networks. In recent developments with decentralized finance, platforms have successfully integrated assets from other chains into their DApp by offering lending and borrowing platforms, payment solutions, and decentralized exchanges that can allow digital assets to find more utility then what is offered on their origin chain.

Even though other chains offer more utility to Bitcoin, only 0.3% has entered the DeFi ecosystem. This may seem like a small figure but this small fraction currently represents over 10% of the $10B total liquidity locked in DeFi protocols. Source

One of the reasons so little Bitcoin has left the native chain is that the early industry is small in scale, the two chains interacting to wrap assets were not created to take advantage of alternate native tokens. In another case, most of the public chains on the current market are for the most part heterogeneous chains. Compared with an ideal isomorphic chain (also referred to as Blockchain 3.0), the data structure and the network infrastructure of the traditional heterogeneous chain are completely different, and the technical difficulty in implementing protocols that can support cross-chain transfers on the layer-1 is relatively large. With respect to the limitations of the underlying technology with the majority of blockchains, many of the current light-node capabilities are restricted, which has resulted in leading Bitcoin wrapping platforms such as wBTC and Ren to resort to off-chain solutions to manage reserve funds.

Conflux Cross-Chain Assets

At Conflux Network we recognize the importance of value in creating a truly interoperable DeFi ecosystem that can let users freely interact with our DApps using their favourite tokens, whether that be Ethereum, Bitcoin, or any ERC-20 asset. Using our ShuttleFlow cross-chain asset protocol, users will soon be able to wrap any asset of their choosing in a decentralized fashion on to the Conflux blockchain by simply providing a token address. With this protocol in place, our DeFi ecosystem can operate freely without having to be restricted by the tokens offered on our blockchain. The first to implement ShuttleFlow was MoonSwap, a gas-free automated market-maker operating across the Conflux Network and Ethereum blockchains. MoonSwap recently completed their migration and currently offer over $10M+ of total locked value in Conflux cross-chain assets such as $ETH, $LINK, $COMP, and others.

ShuttleFlow cross-chain asset protocol token mining process, MoonSwap utilizes ShuttleFlow to wrap ERC-20 tokens on to the Conflux Network blockchain to facilitate trade without gas.

Using our cross-chain protocol ShuttleFlow, traders can enter and exit liquidity pools on MoonSwap as well as make trades on the AMM DEX for free with support from our cross-chain custodian alliance. Once traders choose to migrate their assets on to the L2 solution, their assets will be wrapped and be available for trading after setting up a Conflux Network address using ConfluxPortal. By eliminating gas fees, the MoonSwap team is able to provide an improved transfer fee for liquidity providers. This is implemented by eliminating the high gas associated with trades in the current DeFi ecosystem and slightly raising transfer fees for traders to better incentivize liquid pairs and provide a higher yield for liquidity providers. LPs will receive 0.25% of the 0.3% trading fees that MoonSwap will charge, and 0.05% of that amount will be used to buy $MOON and destroy them, making $MOON deflationary.

A current complaint by many traders in the current AMM space is the exorbitant fees associated with redeeming LP tokens. By using the ShuttleFlow cross-chain solution, traders can easily redeem their LP positions and receive their original ERC-20 assets with no gas fees associated. This is done by wrapping the LP tokens on Conflux Network, then once the underlying liquidity is redeemed, the ShuttleFlow cross-chain alliance will redeem the ERC-20 assets from the reserve account and issue it back to the trader’s Ethereum wallet.

With further implementations and improvements before our mainnet release, the cross-chain assets supported on ShuttleFlow will offer a wide range of different application scenarios ranging from DEXes such as MoonSwap and other DeFi products on the Conflux Network such as life-insurance with DeFiner. In later versions, cTokens will support more public chains and allow cross-chain asset operations among them in a decentralized fashion where any user can create the cToken by providing only the tokens address. The blueprint of Conflux Network’s DeFi ecosystem is not limited to our native assets, ShuttleFlow will help offer scalable, decentralized, and secure assets that can be offered on exchanges on different public chains to expand the liquidity of digital assets in the blockchain and DeFi ecosystem.

With developments of new cross-chain asset protocols such as ShuttleFlow, the DeFi ecosystem can solve previous roadblocks of interoperability with native assets, at least for the immediate future. While some concerns revolving around centralization and efficiency remain with leading solutions such as wBTC and REN protocol, new protocols are being released everyday which aim to solve previous limitations. With the market of wrapping previously untouchable liquidity across different networks being actively solved by new layer-1 blockchains and DeFi projects, the developers of protocols and multi-chain traders can manage their liquidity and introduce new opportunities for the market as a whole, and appears to be the first actionable step in solving the ever-lasting complication of cross-chain composability.

Written by Conflux Network’s DeFi Analyst, Sami Tannir

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