Chainflip Investment Thesis
The efficient cross-chain swapping protocol
In November 2022, crypto exchange FTX filed for Chapter 11 bankruptcy protections as it attempted to assess the value of its remaining assets collapsed. The failed exchange was soon found to have an over $7b shortfall in assets due to bad loans made to sister market-making firm Alameda Research with customer deposits.
In the wake of 2022’s tumultuous events, epitomised by the downfall of FTX, the crypto community faced a stark reminder of the inherent risks in centralised exchanges. FTX’s collapse was not just a one-off scandal but the continuation of a troubling trend of centralised exchange collapses. This incident underscored a fundamental flaw in the opaque nature of centralised exchanges: the over-reliance on trust-based custodial systems. Trust which in this case ultimately ended in fraud and mismanagement.
The Rise of DEXs
The ethos of crypto has always been rooted in decentralization and the elimination of trust-based systems. DEXs embody this principle by enabling permissionless peer-to-peer transactions without intermediaries, mitigating the risks associated with asset exchange. The trustless exchange of one crypto asset for another enables a new way of trading assets, enabling a new way to bootstrap liquidity for a market. The growth in DEX usage reflects a broader industry shift as users seek more control over their assets and a reduction in counterparty risk.
Over the past 4 years, we have seen DEXs rise from a large niche hobbyist market to one of the primary ways transactions are settled in the crypto space. The rise of Automated Market Maker [AMM] DEXs led primarily by Uniswap radically simplified the DEX experience making it easy for anyone to perform a swap in a few clicks. In 2023 the portion of DEX volume relative to CEX volume crossed over 20% reaching an all-time high driven by on-chain trading of meme coins on Ethereum.
DEXs have grown considerably in recent years, and the market is considerably larger when looking at broader centralised exchange volumes. The opportunity for DEXs remains to eat into the CEX market which at its peak in May 2021 rose above $4 trillion in volume and over $1.1 trillion in December 2023. While CEXs historically have had an advantage over DEXs due to superior liquidity and a smoother user experience, DEXs today have an opportunity to dramatically simplify this experience, swapping one asset for another wallet to wallet. For the space to reach its full potential there is a need for permissionless swaps.
The Future for DEXs is Cross-Chain
DEX volume today remains largely exchanging assets that exist on the same chain, however, the dream for DEXs has always been true cross-chain swaps allowing direct exchange of one asset for another between different blockchains. While bridges offer one solution to this problem, they do come with their own trust assumptions and security risks, which may not always be clear to the end user. Seamless cross-chain swaps of one asset for another remain the gold standard for lowering the barriers between blockchains. Crypto is rapidly evolving towards a multichain future, necessitating platforms that enable seamless cross-chain interactions.
Chainflip: The Cross-Chain Liquidity Network
Chainflip is a decentralized protocol designed to address the challenges of cross-chain swaps in crypto. It stands out by enabling seamless and secure exchanges of assets between diverse blockchains, directly from users’ wallets, bypassing the need to rely on centralised exchanges or bridging solutions. Chainflip leverages a dual-layer structure comprising an Accounting Layer and a Settlement Layer. The Accounting Layer, operating on a proof-of-stake consensus, maintains the protocol’s state, including tracking deposits, withdrawals, and swaps.
Chainflip simplifies the user experience of cross-chain swaps by eliminating the complexities associated with wrapped tokens and specialised wallets. The protocol achieves this through a robust network of validators and the use of Threshold Signature Schemes, minimising reliance on centralised entities and single points of failure.
Why is Chainflip better than existing approaches to cross-chain swaps?
Unlike some existing IBC-reliant approaches, Chainflip offers true interoperability between different blockchains without requiring any modifications to the existing chain infrastructure. Chainflip achieves this by facilitating swaps directly from wallet to wallet without using wrapped tokens or specific blockchain integrations, which can limit their scope and increase complexity. This approach also dramatically improves Chainflip’s user experience with users performing swaps directly from their wallets, without transferring assets to a centralised exchange or navigating complex bridging protocols.
The Settlement Layer, known as the Chainflip Engine, manages the actual transfer of assets across different blockchains. Central to its operation are validators, collectively forming the Authority Set, chosen through auctions based on their stake in the native token, FLIP. These validators are crucial for both layers, holding private keys for consensus participation and Multi-Party Computation [MPC]. The protocol utilises vaults for liquidity storage, including smart contract-based Vault Contracts and Native Wallet Vaults, both operating under a Threshold Signature Scheme [TSS] with FROST [Flexible Round-Optimized Schnorr Threshold] for enhanced security and efficiency.
Why is Chainflip better than existing approaches to cross-chain swaps?
Unlike some existing approaches, Chainflip offers true interoperability between different blockchains without requiring any modifications to the existing chain infrastructure. Chainflip achieves this by facilitating swaps directly from wallet to wallet without relying on wrapped tokens or specific blockchain integrations, which can limit their scope and increase complexity. This approach also dramatically improves Chainflip’s user experience with users performing swaps directly from their wallets, without transferring assets to a centralised exchange or navigating complex bridging protocols.
Chainflip also differs from existing cross-chain solutions like Thorchain through its Just-In-Time [JIT] AMM model. Similarly to Uniswap v3, Chainflip’s JIT AMM encourages active participation from market makers allowing them to actively set liquidity ranges in line with market dynamics. By leaning into Just In Time liquidity, Chainflip incentivises market makers to compete with each other to offer the best price for end users ensuring users receive prices close to global index market price.
FLIP Token
The FLIP token in the Chainflip ecosystem is used as collateral for accounts on the State-Chain, operates relayers, and allows users to participate in Validator auctions. Unlike in other Proof of Stake Networks, to become a validator in Chainflip’s validator set, participants must bid for slots in the validator set in auctions which are held every roughly 12 hours.
As validator rewards are not dependent on the number of FLIP tokens staked, participants in these validator auctions bid the amount of FLIP they are willing to stake to join the active validator set. As network emissions for authority validators are currently set at roughly 7%, through this open process, validator returns are determined by the market through these validator auctions. To help offset this issuance, Chainflip also implements a burn mechanism similar to Ethereum’s EIP-1559 model. To achieve this, the protocol charges a 0.10% network fee on all swaps facilitated by the network in USDC, which is periodically used to buy and burn FLIP tokens from the native FLIP/USD pool. This mechanism not only provides rewards for Validators but also provides offsetting deflationary pressures on the supply over time.
What’s the future for Chainflip?
As the network expands we believe Chainflip will play a key role in moving the industry away from centralised intermediaries to decentralized exchanges. This shift towards decentralized exchange is not just a reaction to past failures but a proactive step towards realising the full potential of crypto. We believe that Chainflip is a major step in that direction lowering the barriers between networks connecting currently siloed ecosystems to the wider network of chains and a step towards a more open, transparent and secure financial system.
Support Chainflip’s Mission
- Swap on Chainflip — https://swap.chainflip.io/
- Docs — https://docs.chainflip.io/concepts/welcome
- Twitter — https://twitter.com/Chainflip
- Discord — https://discord.gg/chainflip-community
Disclosure: Eden Block is an investor in Chainflip.
Nothing contained herein constitutes investment, legal, tax, or other advice nor is to be relied upon in making an investment or other decision. This presentation contains the opinions of the author, and such opinions are subject to change without notice. Furthermore, it may also include data and opinions derived from third-party sources. Eden Block does not accept liability for the accuracy or completeness of any such information or opinions which can be subject to change without notice.
