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Why Does the DeFi Market Need Cross-chain?

March 28, 2023

DeFi (short for decentralized finance) is a part of the crypto industry that aims to create a more inclusive, transparent, and accessible financial system for users while preserving the main principles with which cryptocurrencies (particularly the first one, Bitcoin) were initially created in mind. DeFi projects work to remove intermediaries, presented on more popular centralized services like centralized exchanges, but maintain their user-friendly interfaces, seamless operation, and extra services. Although the goal is noble, DeFi is a relatively new field that has to resolve many issues to become a truly accessible, efficient, and worldwide phenomenon.

One such critical problem is the lack of interoperability between blockchains. With dozens of blockchains currently available, it is becoming increasingly difficult for users to transfer crypto assets between them, forcing them to stay on the most popular chains and not explore others. It is especially critical for emerging DeFi projects since it limits the number of users they can attract and retain.

That is where technologies like cross-chain come into play, enabling developers to connect blockchains into one enormous ecosystem. Thus, firstly, it opens up new possibilities for DeFi, allowing, for example, the creation of complex financial instruments that span multiple networks at once. Secondly, it helps to increase liquidity and reduce price slippages. Thirdly, it ensures access to various DeFi services for a wider audience, helping DeFi to become far more inclusive.

Cross-chain Bridges and Atomic Swaps

Two technologies that are currently being explored to connect blockchains more efficiently are cross-chain bridges and atomic swaps. Both aim to create a cohesive ecosystem that allows users to switch between blockchains without the need for centralized exchanges or converting crypto assets. Cross-chain bridges facilitate the transfer of assets and data between different protocols while maintaining the security and integrity of each blockchain. Different experts prefer to identify bridge types differently, but generally, there are three main types: lock and mint, burn and mint, and lock and unlock.

Bridges of the first type, namely lock and mint, allow users to lock tokens they want to exchange (tokens A) within a smart contract on the original blockchain. After that, they can receive access to an equal amount of tokens B on the desired blockchain. When users want to convert their assets back to tokens A, their tokens B (or the remaining amount) are burned, and an equal amount of tokens A is returned to their wallets.

A burn and mint cross-chain bridge is similar to the previous type but with one key difference. Instead of locking users' assets in a smart contract, they get burned. 

Atomic swaps use the Hash Timelock Contract Technology (HTCL) to enable peer-to-peer trading without the need for third-party intermediaries. This technology ensures that both parties involved in the exchange must verify the transaction, making the process more secure. Unlike cross-chain bridges, atomic swaps do not require locking, burning, or minting tokens. 

Without cross-chain technologies, crypto traders would have to go through a tedious process of converting their assets on a trading platform, withdrawing them to a wallet, and depositing them again on another exchange, resulting in multiple fees and a lot of time wasted waiting.

The Future of DeFi

Emerging cross-chain technologies have the potential to revolutionize the way different networks interact with each other. However, several issues need to be addressed before it can be widely adopted. These include a lack of standardization, struggles with attracting sufficient liquidity, and multiple security challenges. 

Fortunately, the latter can be addressed soon with the help of zero-knowledge technology. Its introduction to the market will significantly enhance the security of cross-chain operations by allowing DeFi projects to stop relying on third-party validators and thus protect sensitive information more thoroughly.

The Kinetex team has been working in the DeFi industry for several years, interested in cross-chain solutions and making crypto more accessible and user-friendly. As a result, the Kinetex widget was born. Kinetex allows users to swap over 5,000 crypto assets easily and quickly by aggregating hundreds of liquidity sources.

Kinetex Network: Website | Kinetex dApp