3 - 4 minute read
Blockchain technology has been touted as the future of the internet through its decentralized, trustless nature. However, for this transition from Web2 to Web3 to occur, an interoperable standard that allows for easy integration by every network is necessary. This would enable a fully interoperable blockchain ecosystem at scale and pave the way for a seamless, internet-like experience for the platform and their applications. Industry analysts argue that with the current proliferation of layer 1 blockchains operating in isolated silos, an open communication standard akin to the TCP/IP used on the internet is crucial to ensure that liquidity is not stifled.
Ryan Lovell, director of capital markets at crypto price oracle solutions firm Chainlink Labs, notes that blockchains without interoperability are like isolated machines that cannot transfer data and value across networks. According to Brent Xu, founder and CEO of lending platform Umee, proper risk management systems need to be put in place to facilitate this interoperability. Before real-world assets (RWAs) are brought onboard, financial institutions would need to tick off Know Your Client (KYC) credentials to ensure the authenticity of the RWAs before tokenizing them on-chain. They would also need to ensure that they can be identified by an on-chain proof-of-reserve audit.
To avoid an on-chain catastrophe, Xu stresses that the risk of cutting corners is not worth taking. Cross-chain bridges, independent layer 2 sidechains, and oracles are some of the most commonly used blockchain interoperability solutions. However, there have been cases of exploits in decentralized finance (DeFi) taking place on cross-chain bridges. These vulnerabilities are due to proof-of-authority consensus mechanisms and multisignature security setups which are more centralized than ideal.
Many interoperability solutions favored speed of development over security early on. This misstep has compromised the security of the solutions, providing two ends at which hackers can infiltrate potentially any vulnerabilities. Xu believes that incorporating interoperability within the platform would result in a more secure end-to-end transaction than through the use of third-party bridges. Chainlink’s Cross-Chain Interoperability Protocol (CCIP), the Inter-blockchain Communication Protocol (IBC), Quant Network’s Overledger, and Polkadot are among the most commonly used blockchain interoperability protocols.
The Bottom Line
To avoid potential vulnerabilities and maintain the trustless nature of blockchain technology, it is crucial to develop interoperability solutions that prioritize security over speed. Incorporating interoperability solutions within the platform would be more secure than relying on third-party bridges which create vulnerabilities. Financial institutions looking to tokenize RWAs need to ensure proper risk management systems are set in place to facilitate blockchain interoperability. Interoperability is a crucial aspect of blockchain technology, and the development of an open communication standard that can be easily integrated by every network is vital to ensure liquidity and prevent potential losses due to a contagion.