Investors have access to a wide array of investment instruments including innovative solutions like an AI crypto bot or liquidity mining on decentralized exchanges. Nearly all strategies revolve around using several different digital assets or interacting with a variety of platforms. In this sense, centralized exchanges became a go-to destination for millions of users mostly due to their strong focus on security measures.
Interestingly enough, the robust security achieved by innovation among CEXes is the result of an outstanding number of successful hacker attacks on centralized platforms several years ago. Today, the main target of bad actors are bridges that enable digital asset exchanges like Wormhole which facilitate data transfer between different networks.
This change in the ecosystem’s dynamic is what makes the debate between the proponents of using centralized platforms and those who believe that absolute decentralization and further development of trustless/permissionless systems should be the golden standard for the whole blockchain industry. What are the advantages of enhanced interoperability and why does improving it seem to be so challenging? Let’s discuss these questions.
What is multi-chain crypto trading?
DeFi protocols that can communicate with different networks and transfer data from one to another are highly valuable. The utility enabled by their operation allows investors to effortlessly adjust portfolio compositions and trade freely regardless of their main preferred network where they conduct the bulk of their transactions. If there were no bridges between different architectures, we would have a very fractured, incohesive ecosystem connected through traditional fiat exchanges.
The problem lies in the difficulty of information transferring between ledgers that have different underlying technologies and data handling frameworks. A relay of sorts is necessary to make the transition happen. These intermediaries may also act as fully decentralized, trustless systems that should, in theory, protect the data from any unauthorized tinkering. However, issues with smart contract coding can be quite challenging to catch in time and hackers can exploit vulnerabilities easily.
In 2022, attacks on bridges resulted in a massive loss of over $1 billion which is over 69% of all stolen funds that year. Some of these attacks are very intentional. For example, some of the most prominent hackers originate from North Korea where the government directly supports these operations.
Unlike CEXes which take users’ funds into custody and maintain balances on different wallets to keep trading smooth and seamless, self-custodial solutions tend to solve many logistical problems by implementing smart contracts that can work autonomously. It sounds like an elegant approach to a complex issue, but the implementation is often questionable and leaves much to be desired. However, we still need these protocols to exist.
The advantages of cross-chain swaps
Some experts argue that the introduction of better interoperability solutions will lead to a significant increase in user activity across the whole DeFi ecosystem. It is true that the trading volume on DEXes has been growing steadily in recent times, but the risks associated with these transactions are increasing too. The ideal scenario is when these technologies are working perfectly and users are benefitting from them.
Here are the advantages that can be achieved if we solve some of the existing issues with interoperability solutions:
- Much higher liquidity and interconnectedness. With sufficient liquidity, retail traders will be able to conduct their investment activities with more efficiency and enjoy lower fees. Since it is possible to move assets from one ledger to another effortlessly, many decentralized exchanges will be able to raise more funds from a much more diverse audience of potential market makers and liquidity providers. Chainalysis reports that the total trading volume across all DEXes has increased by over 800% in just one year indicating an explosion of interest from investors.
- Robust security and the lack of intermediaries. One leads to another. Since centralized exchanges are still considered weak points in the DeFi ecosystem despite the best safety measures implemented by companies, the absence of such intermediaries can lead to a less vulnerable infrastructure. It is possible in an ideal world where smart contracts are designed impeccably without a single point of failure and no potential exploits. Currently, up to 50% of all DEX trading volumes are processed via various multi-chain trading platforms, but the number of successful hacker attacks is growing.
- Everything becomes accessible. Learning how one protocol works does not give you an exact understanding of how another one operates. Also, many investors use a single entry point as their gateway to the crypto industry limiting them to tokens that are minted on their introductory network. Users who are accustomed to the ERC-20 standard employed by Ethereum projects may not risk using a TRC-20 standard on Tron. Protocols that make it easier to swap digital assets remove these barriers and allow people to use any coin they want without switching familiar tools.
- Reduced fees. A study by Messari revealed that Ethereum fees can go up to $60 during peak congestion. The problem has been somewhat addressed recently, but using networks when the throughput is maxed out can be quite expensive. By simply moving operations to a less congested blockchain, you can lower commissions by several magnitudes. Layer 2 solutions also focus on reducing fees by wrapping smaller transactions into a single one on the underlying layer.
These benefits are only achievable if everything works as intended. Bridges between networks must work well and offload some of the data recordings to networks that allow for more throughput. It does not happen all the time leading to slow transaction processing by bridges or increased fees for users. At the same time, the technology itself can cause problems.
If you run a crypto trading bot on a centralized exchange, there is nothing to worry about. However, if you plan to actively use decentralized finance for all sorts of activities like liquid staking, lending, and yield farming in general, it is a good idea to learn how these projects operate and which risks they expose you to.
Cross-chain trading risks
Some of the protocols make the exchange of assets across different blockchain networks possible thanks to their ability to provide liquidity to DEXes and provide additional gateways for retail traders to use if they want to engage with different types of assets. However, their utility is tarnished by some severe dangers that many retail traders are acutely aware of:
- Vulnerable smart contracts can be significant weak points. These tiny applications are used to conduct transactions in a trustless and permissionless manner by automating many processes. Errors in the code can lead to hacker attacks like the Poly Network exploit that was discovered by a group of malicious hackers who used it to steal over $610 million in a single sweep. Developers can reduce the potential of these attacks by initiating bug-hunting challenges and conducting thorough audits.
- Oracles and relay networks. These are centralized components of largely decentralized entities operating swaps of crypto assets within the ecosystem. By default, the inclusion of such elements in an architecture that relies on decentralization for robust security makes them targets for hackers. Chainalysis experts argue that over 40% of all successful attacks were aimed at these centralized components.
- Lower-than-expected liquidity. The noticeable trend of user aggregation on certain DeFi protocols is happening due to poor trading experience on lesser protocols that suffer from slippages. With over 30% of all DeFi solutions struggling to keep rates locked for queued transactions, we are seeing that this problem is far from being solved. Increased user activity may help alleviate this grievance but we cannot magically produce liquidity out of thin air.
- Regulatory compliance. One of the biggest issues at the moment is the uncertain legal status of many bridges that facilitate asset swaps but do not fall under the jurisdiction of any governing body. While the EU and some states of Southeast Asia are trying to develop an adequate framework, many of these protocols are still in the grey area in the US and Canada. We still do not know what these official authorities will cook up to oversee many operations within the sector.
- Problems with interoperability. We have already discussed the challenges related to the direct incompatibility of networks. Despite the best efforts from developers, inconsistent standards and data handling methods can lead to significant delays or critical failures. Deloitte conducted a comprehensive study in 2022 revealing that up to a quarter of all transactions between networks do not go smoothly.
- User experience is a big problem. Many Dapps do not operate like traditional fintech software products and do not offer the same level of smoothness and intuitiveness as some of the more established applications from banks and brokers. RIF conducted a survey showing that over 19.8% of users are hesitant to join the market due to the complex diversity of available networks while 13.5% (the third highest response) believe that onboarding and accessibility of Dapps were the biggest entry barrier.
These risks significantly reduce the willingness of investors to use various bridges and exchange assets between different blockchains. The majority of large capital holders prefer sticking to a single network that they believe to be the most profitable or reliable. Convincing them that interoperability opens new opportunities can be challenging and requires solving many issues that are currently present in the industry.
Examples of multi-chain swap protocols
Some of the most interesting solutions in this sector are very popular among enthusiasts even if investors are hesitant to use them as much as it is needed to facilitate meaningful growth. The worsening US economy and the actions of the US treasury can lead to a new period of bearish trends across the whole market. However, it can also open new possibilities for Dapps to attract users who are afraid of the issues that may soon affect fiat.
Most of these solutions use the atomic approach to building bridging technologies as their main method of conducting operations. This concept does not require middlemen and requires only some oversight from developers.
Here are some of the most promising bridges that you can use:
- Across is a bridge that uses an optimistic oracle and connected relayers in conjunction with one-side liquidity pools to ensure that transactions happen smoothly between layer 2 networks compatible with the Ethereum Virtual Machine. As of the time of writing, the protocol had $155 million in TVL (a 41% increase compared to the beginning of the year) and 10 single-sided pools with APYs ranging from 0.01% to 9.69%.
- Stargate is another interesting project that powers the Omnichain concept in the DeFi ecosystem. The platform uses mixed liquidity pools to facilitate fast and reliable transfer of information between different networks. In August 2024, after stabilizing, the TVL reached a sizeable $443 million and the market capitalization of the native token is roughly $64 million. The promise to guarantee instant settlement was not fully realized as people reported delays and even errors. Still, it is an interesting emerging project that should be on your watchlist.
- Hop is a promising solution that develops a fully trustless and permissionless bridge that does not need any intermediaries. The developers argue that critical vulnerabilities appear only on centralized components that may not be up to the task of securing the information. Instead, Hop is conducting all its operations directly on the ledger. The problem is that the protocol is not getting traction to the degree necessary for rapid growth. The TVL is roughly $49 million across 18 single-sided pools.
- Circle CCTP offers a solid catalog of 8 interoperable chains including Ethereum, Base, Noble, Solana, Arbitrum, Avalanche, Polygon, and OP Mainnet. 56 operational routes have a combined daily trading volume of roughly $30 million making it the second-largest operator behind only Stargate. Circle is known for its stablecoin designs like USDC and EURC which are often used by international retail traders to quickly move assets in and out of the crypto market.
- IBC is a popular protocol that supports 110 different L2 and L1 chains with a solid daily trading volume of $25 million. It is built on Cosmos, a layer 0 network that facilitates interoperability and focuses on providing the necessary tools to developers who want to create Dapps that can transfer information between different ledgers effortlessly. As one of the most interesting solutions in this domain, IBC can be a great choice for a tech-savvy investor.
In conclusion
The decentralized finance landscape is quite complicated and the range of cross-chain trading challenges is quite massive. We are still years away from the moment when users can send assets with absolute confidence that they will arrive on time, at a predictable price, and without any security issues or software errors. Nevertheless, it is a growing sector that requires attention from users.
Many investors would benefit from avoiding transactions between ledgers and focusing on other ways of interacting with the market. For example, it is a much easier approach to simply run a grid bot and focus on various tokens listed on centralized exchanges instead of doing everything manually while exposing holdings to additional risks during data transferring.
We must continue observing the development of the industry and the performance of emerging instruments allowing for better interoperability.