How Can Cross-Chain Projects Open Up Growth Opportunities of Layer2 Interaction?

Layer 2 solutions have grown in popularity over the past year due to Ethereum’s network congestion and soaring transaction fees. Up to now, the Layer 2 expansion plan has become one of the roadmaps with the highest consensus in the current Ethereum community and even the entire blockchain circle. “Layer2” or “L2” gave birth to many solutions (rollups, validium, plasma, state channels, etc.). These solutions help DApps scale by taking transactions off-chain, but whether they can trigger a massive boom in on-chain transactions requires more refinement.

However, with the vigorous development of heterogeneous chain ecosystems such as Cosmos, BSC, Avalanche and Solana in the past year, a large number of cross-chain solutions have appeared on the market. Ethereum users in the market want to look at other ecosystems, and other Layer 1 project teams want to attract liquidity from the Ethereum ecosystem as a starting basis. This article will focus on the cross-chain solution projects that I have been following for a long time: Celer Network, Hop Protocol and Connext Network.

Celer Network: the mature cross-chain protocol

Celer positions itself as a multi-chain operating system rather than a simple cross-chain protocol. Celer uses its own State Guardian Network (SGN) to ensure cross-chain interoperability and security. We can clearly see the advantages of cBridge in the entire cross-chain bridge field. With the cross-chain bridge becoming a hacker’s cash machine, cBridge is currently one of the few cross-chain solutions that has not yet experienced a large-scale security breach. Since the mainnet launch of cBridge 2.0, we have observed that more than 25 chains have been connected to cBridge, and the TVL has reached $724.58m. With the recent token airdrops by Layer2 protocols such as Optimism, we expect the TVL data of cBridge to continue to grow further.

cBridge’s TVL data continues to grow, Source: DeFi Llama

The essence of cross-chain technology is the secure and reliable transmission of information between different blockchains. Hence, making transactions and other on-chain behaviors preventable and controllable on the cross-chain bridge becomes crucial. The SGN-as-a-gateway architecture monitors the entire process of cross-chain transactions. Thus, the node selection of SGN is very important for such a PoS consensus security system, and the stable operation of SGN is inseparable from the staking and verification of CELR token holders. The CELR staking process is a key part of the economic security of Celer’s interchain messaging framework. To use SGN’s message routing services and store multi-signature proofs, users must pay SGN for these services. These fees will be distributed to CELR stakers and validators to incentivize their work in securing the network, as well as block rewards. Further growth in CELR staking addresses the growth of the Celer multi-chain network.

Further growth in CELR staking addresses this year, source: Nansen

Liquidity is the foundation on all cross-chain income

Liquidity is the foundation on which all cross-chain benefits are built. The architecture of cBridge allows for both co-managed and self-managed liquidity models for liquidity management. SGN has designed a contract mechanism for managing shared liquidity pools on multiple chains to accommodate the preferences of different types of liquidity providers and cBridge node operators. This approach treats the SGN and the liquidity pools it manages as a single “node” along with all other non-custodial LP-managed nodes, and provides LPs with the option of quickly delegating liquidity without having to run a node. This approach greatly aggregates sources of liquidity.

Native multi-chain DApps are more competitive in the Layer 2 era, source: blog.celer.network

Beta revenue between chains is the main driving force for users to cross-chain at present. This part of beta revenue is mainly driven by airdrop rewards in different public chain ecosystems and yield farming of on-chain finance. As such, the Layer 1 public chain is more closed as a relatively complete ecosystem, while the Layer 2 users obviously have a stronger demand for cross-chain income. Celer apparently not only satisfied this part of the beta benefits after solving the cross-chain bridge problem. Celer’s recently launched messaging cross-chain framework (Celer IM) officially integrates the Alpha revenue opportunities of the multi-chain ecosystem in the Layer2 era. Celer IM is a plug-and-play tool and infrastructure for developers, who only need a simple contract plug-in to convert the original DApp into a native cross-chain DApp. It can be said that the liquidity integration of Layer 2 is expected to reach a new height in the Celer ecosystem, and we will pay close attention to the development of multi-chain DApps in this ecosystem.

Hop Protocol: Cross-chain Lightning Network

Hop Protocol is built by a smart contract wallet team called Authereum, and its founder is Chris Whinfrey, co-founder of Authereum and developer of Solidity, the Ethereum programming language. Hop Protocol’s cross-chain solution is different from traditional state channels, and its cross-chain channel principle is more similar to Bitcoin’s Lightning Network.

The specified path is as follows: fast and high-frequency trading channels can be opened between different transaction parties, a large number of transactions can be moved off-chain, and the security of off-chain transactions can be improved through facilities such as watchtowers. At the same time, Hop Protocol introduced a new role (Bonder) and a new DeFi component (AMM) to build a more complex solution.

When using Hop’s solution, assets need to be transferred to the Layer 2 network through Hop’s bridge. For example, the ETH that enters the second layer through Hop’s asset bridge is called Hop ETH (or hETH). hETH and ETH are identical and can be exchanged through Hop. However, there is also an “official” version of ETH in the Layer 2 network, which is the ETH version commonly used by more people. In theory, the official version of ETH and hETH should be completely equivalent, but due to liquidity reasons, there may be some spreads.

hETH schematic, source: app.hop.exchange

Then Hop Protocol introduced the components of AMM and the “Bonder”. AMM is designed to solve the short-term fluctuation of the price difference between the official version of ETH and hETH, and the role of “Bonder” can be to provide liquidity for users who need to release liquidity in advance, and can also obtain part of the income.

It is here where Hop uses Curve’s StableSwap AMM solution to connect the liquidity of two almost homogeneous assets, which can provide lower slippage. Bonder can advance the official version of ETH for the network by observing the transaction data between different Layer 2 networks, and arbitrageurs between different Layer 2 networks will continue to rebalance in order to maintain the price of AMM at a comparison within a reasonable range.

A single dedicated asset bridge solution is uncompetitive

Since Hop Protocol mainly focuses on the general asset bridge direction, and in the general asset bridge track, there is currently no obvious opponent. We can compare it with the dedicated asset bridge DAI. As one of the oldest DeFi applications in the Ethereum ecosystem, Maker, the issuer of the USD stable currency DAI, initially designed a dedicated DAI asset fast transfer channel for the Optimism network. Users can quickly transfer DAI on Layer 1 to Optimism through Maker’s solution. In the network, DAI in the Optimism network can also be quickly withdrawn to the Layer 1 network.

Hop’s TVL mainly focuses on the Ethereum ecosystem, source: DeFi Llama

However, with the continuous expansion of the types of underlying assets in the Ethereum ecosystem, more asset channels are obviously needed in the ecosystem. And Hop’s Universal Asset Bridge has launched the function of instant transfer. As the number of assets and layer 2 networks it supports grows, users are more willing to transfer tokens between networks. Hop issues its own “hToken”. hTokens can be quickly and inexpensively transferred between Layer 2 networks and burned upon redemption. Hop is also launching StableSwap automated market makers on every supported network to facilitate trading between hTokens and their underlying assets. From this point of view, Hop’s general asset bridge solution is obviously more marketable than a single dedicated asset bridge.

Connext: Fast Transactions Serving Web3.0

Connext originally developed a Layer 2 expansion solution based on state channel technology. However, under the premise that the current Ethereum community is more focused on expansion schemes such as Rollup, they have changed their thinking in a timely manner. Instead of competing with these Rollups, they provide a fast transaction network across Layer 2. According to the Connext team, the Vector routing network technology they developed can link various Layer 2, Ethereum 2.0 shards and other public chain networks. This also shows that their technology is scalable to larger scenarios. However, under the premise of the current ecological development, it is obviously more needed by the community to meet the fast transactions between Layer 2 networks.

Since they are all state channel technologies, the implementation can be compared to Bitcoin’s Lightning Network. To deploy Connext’s smart contracts in different Layer2 networks, users only need to submit assets to the Connext network through this contract, and they can then conduct high-frequency off-chain transfers with some operators, constantly update the latest status, and ultimately also billing in the Layer2 network. The Connext team said that this solution can also support non-EVM (Ethereum Virtual Machine) compatible chains, but requires Turing completeness.

Image Shows Connext: Transfer from Ethereum to Fantom, Source: bridge.connext.network

From the data point of view, Connext’s TVL data is not as bright as Celer and Hop. The main reason is that most of the DeFi products built for the Layer2 cross-chain ecosystem are in testing. And because the supported DeFi assets are still few, it is relatively weak in the competition. However, judging from its product roadmap, the grant model has obvious late-mover advantages. If the team can continue to polish the product, the solutions designed relying on cross-chain in the Web3.0 era will have a cluster effect.

Who will lead the growth acceleration of cross-chain interaction?

The above projects are conceptually based on the expansion route of the Ethereum ecosystem, but what they do is “going out”. Despite Ethereum network congestion, the Layer2 solution allows users of any Ethereum application to enjoy instant and affordable transactions at extremely low gas costs, while still enjoying the strong security and decentralization of the Ethereum mainnet performance.

Therefore, we believe that there will be a round of climax on the mutual deconstruction of the public chain ecology in the competition of Layer2 solutions. Since the current cross-chain asset types are still thin and unimaginative, various public chains and Layer 2 solutions are mainly dependent on the cross-chain benefits of mainstream assets. This is not to say that DeFi’s cross-chain gameplay is unsustainable, but because this interactive gameplay itself is difficult to create long-term demand, it will eventually return to the web3.0 product itself.

We all know that cross-chain cannot create more Web3.0 production materials, so the multi-chain ecosystem is more attractive. Looking at the next stage of cross-chain with a unified global thinking, it is not difficult to find that projects like Celer with their own technical ingenuity and ecological thinking are more likely to guide liquidity to the reality of Web 3.0 landing scene. Of course, judging from the current data, everyone is at a similar starting point.

Looking back at these three projects, each of them face many unknown problems, including the lack of innovation in Layer2’s DeFi products, whether the protocol needs governance tokens, and the relatively centralized mechanism, which still needs time for the team’s subsequent improvement. In addition, regarding the solution of cross-chain technical difficulties and the optimization of user experience, this is also a problem that projects in the cross-chain field must face. For these, we firmly believe that with the passage of time, the growth opportunities and scalability of the “chain x chain” will be due to modularisation and interoperability. These projects will have diversified income colors, and we will also see a more fragmented multi-chain landscape.

By Kyle, Investment Manager@Bing Ventures