The market of smart contract platforms today looks very different from how many market participants have depicted it in 2019 and 2020.
After the incredible price appreciation in 2017 and the following bubble pop, almost all alternative layer 1s (“Ethereum killer”) failed to achieve usage, which quickly reflected in price going down 95%.
However, while the ETH price didn’t hold up any better than its competitors, demand for Block space and innovation on the App layer was starting to pick up again. It was during that time in late 2018/19/20 where most of the app layer innovation originated, which until today serve as key building blocks in the Defi ecosystem (Uniswap, AAVE, Maker and more).
The sentiment was pro Ethereum (compared to Alt L1s) since that’s where builders went, and innovation occurred. Most people counted on Ethereum to solve its Scalability problems with ETH 2.0 at some point in 2019 or 2020. Even during the Defi Summer of 2020 when ETH fees starting to increase, all innovation was still happening on Ethereum.
The Market today however paints a very different picture and is clearly signalling a need for Alternative Layer 1 Chains, which can achieve Scalability faster than Ethereum (by making different trade off on the Scalability Trilemma)
Ethereum dominance in TVL reflects this clearly by declining from 97% in the beginning of 2021 to just above 60% in just 13 Months. Not only TVL, but also Innovation is starting to leave Ethereum, with many Projects using high TPS (Transactions per second) chains to innovate in new Areas. This is ultimately also reflected in prices, with almost every Alt L1 outperforming ETH over the course of the year.
(It is still important to keep in mind that TVL on ETH lost Market Share but still grew 530% in 2021)
In a Multichain world, different Smart Contract Platforms can coexist and fulfil different use cases based on how suitable their design tradeoffs are for certain use cases. For Example, Ethereum Layer 1 with its focus on Security and Immutability could be home to high dollar transactions and expensive NFTs, where Users are willing to pay a premium for the Service of Security Ethereum provides. While Solana or Avalanche are home to User which have priorities on fast and cheap transactions while sacrificing Security to an extent. Tezos could become the home of NTFs, or Applications could build on their own chains on Cosmos SDK.
These blockchains would not have to compete for users since their user profiles are vastly different, making is a very positive sum for the whole industry by improving the Smart Contract User Experience.
(Devil’s Advocate)
One could argue that much of the activity on other Layer 1 Chains can be credited to a year-long bull market, where people continue to venture out into different obscure alternative layer 1 ecosystems in the search of higher and higher returns. A phenomenon which is common to all markets, where participants venture out more and more on the risk curve the longer the cycle goes on. All while most projects on those obscure ecosystems are 1:1 forks of existing projects on Ethereum, basically only providing the User with a service of “being able to be early to an ecosystem” while using liquidity incentive programs to lure in more user and hackathons/grants to fund developer to copy and paste Ethereum projects onto the chain.
All while VCs and Exchanges lure Retail investor into believing in a “Multichain Future” since their Business Models are dependent on multiple different coins capturing mindshare. To A) earn exchange fees by people trading back and forth between different Assets and B) Buy their presale bags which have been acquired at 1/100 of the cost. Similar to how much of the Altcoin cycle in 2017 played out.
Kyle Samani from Multicoin Capital on this topic (Solana investor from Seed onwards and early to EOS in 2017)
(I am not trying to villanize VCs, since that is simply their business model and their responsibility towards their LPs.)
However, while these are valid arguments, and I would agree that Ethereum could regain Market Share in TVL during a calmer (bear) market where less opportunity exist on different layer 1s. I still strongly believe that the transition from Mindshare and most importantly developer away from Ethereum is a strong trend, which will persist for the next years.
Ethereum’s vision of a Multichain Future:
Ethereums vision of the Future doesn’t look too different from the one described. The vision has shifted from that of a Monolithic Base Chain where all transactions are done and settled on Ethereum Layer 1 towards the vision of a modular rollup centric blockchain where Scalability is achieved without sacrificing the superior security and decentralization of the Ethereum base chain, by relying on Layer 2 chains like Arbitrum, Optimism, Starkware or ZkSync to facilitate Transactions away from the Ethereum base chain and then post proofs of these transactions to the main chain.
The Ethereum main chain as we know it today would become a “chain of chain” which doesn’t facilitate transactions for most people (since fees are astronomically high), but rather executes transactions separately from the main chain but then posts proof of these transactions to the main chain (herby inheriting the security from the main chain).
Whether you sympathize with an Ethereum centric rollup future or that of multiple Layer 1 Chains sharing market share, it seems inevitable for a Multichain future to become dominant since all players are working towards it
This increasing activity happening between chains is opening up a new market opportunity for a new set of Protocols: Bridges
In their simplest form, Bridges allow a transfer of information between multiple Blockchains.
This connectivity between blockchains is a very important function for many reasons:
Bridges fight a fragmentation of Liquidity. Assets can be bridges between chains within minutes, so the location of Assets becomes less relevant since capital can move quickly once a better use of capital is detected.
This increased connectivity between Blockchains is also very positive sums for all players.
Many new apps can utilize the existing bridge infrastructure (or build new innovation which leverages this technology) to create new creative products for customers. Existing apps can venture out to add new use cases, which are enabled by a flourishing multichain activity and the connectivity between chains.
This aggregates liquidity between chains and improves the User Experience, which is very positive Sum for the whole Space, similar to how global trade is positive sum for all participants.
Furthermore, Speculators can roam freely between chain and arbitragers can have an easier time keeping Asset prices in line between chains. Arbitrage Volumes between chains should become major parts of total bridge volumes, similar to how Market Makers are responsible for most CEX volume and most inter exchange transfer volume is done by Arbitrage firms.
Categorizing the Bridging Landscape:
2 Way Chain Bridge:
These are fairly simple constructed Bridges, which are used to connect maximum two blockchains. This allows users to send funds from the destination chain to the bridge and receive an equivalent amount of coins on the recipient chain. This mechanism works by locking the coins on the destination chain and minting an equal amount of new “wrapped” tokens on the recipient chain. If the user decides to bridge back to his destination chain, he sends his funds to the bridge, which burns them and unlocks his “original” funds on the chain. This redeeming process is smooth and takes a few minutes, which allows the wrapped tokens to hold their peg very well (if trust in the bridge protocol is high).
So technically bridges don’t transfer assets between chains, but rather lock them up on one chain and issue them on the other chain, but this is purely a technicality.
This type of Bridge is the most popular at the moment if measured by TVL and Transaction Volume with the most popular Bridges being: Avax Bridge ($5.1b TVL), Ronin (Axie Infinity) Bridge ($3.6b TVL), Polygon POS Bridge (3.2b TVL), Arbitrum Bridge ($1.3b TVL) and the Solana Bridge which is integrated in the Sollet Wallet ($0.5b TVL).
The relative simplicity these Bridges enjoy often allows them a fast time to Market. They are often created by the team behind the Layer 1 Protocol, which is connected with the Ethereum Network. For Example, the Avalanche Bridge was created by Ava Labs to allow easy connectivity between Avalanche and Ethereum (only allows ERC20 Transfers) which is a crucial property to allow for activity, especially in the early stages when Multichain Bridges have not integrated the Network yet.
Asset Bridges:
These Bridges serve the purpose of creating new Assets, from foreign chains, which can then be used to easily bridge to new chains and use the new Asset in the native Ecosystem of the new Chain. The best Example is BTC on Ethereum. Currently, over 333.768 (=$12b) wrapped versions of BTC exist on Ethereum, which are used in various different Defi Applications. These wrapped BTC are fully collateralized by BTC on the Bitcoin Chain and are held either in a custodial manner like wBTC which is held and issued by the centralized custodian BitGo.
or in a non-custodial manner like renBTC, where multiple validators execute transactions by coming to consensus using the multi-party computation algorithm RZL sMPC. These Validators each have to lock up 3x the BTC Value they secure in REN to disincentivize malicious behaviour. (Less trust Assumption with lower capital efficiency)
The custodial solution wBTC holds more than 80% Market Share. Since all different versions of wrapped BTC are different ERC-20 tokens, they are non-compatible and Defi protocols would have to set up individual Products (e.g., Lending Pools or AMM Pairs) for every wrapped BTC token. This normally doesn’t happen, but Defi Protocols rather default to the most liquid and commonly used version, which can lead to insanely strong MOATS (reflected in the 80% Market share Dominance).
Application Layer Bridges:
A bridge that connects multiple Blockchain, but only for a specific use within an application. A successful Example is the Thorchain Protocol, which has built a separate Blockchain on the Cosmos SDK, which focuses on being a Cross-Chain-Exchange. The Thorchain Protocols enables swapping between many Blockchains without the need for wrapped Tokens. Simplified, this works by User sending funds “Vaults” on the recipient Chain (e.g., Bitcoin) which are controlled by the Thorchain Nodes (they use TSS to come to consensus on the validity of inbound transactions to the “Vaults”). Once the transactions has been finalized, the Protocol initiates a withdrawal of (e.g., ETH) from the Output Vault on the Ethereum Chain to the recipient’s ETH wallet.
In general, Multi Chain Defi Protocol which either (like Thorchain) use their own Bridge Protocol or embed existing Bridging Solution into their protocol could enable many new and interesting use cases in the coming years.
Centralized Bridges (CEX):
By allowing withdrawals of Assets to different native chains, Centralized Exchanges also offer a bridging service. An Example is Binance which works as the main Bridge for BSC User (Binance Smart Chain) to the extent that Binance didn’t see a need to build out a 2Way Bridge to Ethereum but rather refers User directly to the Binance Exchange
(https://www.binance.org/en/bridge)
Binance also operates as custodian for many wrapped tokens on the BSC (e.g. BBTC, ETH, BUSD), meaning they are also operating an Asset bridge.
However, Centralized Exchanges are not really making any steps into fully developing their bridging service. Binance for Example only allows withdrawals of Stable coins (USDT/USDC) to the Binance Smart Chain, Ethereum and Tron, while many Multichain Bridges allow Stable coin bridging for more than 10 chains.
While CEXs as Bridges can be a good choice for less active user, the UX for people use bridges on a regular basis is definitely inferior.
Bridge Aggregators:
Bridge Aggregator find and bridge you through the fastest /cheapest available option. In general, this is an interesting concept for “power user” like arbitrage or trading firms which want to find the fastest bridge to get from chain x to chain y however for the average user it might not be a priority to save a minute in bridging time or save a few cents. The risk for Bridge Aggregators could be the Bridging Market playing out similar to the DEX Aggregator market, where many people actually prefer to use the underlying protocols, which have some Name brand recognition like Uniswap or Sushiswap rather than using DEX Aggregator even if this would save them a bit in fees and market impact (less slippage).
Multichain Bridges:
These bridges are protocols, which serve the purpose of transferring value between multiple different blockchains. There are many different designs to achieve this goal, however similar to the smart contract space there usually are tradeoffs in security/decentralization which have to be done to achieve scaling and high capital efficiency.
The basic building blocks for most bridges look relatively similar: Users send funds via a front end to a specific deposit contract on the source chain. This transaction is then confirmed, and the correct amount of funds gets minted on the recipient chain, which is sent to the user wallet.
However, who confirms that the transaction is sent correctly to the deposit address? This is the vulnerable part in the whole bridging process since malicious actors have to be hindered of confirming that assets have been sent to the deposit contract, which haven’t (allowing them to mint free wrapped token on the recipient chain).
This is where validators come into play. Validators monitor the deposit address and confirm transactions by coming to consensus. In more centralized bridges, there might only be one validator (wBTC) or multiple (Anyswap has 32). These validators are also in control of holding the private keys of the deposit address. In the case of multiple Validators, the private key is decided into multiple pieces, so we don’t have to trust a single node to hold the private keys to our funds.
Economic Incentivizes:
Trusted Validators: While having 32 different Validators sounds secure, there is in theory nothing holding them back from colluding and stealing user funds. In the case of wBTC we must trust the good reputation of the company (BitGo). Most projects relying on trusted Validators are relying on this more centralized model with higher trust assumptions to get to market faster, but are planning to transition to a more trustless model in the future.
Bonded Validators: This works similar to the slashing mechanism in Ethereum 2.0. Validators have to lock up a stake, which can be slashed (destroyed) if they behave wrongly. This means everyone can become a Validator. However, this collateral has to scale proportionally in value to the economic throughput or value at risk from funds, otherwise the game theoretical incentives from Validators to behave correctly breaks down.
Insured Validators:
This is an evolution of the bonded Validators where validators also have to lock up collateral, which doesn’t get slashed in the event of wrong doing but gets redistributed to the affected users. However, deepening on the collateral (often the coin of the bridge e.g. renvm validators look up REN) it could be significantly less valuable after a successful attack, making it hard to reimburse users.
After the Validators have confirmed (and come to consensus) on the validity of your transaction to the deposit address, the correct amount of funds will be minted on the destination chain and send to your wallet.
A different interesting design approach are Bridges which work with Liquidity pools similar to AMMs (Automated Market Makers) e.g., Connext or Celer cbridge. They work by Liquidity Provider depositing assets in locked pools on both source and destination chain. By providing Liquidity, they earn fees for the pair they have provided liquidity to. This yield changes, deepening how much Liquidity is needed in different swap pairs where it is needed. Similar to AMMs user request a quote for a swap. If user accepts their assets will be locked on the source chain and soon after the assets will be unlocked on the destination chain. If the transaction is not fulfilled correctly (by both parties) within a fixed amount of time, the transaction gets reverted, and both parties receive their assets. This bridge design reduces trust a bit however, at the expense of capital efficiency. Sometimes, certain swap pairs/ chains are unavailable since there is not enough liquidity on both chains to generate the swap, which could hinder user with bigger wallets from using these bridges.
Market Opportunity:
Multichain bridges will likely not be a winner take all market since similar to Layer 1 Blockchains many different Design approaches exist, which make different Tradeoffs and are suited well for different user. However, unlike Layer 1s bridge fees don’t scale with usage and are already relatively cheap even with lower trust assumption bridge design, so there likely won’t be a tradeoff between trust assumption and cost but rather a tradeoff between trust assumption and latency.
The total addressable Market of Bridges is hard to estimate since theoretically the TVL on all Smart Contract Chains ($225b), but since bridges take a fee from volume bridged it also depends on how quickly capital is rotating between chains.
Investability:
Bridges or Middleware Protocols more broadly could benefit from superior Investability, meaning they could become decent indexed bets for Market participants which seek exposure to the Multichain thesis but don’t have the time to keep up to date with innovation happening on different chains / apps enabled by multichain. (= “Selling Shovels Thesis.”) Bridges would become a decent bet from those participants, similar to how LINK as Oracle Middleware benefited from the same indexing approach by many investors during the first Defi Mania, e.g. (Fund XYZ (in 2020) wants exposure to Defi but doesn’t know which App to pick: Buys LINK; Fund XYZ (in 2022) want multichain exposure but doesn’t know which App/Chains to pick: Buys Bridge tokens.)
Unsolved Issues:
While Bridges are a key piece of infrastructure, there are still some unsolved problems and vulnerabilities which could pose serious threats to the underlying networks.
One of the biggest unsolved questions at the moment is how bridges would deal with blockchain rollbacks /block reorgs. Suppose a Chain get 51% Attacked successfully and the attacker can censor / revert transaction, he however cannot propose a block that takes away your Coins. So, if you have x ETH which you sold for y DAI after the Attack, you will either have x ETH or y DAI (depending on to which time the chain is reverted). Bridges however add a layer of added complexity in the case of a 51% attack.
Let’s say the attacker deposits ETH into a Solana bridge (get wETH on Solana) but reverts the deposit transaction after the wETH was minted to his Solana Address. Since wETH on Solana and ETH on Ethereum would not be fully backed, any more users holding wETH on Solana would lose Money. Since however not only 2 Chains exist (Solana and Ethereum) but rather hundreds which are all connected by bridges, an 51% attack on one chain could create a systemic contagion, which affects all chains which are connected through bridges with the attacked chain.
Vitalik has written an interesting Reddit post about this topic, which goes into much more detail:
Thanks for reading! ^_^
