Blockchain Compatibility for the Pluggable Future
More and more people consider blockchain to be a particularly safe and promising technology. According to Coinmarketrate.com in recent years, thousands of projects based on various blockchains have appeared. They specialize in things like payments, smart contract platforms, data storage solutions, supply chain management, etc. These blockchains are either public or private and have various options for security, scalability and decentralization, each of them has a unique management and a special consensus algorithm.
As a result of all these decisions and goals, there are no universal standards for blockchain development. The blockchain ecosystem is heterogeneous, and the potential of this technology remains unrealized if it works in isolation. For example, we cannot initiate a payment supported by blockchain A after delivery has been made according to blockchain B, delivery management. The reason why this cannot happen is because blockchains are not compatible.
What is interoperability?
Interoperability, according to the Oxford Dictionary, is the ability of computer systems or programs to exchange information. In the current conditions, the blockchain, as a rule, works in isolation, which limits the possibilities offered, their use and, ultimately, their acceptance.
Soon we will be able to extend interoperability to a wider range of assets and activities. This activity may include things like: land registry on the blockchain, which allows you to pledge your property rights on a credit platform to obtain a mortgage. Or your digital identity stored on the blockchain, which allows you to unlock your bank account and gain access to the social security system.
Interoperability allows blockchain to communicate and exchange data and values. Interchangeability can destroy isolation, and serve as a catalyst for the mass adoption of cryptocurrencies.
Compatibility will facilitate communication and exchange of values between blockchains. Let’s look together at the various functionality that interoperability will create.
- Atomic exchange
An atomic swap is an exchange of tokens on two blockchains. Imagine that you and your friend have Bitcoin (BTC) and Ethereum (ETH) wallets, and you want to exchange BTC for ETH, and your friend wants to exchange ETH for BTC.
Interchangeability will allow the transfer of property on the principle of “equal to equal”, as shown in Figure 1.
As the name implies, this is an asset exchange, and atomic. Atomic means that it is either fully executed or not executed at all. It does not allow partial execution, i.e. it is impossible for only your buddy to receive an asset from you, but not vice versa. Thus, an atomic swap eliminates counterparty risk.
- Asset portability
Asset portability is the ability to move a token (or part of it) from one blockchain to another, while preserving its history in the first blockchain, as shown in Figure 2.
An example of use may be a medical book in which all medical records of patients are securely stored. Then the patient can send all or part of the data to another account book (insurance company, hospital or attending physician). This improves the quality of data, since they will be recorded and aggregated in the blockchain, and the patient will be able to retain ownership of their data.
- Inter-chain oracles
Inter-chain oracles allow the blockchain to make a decision about an event that it observes on another blockchain.
For example: financial platform A, built on Polkadot, allows liquidity providers to put collateral on Ethereum. The Chainlink solution is used to control the value of the collateral. If the value of the collateral in Ethereum falls below the threshold value, liquidation begins on platform A.
An example from supply management: One can imagine that Company A uses its blockchain solution for supply management to wait for its supplier to deliver the goods. By receiving constant information about its order, which is tracked in the supplier’s blockchain, Company A can optimally plan its production. Conversely, the system can automatically generate an order when Company A runs out of stock of an intermediate product supplied by the supplier.
This system can be extended to several blockchains and companies. Interchangeability will allow you to create a place for interaction, instead of using a variety of two-way solutions.
- Asset lending
Asset lending is an opportunity to lock an asset on one blockchain chain, and unlock it when a certain condition is met on another chain.
In the previous example with liquidity providers, compatibility provides atomic transactions that eliminate counterparty risk.
Secured loans are an ideal use case. Imagine blocking assets on one blockchain and issuing a loan on another blockchain. Compatibility will eliminate counterparty risk, since both actions are atomic.
Why Investors Should Care about Compatibility
Blockchain is difficult to design, because a well-functioning blockchain requires the coordination of incentives of various stakeholders. The complexity of blockchain development increases with each additional function, as the alignment of incentives for additional functions must be scaled. And with increasing complexity, the attack area also increases. Therefore, blockchain is usually suitable only for achieving specific and limited goals.
If an investor believes that we will live in a world with several blockchains coexisting to perform various functions, then these blockchains must somehow be able to work together. Interoperability solutions fill this gap.
Currently, money is undoubtedly one of the use cases that public blockchains solve. This summer, Ethereum showed that blockchain can be useful for other aspects, such as lending, profitability automation, and so on. More than 150,000 BTC (worth more than $2 billion) are on the Ethereum blockchain, which proves that there is a demand for inter-blockchain asset transfers. Existing solutions allow mining BTC (so-called wrapped BTC) on Ethereum, with the help of some intermediaries. Interoperability will facilitate these operations.
Developers are creating compatibility solutions that allow assets to be transferred between two different blockchains without the involvement of intermediaries. Seamless transfer of assets between blockchains will provide easy access to liquidity, allowing liquidity providers to profit with less effort. Thus, interoperability solutions will be able to generate a certain value for facilitating the smooth and secure transfer of assets by charging a certain fee.
As the volume of inter-chain data transfer increases, interoperability solutions will continue to benefit. Therefore, we believe that it makes sense to evaluate investment opportunities within the framework of various interoperability solutions.
Interoperability is the ability of computer systems to exchange information and values. It is a catalyst for the introduction of blockchain and cryptocurrencies. Namely, it has the potential to create a blockchain network by building bridges between them.
Relay sidechains are common and promising solutions that offer more opportunities than other approaches. Among the possibilities, atomic swap, asset transfer and asset lending are widely used. In this way, they can form the digital ecosystem of tomorrow.