There are more than 17,000 different cryptocurrencies and thousands of different networks. While each cryptocurrency uses blockchain technology, most operate as islands with their own communities and economies. And of course, these kinds of walled gardens are precisely what Web3 seeks to eliminate through decentralization.
Polkadot, Cosmos, Avalanche, and other cross-chain infrastructure solutions are gaining popularity, but there's still no easy way for users to move digital assets between any blockchain with minimal friction. And developers want to build dApps and other services that operate across blockchains rather than tie their business to a single solution.
Let's look at how cross-chain brides solve these problems, along with some caveats to keep in mind.
Decentralization doesn't have to mean isolated silos—cross-chain bridges could join disparate networks to create an interoperable environment for developers and consumers.
What is a Cross-Chain Bridge?
Blockchain bridges enable the transfer of tokens, smart contracts, or other data between blockchains with different protocols, rules, and governance models. For example, they could allow developers to execute dApps across more than one platform or transfer tokens from Bitcoin to Ethereum without third-party intermediaries.
There are two types of blockchain bridges:
- Decentralized cross-chain bridges enable you to move assets without using a third party. For instance, a "lock and mint" strategy involves freezing a token on the original blockchain using a smart contract then minting new tokens of an equivalent value on the receiving blockchain. After redeeming the new tokens, the contract burns the original tokens to prevent a double spend.
- Centralized cross-chain bridges involve the use of a trusted intermediary to move assets. For example, wrapped crypto strategies involve depositing the original tokens into a wallet controlled by a trusted custodian who mints new wrapped tokens of equal value on another network. All wrapped tokens are backed one-to-one with the original token.
In addition to cross-chain bridges between networks, sidechain bridges connect a parent blockchain to a child blockchain. For instance, you might deposit tokens from a parent blockchain into a sidechain bridge that relays them to a game's sidechain. These are especially common for Ethereum sidechains, given Ethereum's scaling challenges.
Examples of Cross-Chain Bridges
Cross-chain bridges have more than $200 billion locked up compared to just $25 billion a year ago, according to Footprint Analytics. As the crypto ecosystem grows, these figures are likely to continue their rise. New approaches and technologies could also lead to more options over time, resulting in lower costs and greater reliability.
Some of the most popular cross-chain bridges include:
- Ronin Bridge - Ronin is an Ethereum sidechain built to handle the demands of Axie Infinity. Using sidechain transactions, the network enables cheap in-game microtransactions without high gas fees.
- Avalanche Bridge - Avalanche Bridge transfers ERC20 tokens from Ethereum to Avalanche's C-Chain and vice versa. The C-Chain is purpose-built to scale financial transactions on the blockchain.
- Polygon Bridges - Polygon Bridges enable a trustless transfer from Ethereum to Polygon and back again without third-party risks or market liquidity limitations.
- AnySwap Bridges - AnySwap is a fully-decentralized cross-chain swap protocol with an automated pricing and liquidity system, catering to a wide range of networks.
When choosing a cross-chain bridge, you should look for a stable "total value locked" (TVL) with minimal volatility, reasonable transfer costs and speeds, and security to safeguard against attackers. CoinTofu and other tools can help you find the best cross-chain bridges for a given pair of cryptocurrency networks by comparing different options.
Why Cross-Chain Bridges Matter
The interoperability between blockchains will be essential to the long-term success of cryptocurrencies, non-fungible tokens, and other blockchain use cases. Most users and developers don't want to choose between platforms when building apps, playing games, or investing money. Interoperability creates more value for everyone.
Interoperability is critical for several use cases:
- Collateral - Many blockchains, like Bitcoin, hold a significant amount of value without an advanced DeFi ecosystem, limiting the ability to generate income from any holdings. Cross-chain bridges could help provide anyone with easy access to DeFi capabilities.
- Scalability - Many proof-of-stake blockchains have scalability issues, particularly as the number of transactions continues to soar. Cross-chain and sidechain bridges could help alleviate these issues without switching networks completely.
- Efficiency - Along with greater scalability, crypto users may want to conduct transactions on blockchains with lower fees, helping reduce congestion on parent blockchains and saving significant amounts of money on gas fees.
- Web3 - Web3 will rely on the interoperability between different blockchains to drive adoption. For example, users will want to keep their avatars, currencies, and other NFT and fungible assets between games and experiences.
The development of cross-chain bridges remains in its infancy. While there are many different bridges, most cater to specific communities and use cases rather than providing a broad-based solution. The exceptions are Polkadot, AnySwap, Cosmos, and a handful of other projects seeking to connect decentralized networks for easier interoperability.
Cross-Chain Bridges Risks
Cross-chain bridges may be growing in popularity, but that doesn't mean they're without risk. For example, Ethereum's Vitalik Buterin argues that cross-chain bridges increase security risks when transferring assets by increasing the surface area for attack. These problems worsen when going beyond two chains to three or even a hundred.
Here's how he put it in a recent tweet:
"Imagine what happens if you move 100 ETH onto a bridge on Solana to get 100 Solana-WETH, and then Ethereum gets 51% attacked. The attacker deposited a bunch of their own ETH into Solana-WETH and then reverted that transaction on the Ethereum side as soon as the Solana side confirmed it. The Solana-WETH contract is now no longer fully backed, and perhaps your 100 Solana-WETH is now only worth 60 ETH. Even if there's a perfect ZK-SNARK-based bridge that fully validates consensus, it's still vulnerable to theft through 51% attacks like this."
Multi-chains, like Cosmos or Polkadot, avoid these problems by relying on a shared security mechanism along with cross-chain bridges. Developers can set up their own custom parachains on the foundation of these types of services while relying on them to coordinate security and the transfer of assets between various parachains.
Finally, cross-chain bridges could also have tax implications. For example, Axie Infinity is built on the Ronin sidechain of Ethereum. When you sell ETH to purchase an Axie, you must pay tax on any appreciation in the ETH since you acquired it. You may also owe taxes when you sell an Axie for a profit, earn SLP, or even breed Axies.
The Bottom Line
Cross-chain bridges connect disparate blockchains to facilitate the transfer of tokens, smart contracts, and other data. By connecting these networks, the bridges could enable lower-cost transactions, collateralized assets, greater scalability, and ultimately, unlock the potential for Web3—the next iteration of the internet and commerce.
ZenLedger can help track crypto transactions across wallets and exchanges to ensure that you accurately report your capital gains and losses to the IRS—and avoid overpaying taxes, too.
