What is interoperability?

What is interoperability?

In blockchain systems, interoperability is the ability of different networks to interact, exchange data and execute transactions. In particular, it enables assets to move between chains without intermediaries such as centralized exchanges.

One of the main obstacles to mass adoption of blockchain and Web3 is network fragmentation. Users who opt for a single blockchain (for example, Ethereum) can readily use decentralised applications (dapps) within that network, but interacting with other systems (Polkadot, Avalanche and so on) can be cumbersome. This splits liquidity across networks and forces developers to spread resources to support projects on several blockchains at once.

Solutions aimed at interoperability seek to eliminate this fragmentation by enabling effective interaction among existing networks.

Shared standards and protocols help build a more connected ecosystem in which assets and information move seamlessly across platforms. This is achieved through specialised technologies that remove barriers between siloed blockchains.

What are the benefits of interoperability?

The main advantages include:

Greater liquidity and access across ecosystems

Cross-chain compatibility increases liquidity and the accessibility of assets by allowing users to move between different blockchains. It opens new investment horizons, enabling engagement with a wider range of assets across platforms and encouraging portfolio diversification.

Cross-chain interoperability also strengthens dapp infrastructure, supporting broader adoption.

Scalability and efficiency

Distributed networks routinely face constraints on throughput and transaction speed. Cross-chain interoperability protocols address this by spreading transactions across multiple chains.

This raises overall scalability and efficiency. Blockchain ecosystems can meet growing user and application demand without sacrificing performance.

Spurring innovation

Cross-chain interaction fosters collaboration, letting developers harness the strengths of different blockchains to build novel solutions.

By stimulating projects focused on compatibility across distributed systems, it accelerates the evolution of decentralised technologies. Developers can more easily integrate functionality from multiple chains, opening new use cases for dapps.

Lower counterparty risk

Using CEX and other centralised platforms entails counterparty risk when transacting.

Cross-chain compatibility removes intermediaries, reducing this risk and improving the security of interactions across blockchains. With direct communication enabled by interoperability protocols, users can transact securely without relying on trusted third parties.

Business development

By using interoperability solutions, crypto firms can:

• optimise financial operations;
• reduce costs;
• exchange assets and data transparently.

Seamless cross-chain operations streamline supply chains and simplify cross-border payments, opening new avenues for growth.

Improved user experience

Interoperability technologies create a unified, integrated blockchain environment, encouraging wider adoption. As a result, the TVL of DeFi rises and liquidity fragmentation diminishes.

What solutions deliver interoperability?

As DeFi and the broader crypto market have developed, a range of technologies has emerged to ease cross-network interaction. Each has its own approach and characteristics.

Atomic swaps

Atomic swap is a decentralised cryptocurrency swap in which two parties exchange assets directly without intermediaries. The deal is instantaneous and atomic—either both parties receive the desired coins, or the exchange does not occur.

Atomic swaps use hashed timelock contracts (HTLC). These require the payment recipient to confirm receipt by generating cryptographic proof before a set deadline. Otherwise, the transaction is invalidated and funds are returned to the sender.

Such operations can take place on-chain—directly between blockchains of different cryptocurrencies—or off-chain, outside the distributed system.

Atomic swaps can be used for:

• decentralised trading;
• on-chain transfers;
• running dapps.

Advantages:

• security: no need to trust a third party; the risk of fraud is absent;
• privacy: users’ personal data are not disclosed;
• decentralisation: transactions are censorship-resistant and not geographically restricted;
• efficiency: swaps are fast and incur minimal fees.

Inter-network protocols

IBC protocols simplify interaction between blockchains, creating a unified environment for routing payments across networks. These solutions enable value to move freely between independent ecosystems, helping to build a unified financial infrastructure.

By establishing shared rules and routing mechanisms, inter-network protocols make seamless transactions across different blockchains possible. They are an effective means of delivering cross-chain compatibility.

LayerZero is among the best-known IBC protocols. It seeks to remove communication barriers between blockchains without compromising security or decentralisation. According to the developers, the omnichain solution combines the economic efficiency of Polkadot with the security of Cosmos.

Since inception, the project has raised $263m across five rounds. It is valued at $3bn.

Examples of infrastructure services built on LayerZero: Gas.zip, Telos Bridge and Decent.

Cross-chain bridges

Cross-chain bridges are decentralised applications that move assets between different blockchains.

They handle tokens of various standards (ERC-20, BEP-20 and others) across networks. There are also bridges that transfer funds between blockchains built with different technologies (Bitcoin, Ethereum, Litecoin, Dogecoin), as well as among layer-two scaling solutions (Arbitrum, Optimism).

Cross-chain transfers can involve creating wrapped assets, using liquidity pools in multiple ecosystems, or relying on relayer nodes that hold funds across different blockchains.

What other technologies enable cross-chain compatibility?

Chainlink’s CCIP

Cross-Chain Interoperability Protocol (CCIP) is an open-source, decentralised protocol developed by Chainlink. It aims to be a unified interoperability standard for the Web3 ecosystem, allowing smart contracts on any network to interact seamlessly with one another.

CCIP is used in well-known Web3 projects:

• Synthetix: a decentralised exchange for synthetic assets;
• Aave: a leading decentralised lending protocol.

Wormhole

Wormhole is a decentralised protocol that enables seamless transfer of assets across different blockchains.

The solution provides uninterrupted data exchange between distributed systems, which can be useful for developers building dapps with multi-chain functionality.

The Wormhole protocol launched in 2021. Since then, the network has processed more than 2m cross-chain transactions daily, worth roughly $35bn.

At the end of 2023, the project raised $225m at a $2.5bn valuation.

Hyperlane

This protocol, built on a DPoS algorithm, provides verification and security for cross-chain communication through flexible consensus methods.

Network validators verify transactions on each blockchain connected to the ecosystem. Hyperlane includes a fraud-detection system involving Watchtowers to confirm the correctness of inter-network messages.

Avalanche Warp Messaging

Avalanche Warp Messaging (AWM) is a data exchange protocol. It allows any subnets in the Avalanche ecosystem to send and verify messages from other subnets or specialised blockchains.

Cross-Consensus Message Format

Cross-Consensus Message Format (XCM) enables communication among consensus systems on Polkadot.

XCM supports various cross-chain scenarios:

• it allows tokens to be transferred securely and without intermediaries between parachains and other blockchains;
• it enables smart contracts on different parachains to interact, creating new opportunities for decentralised applications;
• it can be used for governance across parachains and other blockchains, for example to vote on proposals or change configurations.

Thanks to XCM, Polkadot is not merely a set of independent blockchains but a unified ecosystem in which participants can interact freely.

Axelar

Axelar positions itself as a scalable interoperability platform for Web3, using PoS. The project seeks to eliminate blockchain fragmentation by offering a decentralised validator network and a toolkit for developers.

The technology simplifies asset movement among dapps and interaction across networks. The platform enhances security and supports complex cross-chain operations.

Axelar’s partners include MetaMask, Trust Wallet, Celestia, Lido, Uniswap, Microsoft and Circle.

What are the obstacles to interoperability?

Interoperability technologies have made notable strides in recent years, but their deployment still faces several hurdles.

Cross-chain bridges are complex mechanisms that interact with ecosystems using very different programming languages. They also often concentrate assets in a single smart contract on a given blockchain. Such design features create ample opportunities for hackers.

Maintaining data integrity during cross-chain interaction is another challenge. Differences in consensus mechanisms and governance models can create mismatches and vulnerabilities. Robust solutions and compatibility standards are needed to preserve the integrity and security of shared data across decentralised systems.

Blockchains rely on different trust models and security protocols. Integrating disparate systems without degrading security or decentralisation is difficult.

Regulation poses a further challenge. Legal uncertainty and the need to comply with rules across jurisdictions can hinder the rollout of interoperability solutions.