After a series of large-scale exploits by Bridges, the narrative that cross-chain technology is inherently flawed is given plenty of oxygen—that cross-chain interoperability means risks. With an estimated $2 billion lost this year from 13 bridge hacks, it’s becoming increasingly difficult to ignore this argument.
At deBridge, we believe it is not only imperative, but inevitable that all cross-chain bridges completely rethink their approach to liquidity aggregation.
The limits of blocked liquidity
By locking in liquidity to provide cross-chain routing (as almost every bridge is currently doing), bridges have faced a competition they are bound to lose. We see bridges competing against established, purpose-built liquidity protocols such as AAVE, Compound and Frax, projects that will no doubt monetize liquidity more effectively and securely. There are many examples of bridges with hundreds of millions of dollars in TVL, with extremely low utilization of the locked liquidity.
With this design, bridge projects are forced to engage in unsustainable liquidity mining campaigns that do not provide long-term solutions for capital efficiency. Unless token incentives are maintained indefinitely – an unsound goal for any project – liquidity providers will inevitably withdraw capital to pursue higher return opportunities.
In order to safely aggregate liquidity, bridges would need to purchase insurance policies to allow liquidity providers to hedge risk. This is another expense that makes monetizing liquidity even more difficult. Because of this, most existing bridges are not profitable, as the costs and rewards paid for liquidity extraction often exceed the net profit of the protocol.
Architectural considerations also come into play here, as cross-chain value transfer is a requirement that can be handled in a number of ways. All existing bridges process these orders from their own liquidity pools, where liquidity is continuously locked if it is only needed at the precise moment the value transfer is to be executed.
The size of the order can also differ – if it exceeds the size of the bridge’s liquidity pool, the sender will end up with wrapped tokens or an indefinitely suspended/stalled transaction. On the other hand, if the order is too small for the size of the liquidity pool, the liquidity utilization is very low and inefficient. This vicious circle further underscores that this liquidity protocol approach to bridge design is ineffective and fundamentally flawed.
solving the security problem
Important as the issue is, economic unsustainability is not the only major challenge here. Even when bridges have found a way to leverage the locked liquidity approach and remain capital efficient, it is evident that building a safe liquidity protocol is an all-consuming task. Knowingly or unknowingly becoming liquidity protocols, bridge projects give themselves the immense task of protecting a multifaceted attack surface.
To start at a high level, one of the obvious problems with a locked liquidity bridge is that it creates a risk multiplier effect, where vulnerabilities in one supported chain can spill over to capital held in other ecosystems.
Here there is the problem of security through proxy. A bridge can compromise its entire liquidity base if there is a potential vulnerability in the code base of a supported blockchain/L2. We saw this possibility earlier this year with a vulnerability discovered in Optimism that would have allowed attackers to mint any set of assets and likely trade them for tokens in other ecosystems.
Last week I discovered (and reported) a critical bug (which has been fully patched) in @optimismPBC (a “layer 2 scaling solution” for Ethereum) that would have allowed an attacker to print any amount of tokens for what I won a bounty of $2,000,042. https://t.co/J6KOlU8aSW
— Jay Freeman (saurik) (@saurik) February 10, 2022
Again, any issues with a chain’s consensus mechanism can also lead to systemic contagion, putting liquidity locked in other supported chains at risk. In this case, the bridge simply sends the exploit to other chains. This could include 51% attacks or other protocol-level errors.
Aside from these types of inherited risks, we are increasingly seeing situations where failures in the bridge projects themselves have, in one way or another, resulted in a loss of tied-up liquidity. From botched protocol upgrades, poor smart contract design, or compromised validator infrastructure, there are many scenarios where bad actors can exploit vulnerabilities in the bridge itself.
All of these risks compound quickly and, as we have seen on too many occasions, are eventually borne by liquidity providers as they lose the redeemability of their packaged assets. Such a possibility should be unacceptable.
Few deny the great promise of cross-chain interoperability to take Web3 adoption to new heights. But given the sheer size and frequency of bridge exploits, it has become painfully clear that the fundamental design of bridging technology needs to be rethought from the ground up. The bridge-turn liquidity protocol design just doesn’t work.
Is there a way to create a fundamentally new and unique approach to bridge design, one that completely eliminates risk for liquidity providers, eliminates attack vectors while maintaining the highest level of capital efficiency?
That could be the case in the near future. At deBridge we are working on a new cross-chain liquidity routing that will solve all these problems. Stay tuned.
Guest post by Alex Smirnov from deBridge Finance
Alex Smirnov is a mathematician, researcher, developer and blockchain enthusiast. He is CEO and co-founder of deBridge, a generic messaging and cross-chain interoperability protocol, where he focuses on protocol design, product management, partnerships and operations. Alex is co-founder of Phenom, a blockchain research and development company, and he has also led a team that has won numerous hackathons and developed various blockchain solutions and dApps.
Learn more →
Get one edge on the crypto market 👇
Join CryptoSlate Edge and access our exclusive Discord community, more exclusive content and analysis.
On-Chain Analysis
Price Snapshots
More context
Sign up now for $19/month. Discover all the advantages
Learn Crypto Trading, Yield Farms, Income strategies and more at CrytoAnswers
https://nov.link/cryptoanswers
Comments are closed.