Finance needs a blockchain interoperability solution

Robust standardised rules needed to ensure interoperability infrastructure works safely and seamlessly

Much like the early internet, blockchain networks currently exist as siloed networks with their own community in different parts of the world with differing methods for connecting. However, there exists a limitation on the ability to transfer data or cryptoassets from one blockchain to another. Doing this on one chain is simple. But since assets are being issued on many chains, if liquidity is to be ensured, these assets must be able to move between blockchain protocols safely and efficiently. Interoperability solves this problem.

Blockchain interoperability refers to the ability of different blockchain networks to seamlessly communicate and share data. It allows users, developers and applications to operate on top of multiple blockchain platforms, which, in turn, aids a wide range of functionalities within a broad multi-chain ecosystem.

Cross-chain interactions

The foundation of blockchain interoperability lies in cross-chain messaging protocols, which enable blockchains to read data from and send data to other blockchains. There are multiple cross-chain interactions currently in existence.

For instance, sidechains, which are a type of layer-2 scaling solution that operates on top of a blockchain to increase scalability and efficiency. These secondary blockchains have their own consensus protocols, which allow privacy and security to prevail, and minimises the additional trust required to maintain the network. Sidechains facilitate smoother asset exchanges between the main chain and the secondary chain.

Another cross-chain interaction to consider are cross-chain bridges, which facilitate a connection, allowing the transfer of digital assets and data from one blockchain to another. The chains may have different protocols, rules and governance models but the bridge provides a method of communication between the two chains.

In addition, cross-chain atomic swaps facilitate an exchange of tokens across chains. The swaps are ‘atomic’ because they are ‘all or nothing’ – both sides succeed or the entire transaction reverts. For atomic swaps to work across blockchains, both blockchains need relative time lock operation, as well as the ability to hash data and check that data against a given hash.

Lastly, oracles are entities that connect blockchains to external systems and allow smart contracts to execute depending on real-world inputs and outputs. Decentralised oracle networks enable the implementation of hybrid smart contracts, in which off-chain infrastructure and on-chain code are coupled to provide decentralised applications that react to real-world events and interact with traditional systems.

What’s next for blockchain interoperability?

The following phase of blockchain interoperability will be the ‘interchain’, composed of applications built with a chain-agnostic approach that spans all Web3 ecosystems – much like how the internet connects multiple siloed networks.

However, there are both advantages and disadvantages to blockchain interoperability. Interoperability enables collaboration between different blockchain networks, which is essential for the development of a more connected and versatile ecosystem and the sharing of resources across blockchains.

Also, by connecting different blockchains, the transactional load can be distributed, which facilitates smoother scalability. Beyond this, another element of interoperability – asset portability – allows for the seamless transfer of assets and data across different blockchains, therefore not only providing flexibility but reducing dependence on a single blockchain network.

However, ensuring the safety of transactions and data transfers across different networks requires robust security measures to prevent vulnerabilities and potential attacks. Interoperability may also raise concerns about privacy, as information is shared across different blockchains. Implementing privacy-focused solutions will be crucial in an interoperable environment.

Interoperability infrastructure currently exists but will continue to develop as the industry becomes more connected. Robust standardised rules are needed to ensure perfect, safe and seamless interoperability.

Charles Kerrigan is Partner at CMS.

This article is part of OMFIF’s upcoming Digital Monetary Institute Annual, publishing on 6 February.

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