Bridging The Gap
By: @0xLayerTwo
The current state of the bridging ecosystem can easily be summarized in one word:
Broken
A total of around $1.4 billion has been lost to breaches on these cross-chain bridges since the start of the year, according to figures from blockchain analytics firm Chainalysis. This is approximately equivalent to the total GDP of some smaller countries, such as Belize, and larger than the GDP of 17 different nations around the world. Suffice it to say that these exploits have been a stain on the crypto community as a whole and is a problem that must be remedied in order to usher in a healthy, decentralized financial future.
What is a Blockchain Bridge?
Blockchain bridges work exactly as the name implies. Just as a physical bridge connects two locations in the real world, a blockchain bridge connects two blockchain ecosystems, whether connecting one Layer 1 Blockchain to another, say Ethereum to BNB, or a Layer 1 with Layer 2s, such as Ethereum to Optimism or Arbitrum. Bridges facilitate communication between blockchains through the transfer of information and assets.
Unidirectional or one-way bridges, allow you to port assets to the target blockchain but not the other way around. For instance, Wrapped Bitcoin allows you to send your BTC to the Ethereum blockchain but it doesn’t let you send ETH to the Bitcoin blockchain. Bidirectional bridges like Wormhole and Multichain are two-way bridges, meaning you can freely convert assets to and from blockchains. Just as you can send BNB to Ethereum’s blockchain, you can send ETH to BNB.
Why do we need Blockchain Bridges?
Being able to bridge assets from one blockchain to another blockchain comes with many benefits for users and the ecosystem as a whole. First, the blockchain onto which you port assets might be cheaper and faster than its native blockchain. This is certainly true for Ethereum, where high transaction fees and slow throughput make it difficult for newcomers to get involved in the many different DeFi offerings available. Enter Layer 2. By bridging their assets to a layer 2 network such as Optimism, Arbitrum, zkSync or any of the other rollup solutions, they could trade ERC-20 tokens for a fraction of the cost without sacrificing exposure to Ethereum tokens.
Other investors use bridges to make the most of markets that exist only on another blockchain. For instance, there are DeFi protocols that are only available on chains outside of Ethereum, but supports a wrapped version of ETH. This allows users to bridge their ETH to another chain and use it in DeFi without needing to sell their ETH, convert it to the native token of said other chain, and then use that token.
Types of Bridges
Bridges, like many other aspects of cryptocurrency, can be either centralized or decentralized. Each comes with their benefits and drawbacks.
Centralized Bridges, such as the WBTC Bridge, depend upon a central entity or system for their operations. This means that they rely on central actor trust assumptions concerning the custody of funds and the security of the bridge. Users mostly rely on the bridge operator's reputation for assurances. One of the benefits of a centralized bridge is that there may be mechanisms by which the bridge can override a malicious act or pause the bridge until they are able to work out the issues. A drawback to this, is the ability to use this power maliciously.
Decentralized Bridges, such as Nomad, operate using smart contracts and algorithms. Users remain in custody of their funds and the security of the bridge is the same as that of the underlying blockchain. The main drawback in the case of many decentralized bridges, such as in the Nomad attack, is that the team gave up its policing power in favor of decentralization, so they were powerless to help stop the exploit.
While inherently necessary to access the plethora of opportunities available across the multichain landscape, the Ethereum Foundation warns us that interacting with any type of bridge carries risk:
Smart Contract Risk — the risk of a bug in the code that can cause user funds to be lost.
Technology Risk — software failure, buggy code, human error, spam, and malicious attacks can possibly disrupt user operations
Censorship Risk — centralized bridge operators can theoretically stop users from transferring their assets using the bridge
Custodial Risk — centralized bridge operators can collude to steal the users’ funds
While bridges are crucial to onboarding users onto Ethereum Layer 2s as well as opening up opportunities across multiple Layer 1s, users must understand the potential drawbacks of each type of bridge given the risks involved in interacting with bridges.
Not financial, legal or tax advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. All opinions expressed are solely those of the individual author. This newsletter is not legal advice and does not create an attorney-client relationship. This newsletter does not constitute tax advice. Talk to your independent attorney and/or accountant for any questions specific to you. Always do your own research and use caution when interacting with smart contracts or the blockchain