By connecting different blockchain networks, cross-chain bridges are instrumental in making digital assets interchangeable. The most popular use of bridging is when Bitcoin is converted to Wrapped Bitcoin (WBTC), an ERC-20 token holding the same price as BTC but compatible with Ethereum.
Although crypto bridges are important to connect blockchains into a meta-network of digital assets, investors should be aware of their inherent faults. For starters, they have been heavily targeted and victimized by hackers.
What Are Crypto Bridges?
Crypto bridges enable digital assets to move back and forth between different systems.
Why Are Cross-Chain Bridges Needed?
To secure a blockchain network, it has to be inviolable. New data blocks (transactions) can only be added under the network’s rules, enforced by either miners or validators. In turn, these network enforcers follow procedures to deem transactions authentic.
This is how they generate an immutable public ledger. Each blockchain network has a different set of rules and is inherently isolated. This is why bitcoins from the Bitcoin network cannot just be added to an Ethereum network. For that to be possible, Bitcoin would have to don a spacesuit to enter a foreign ecosystem.
Specifically, Bitcoin would have to be imbued with ERC-20 token functionality. In fact, it is because Bitcoin and Ethereum are the two largest blockchain networks, it is their conversion demand that spawned blockchain bridging.
Benefits of Bridging Tokens
When people travel and use Visa cards in a foreign country, they don’t think about the underlying processes that facilitate this convenience. One doesn’t even need to exchange their money into a new national currency, if they are withdrawn from a bank account linked to the card.
That’s because there is an entire network of protocols t between different currencies. Likewise, there are multiple benefits for having bridged tokens:
- Boosted token transfer performance. For example, when Ethereum completes its Surge sharding upgrade, transactions with WBTC could be completed within seconds instead of minutes.
- Increased liquidity and stability of the DeFi ecosystem, as each digital asset breaks self-isolation.
In addition to these key benefits, bridged tokens could upgrade their utility, as they are added into a non-native ecosystem. WBTC best exemplifies this because it transforms a store-of-value Bitcoin into a DeFi utility token.
How Do Blockchain Bridges Work?
Blockchain bridges are smart contract repositories. Although they are called cross-chain bridges, funds are not actually “moved.” Instead, for one token to enter another blockchain network, a smart contract converts it.
In the case of Ethereum to Avalanche transfer, the bridging process would look like this:
- User sends ERC-20 tokens to Avalanche Bridge frontend, via connected MetaMask wallet.
- The bridge (smart contract) locks and indexes those assets to create an equal output.
- The bridge mints new assets compatible in the Avalanche ecosystem, as wrapped ERC-20 tokens.
Through the same bridge, these tokens can then be unwrapped. Presently, Avalanche Bridge operates in one direction so only assets shift from Ethereum to Avalanche. Because Avalanche processes transactions faster and has negligible gas fees than Ethereum, traders may take advantage of their Ethereum assets on Avalanche lending dApps or NFT marketplaces.
Nevertheless, the most popular bridging is done from Bitcoin to Ethereum.
Wrapped Bitcoin (WBTC) As Pioneering Bridged Tokens
Kyber Network, BitGo, and Ren (former Republic Protocol) comprise the consortium that first published the Wrapped Bitcoin whitepaper in January 2019. WBTC launched with just eight merchants using the conversion protocol. Since then, it has expanded massively to every major dApp and network.
How Does WBTC Work?
WBTC protocol is run by a decentralized autonomous organization (DAO). Like shareholders for a company, each merchant holds a multi-sig wallet to access it, add funds, and vote on how WBTCs are minted or burned.
In other words, because WBTC represents Bitcoins, the WBTC DAO ensures that each WBTC, as ERC-20 token, is backed by one Bitcoin. This means that wrapped bitcoins function as BTC stablecoins for the Ethereum ecosystem, just like USDC is a tokenized version of the dollar.
Smart contracts maintain that peg and mint new WBTC at the request of merchants like Maker or Aave. Therefore:
- Users request WBTC conversion by transferring original BTC amount to a custodian merchant address.
- The custodian then locks the received original BTC.
- The custodian mints ERC-20 tokens, WBTC, equal to the original BTC.
Users can then use wrapped Bitcoins across lending dApps as a loan collateral. Because Bitcoin is the largest cryptocurrency by market cap, this is useful for borrowers because large market cap coins are more resistant to wild price swings. Otherwise, with a highly volatile collateral, borrowers could risk loan liquidation.
In the end, users can request WBTC de-conversion into the original Bitcoin.
Types of Token Bridging
Outside of being bidirectional or unidirectional, cross-chain bridges fall into:
- Custodial: Repositories rely on centralized (trusted) control of locked and minted crypto assets.
- Non-custodial: Repositories rely on decentralized (trustless) control of locked and minted crypto assets.
Case in point, BitGo holds custody of WBTC coins, which means that it is a centralized bridge. On the other hand, a bidirectional bridge Wormhole, connecting Solana and Ethereum, is decentralized and trustless.
Is One Bridge Type More Secure Than the Other?
Not quite. Chainalysis analytics firm identified cross-chain bridges as the most vulnerable cogs of the blockchain infrastructure.
During 2022, up to August, there were 13 bridge attacks, making 69% of all stolen funds for the year.
From the Ronin bridge hack, connecting Axie Infinity to Ethereum, to Wormhole hack, their vulnerability stems from their inherent weakness as repositories. No matter if assets are secured with a custodian, or trustlessly with network nodes, these smart contract repositories represent central points of failure.
Interestingly, Sky Mavis ran multiple code audits prior to the Ronin bridge hack, having failed to detect the critical exploit. The implication is then clear, token bridging is still experimental, and a robust model is yet to be developed.
For this reason, one should proceed with extreme caution and avoid using cross-chain bridges as one would use crypto exchange accounts. It should be done for a specific purpose for a given time period.
This series article is intended for general guidance and information purposes only for beginners participating in cryptocurrencies and DeFi. The contents of this article are not to be construed as legal, business, investment, or tax advice. You should consult with your advisors for all legal, business, investment, and tax implications and advice. The Defiant is not responsible for any lost funds. Please use your best judgment and practice due diligence before interacting with smart contracts.