Cryptocurrencies have certainly come a long way from Bitcoin’s inception in 2009. This project falls under the umbrella of so-called first-generation blockchains, primarily focused on providing digital P2P payment services.
The crypto industry went along just fine for several years, despite that these coins were only limited to one function. A plethora of other projects like Litecoin, Monero, Dash, Namecoin, and Verge came into the picture seeking to emulate Bitcoin’s massive success.
It wasn’t until the introduction of the world’s second-largest digital asset, Ethereum, that we genuinely saw other previously unprecedented use cases of cryptocurrencies.
This is what we’d refer to as second-generation blockchains, mainly concentrated on creating decentralized applications alongside acting as a payment method in their respective ecosystems.
Projects in this realm focus heavily on scalability by processing thousands of transactions per second to provide a cost-effective and advanced user experience.
While the second generation is still in full effect, another problem reared its ugly head where both forms of blockchains had issues communicating with each other. Eventually, ‘blockchain interoperability’ became a buzzword and topic of hot discussion describing the importance of cross-chain compatibility.
This is, essentially, ‘blockchain 3.0’ and represents the trajectory that only the most ambitious blockchains will follow. So, what exactly is blockchain interoperability, and why does it matter so much? Let’s find out.
What is blockchain interoperability?
They say teamwork makes the dream work. Most of the technologies available at our disposal are highly collaborative. Let’s consider a simple example like email, where there are dozens of email providers in the marketplace.
However, our lives would have been inconvenient if one couldn’t send mail from Outlook to Gmail, from AOL to Proton, or vice versa. The end goal of email was a more straightforward, electronic method for the end-user to distribute messages via a computer network.
Even with countless services based on wildly unrelated technology specifications, we are achieving the objective of email from the start. If we break down ‘interoperability’ into two words, we see ‘inter’ means ‘between’ and ‘operability’ means ‘ the extent to function.’
Interoperability with blockchains is simply a characteristic for different products and systems to work collaboratively. In other words, the goal is for separate blockchains to speak between one another without any restrictions.
Interoperable distributed ledgers can exchange various types of data and assets, allowing for innovative use cases and providing an overall convenient user experience.
One prominent example where interoperability is necessary is between Bitcoin and Ethereum, as they are the two largest cryptocurrency projects. Presently, you cannot use the native Bitcoin on any of the long lists of Ethereum-based applications.
The problems of non-interoperable blockchains
In a tweet from March 2020, Ethereum’s ‘frontman,’ Vitalik Buterin, said, “it’s embarrassing that we still can’t easily move between the two largest crypto ecosystems trustlessly.”
As previously mentioned, you cannot use the original Bitcoin on any Ethereum-based application. To combat this substantial problem, the Wrapped Bitcoin (WBTC), an ERC20 or Ethereum-built token, was created in January 2019.
A wrapped or proxy token is a tokenized version of an existing cryptocurrency designed to work organically on a non-native blockchain, to which its value is pegged with the original asset.
Although this solution has, thus far, proven successful, it still takes a lot more work than if the native Bitcoin could be compatible with Ethereum. When a wrapped token is created, a custodian must put the original coin in a ‘wrapper’ or ‘vault’ to issue the new asset.
When someone wishes to switch back to the previous cryptocurrency, the wrapped token undergoes a ‘burning’ process to limit over-supply. Moreover, this custodian needs to audit these transactions to ensure transparency and non-manipulation regularly.
Essentially, without interoperability, more human-based processes need to be in place, which is cumbersome, time-consuming, and costly. With interoperability, a lot more things can be autonomous and code-focused.
Ultimately, people need to maneuver around different things to achieve a relatively simple objective.
The benefits of blockchain interoperability
The previous example was focused on Bitcoin and Ethereum. Furthermore, there’s been frequent talk on the significance of the compatibility between these two cryptocurrency giants, particularly if we consider the importance of decentralized finance.
One of the benefits of WBTC is how it leverages the immense liquidity of Bitcoin onto Ethereum’s ecosystem. For instance, users can now have more collateral options on lending platforms through WBTC due to Bitcoin’s inherently substantial market cap.
Of course, the lack of cross-chain compatibility is not a problem only present with BTC and ETH. Other large blockchain ecosystems like the Binance Smart Chain and Solana face similar integration problems with Bitcoin and Ethereum across their product suite.
Let’s detail some of the main benefits of blockchain interoperability.
- Enhanced industry collaboration: This is perhaps the primary goal of cross-chain compatibility. Industries and business applications that were once considered separate can transfer data and value seamlessly without intermediaries.
As we saw in the example of Wrapped Bitcoin, more centralized controls are in place, which is just extra costs. Such mechanisms wouldn’t be necessary if Bitcoin could work on Ethereum.
Law, real estate, and healthcare, which are presently private and centralized networks, are some of the several industries that could benefit from more seamless publicly distributed ledgers.
- Innovative products: If a blockchain can only transact in a limited number of digital currencies, the process is less sophisticated and pleasant from a user experience. With interoperability, we should have, for instance, more advanced multi-token transactions and multi-wallet systems.
- Increased security: By enabling cross-chain functionality, this enables enhanced security across multiple blockchains as one ledger leverages off the inherent network strength of the other.
We can think of the interoperability era as the ‘blockchain for blockchains.’ Notable projects in this realm include Polkadot with their side chains, Cosmos with zones, and Chainlink bridging on-chain and off-chain data through oracles.
Other ventures focused on inter compatibility include IOTA, Holochain, VeChain, Harmony, and many more. Presently, ledgers operate in silos, resulting in severe scaling and economic limitations.
Ultimately, blockchain experts believe these concepts are crucial for the global adoption of cryptocurrencies to reach unimaginable heights.