Blockchain Interoperability

A sidechain is in effect an autonomous blockchain, which is linked to the main blockchain through a two-way peg or bridge. A two-way peg serves as an intermediary, securing an asset in one blockchain until its transfer to the other is finalized. Sidechains employ distinct consensus algorithms and possess unique native tokens. This in turn enhances scalability by processing a portion of the main blockchain’s data. In addition, these secondary blockchains feature distinct consensus protocols, enhancing a blockchain network’s privacy while simultaneously reducing the reliance on additional trust to uphold the network. This enables the transfer of digital assets, such as tokens, between blockchains, empowering projects to organically expand their ecosystem in a decentralized manner.

A good example of this particular methodology is the Liquid network, which was designed to facilitate faster and more private transactions in comparison with the original Bitcoin network. The two-way peg system enables the transfer of Bitcoins in both directions between the main Bitcoin blockchain and the Liquid sidechain. This acts as an additional supplementary layer resulting in a beneficial use case for fast trading and exchange-related activities, coupled with privacy enhancements whilst simultaneously remaining anchored to the BTC blockchain.

What is commonly referred to as a cross-chain bridge, consists of the separate blockchain being able to expedite the seamless exchange of data, assets, and messages between these networks, hence eliminating the necessity for intermediaries. This separate blockchain, is in effect positioned between the two blockchains wishing to exchange data and upholds a cryptographically timestamped, secure ledger, that records messaging and transactional activities between them.

Various interoperability tools exist, for example, general-purpose bridges to hub and spoke models are utilized, in order to realize the required connectivity between the blockchains in question. However, other methods being more commonly utilized also exist, such as chain-specific bridges, wrapped tokens, and multiple chains.

Various blockchain projects and companies deploy cross-chain bridges such as Avalanche, Cosmos, and Wanchain. However, Polkadot is a multi-chain network known for its parachain and relay chain architecture. As Polkadot supports cross-chain smart contracts, this opens up the possibility for various use cases allowing DeFi projects to gain access to a wider range of services and assets. To briefly summarise, via its cross-chain bridges, the network is then able to facilitate seamless communication with other custom blockchains.

Further reading and more information on these solutions can be found here regarding other solutions for cross-chain bridges.

Token bridges enable users to transfer assets seamlessly between different blockchain networks, and the specific process can vary across different bridges. Certain bridges employ a lock and mint mechanism, which basically results in deploying a smart contract on the blockchain that locks a crypto asset, while simultaneously another smart contract on the receiving blockchain network mints an identical version of the asset.

Generally speaking, Token bridges can be defined into two categories, trust-based bridges, and trustless bridges.

Firstly, trust-based bridges are commonly referred to as custodial bridges, or trust-based federation bridges that operate under the control of a group of mediators or a central entity. Users that wish to convert one asset/token into a different asset/token, are reliant on the members of the federation to authenticate and validate the transaction. With this methodology the mediator’s prime objective is the smooth flow of a transaction, hence their focus on preventing or identifying any fraudulent behavior is secondary. Trust-based bridges offer a fast expedient and relatively cheap solution. So the main incentive is to facilitate the transaction with relative ease and in a timely manner.

Trustless bridges are also referred to as decentralized bridges and hence rely on smart contracts to perform and execute the required transaction. These types of bridges involve the participation of individual blockchain networks to validate the transactions. Trustless bridges offer an enhanced level of security and flexibility.

To summarise here, the difference between the two types of bridges described in this section, are that token bridges frequently utilize a cross-chain messaging protocol designed specifically in order to transfer tokens between different blockchains. Whereas cross-chain bridges commonly requires the burning or locking of tokens on the source chain using a smart contract, this is then succeeded by the unlocking or minting of tokens on the destination chain via a separate smart contract.

A well known blockchain project deploying token bridges is Wrapped Bitcoin (WBTC). Briefly, the process involves a token bridge whereby a participating user’s BTC is locked on the Bitcoin blockchain. This results in an equivalent amount of WBTC being minted on the Ethereum blockchain. On the other hand, when the user wants to redeem their Bitcoin, they can burn the WBTC tokens on the Ethereum blockchain, and the corresponding amount of Bitcoin is released on the Bitcoin blockchain. This technique opens up the possibility for a variety of use cases, as users are then able to access decentralized applications (DApps) and smart contracts using their BTC holdings on the Ethereum platform.

Atomic swaps can be thought of as facilitators that manage the exchange of tokens across multiple blockchains. With this method, peer-to-peer token exchanges can be deployed, whereby transactions occur directly between chains, eliminating the need for any centralized intermediaries such as CEXs. Although this methodology does not offer seamless cross-chain communication, it does provide a technique whereby direct transactions can take place between different blockchains.

To give a very brief example, an atomic swap allows the trustless exchange of token 'x' on one chain to token 'y' on a different chain. It is not necessary that verification from either chain is required, as the data is exchanged between the involved peers.

One example of a blockchain project using atomic swaps is Decred (DCR). Briefly, the usage of atomic swaps requires cross-chain compatibility between the tokens in question, and to accomplish this, Hashed Time-Locked Contracts (HTLCs) are deployed. HTLCs ensure that the swap is atomic, hence, it either happens entirely or not at all. This involves a time lock and a hash lock, which enables both parties to create time-bound contracts with certain conditions that allow parties to create time-bound contracts in a specified timeframe.

To gain more in-depth knowledge of how this mechanism functions, please read this description of atomic swaps.

Oracles can best be described as bridges or links that connect the blockchain to external entities, namely the outside world. They enable smart contracts to incorporate data from a wide array of sources such as stock prices, weather information, flight details, etc. In theory, this could be any type of real-world data so the possibilities of a wide variety of use cases exist ranging from DeFi, and Cross-chain services to NFTs, to name a few. Furthermore, oracles offer a means for the decentralized Web3 ecosystem to connect with established data sources and legacy systems. Since blockchains lack inherent access to what is known as 'off-chain' data by themselves, oracles play a pivotal role and hence, provide a valuable third-party service that significantly expands the use cases for smart contracts.

The potential of decentralized oracles lies in their ability to introduce protective mechanisms that could result in significantly reducing systemic risks. Hence, the secure and trustworthy implementation of blockchain oracles can be considered as a crucial element, that is essential for aiding and promoting the reliable and secure growth of the blockchain ecosystem. To summarise, ultimately they are the link between on-chain and off-chain data, and certain types of oracles exist from inbound and outbound, to centralized and decentralized oracles.

Although oracles are primarily utilized to provide smart contracts with external data, thus augmenting their potential functionalities rather than directly enabling interoperability, certain projects exist leveraging oracles in order to facilitate cross-chain communication and retrieve external data. Chainlink (LINK) is one such entity that operates a decentralized oracle network, whereby it acts as a bridge between on-chain and off-chain data sources that enables smart contracts on a variety of blockchains to connect in a secure manner with real-world data, payment systems, and APIs.

More in-depth information can be found here in this guide to oracles.