The blockchain and web3 technology is extensive, diverse and impressive. For some time it has been reshaping our day-to-day lives, including the entire Internet, our financial systems, the gaming industry, mobile application development, and so much more. Despite the revolution that the blockchain technology has brought to the digital world it does face numerous problems. One of these problems is the fact that blockchains operate in isolated networks, meaning that in general principle different blockchains don’t directly interact with each other. The lack of this communication availability has led to the development of “blockchain bridges”, which establish a collaboration pathway among these networks.

What are blockchain bridges?

Blockchain bridges by themselves represent separate protocols that realize the connection between two or more blockchain networks. They act as the “middle man” in facilitating security and technical intricacies in cross-chain communication. Through these bridges blockchain protocols exchange data and assets, which in turn increases their interoperability and allows users to effortlessly transfer tokens and utilize various dApps through secure and trusted channels.

Bridges essentially provide the solution to the “fragmentation dilemma”, which is the downside to the prioritization of scalability over interoperability in blockchain systems. When blockchain scalability fixes emerge they assist with slow throughput but at the expense of protocol networks remaining separated, creating isolated ecosystems limiting the technology’s global potential. 

How do blockchain bridges work?

Imagine a user wants to transfer ETH (from the Ethereum network) to e.g. Binance Smart Chain (BSC) in order to use it on dApps on that platform. A blockchain bridge will allow for that connection and transfer to securely happen, by locking the assets in a smart contract on Ethereum’s side and releasing equivalent minted assets on BSC’s side, fundamentally completing an interchain asset trading. 

Blockchain bridges apply specific methods to create a secure and successful cross-blockchain communication. Two main types are present:

Wrapped asset method

This method is the most popular one, allowing the assets from one blockchain to be used on another one, by creating a tokenized version of an asset, usually in the form of an ERC-20 token. This is called a wrapped token and its method is common when transferring non-ETH assets to Ethereum and any other smart contract-based protocol. 

The main idea is that an equivalent in value asset is created as a wrapped asset and the original is 100% backed up and “locked” in a secure smart contract or custodial wallet controlled by the bridge or wrapping service. 

The wrapped token on the destination protocol can then be used, traded and transferred.

By keeping the asset on the source network “locked” the bridge mechanism ensures that there would be no double-spending. At the same time, in case the user wants to return and use the original tokens, the process is reversed - the destination chain assets are “burned” and the corresponding amount of assets is then unlocked back at the source chain. 

Some of the most famous wrapped tokens include: 

• Wrapped Bitcoin (WBTC) - a tokenized version of the Bitcoin used on the Ethereum network;
• Wrapped Ether (WETH) - a tokenized version of the Ether wrapped for ERC-20 compatibility;
• BTC.b - stands for “Bitcoin Bridged”, Avalanche’s native wrapped tokenized Bitcoin minted via the Avalanche Bridge;
• WBTC.e - stands for “Wrapped Bitcoin on Ethereum”, an ERC-20 token representing Bitcoin, bridged to Avalanche from Ethereum;
• SoETH - Ether wrapped for use on Solana protocol;
• Wrapped USDC (on Avalanche) - USDC stablecoin wrapped for native use on the Avalanche protocol;
• wUSDC - a wrapped version of USDC enabling the stablecoin on the Base blockchain;
• wARB (Wrapped Arbitrum) - a wrapped version of the Arbitrum token (ARB) allowing it on the Base blockchain;
• Wrapped Solana (WSOL) - a Solana token wrapped to operate on Ethereum;
• Wrapped BUSD (wBUSD) - a tokenized Binance USD for use outside Binance’s native platforms;
• Wrapped Avalanche (WAVAX) - an Avalanche token wrapped for Ethereum and other protocols.

Examples of Use Cases for Wrapped Assets:

• Bridging Bitcoin and Ethereum
• Tokenizing Non-Ethereum Assets
• Cross-Chain Liquidity Pools
• Yield Farming

Liquidity pool method

This is an important but more complex concept that allows users to pool their assets together to provide liquidity for lending, trading or other decentralized financial activities, while at the same time easing the transfer of assets between various blockchains. 

This method does not require a 1:1 direct swap and does not rely on centralized custodians. Instead it uses a shared liquidity pool and the steps include:

• Creating the liquidity pool which contains assets from each participating blockchain;
• The Liquidity providers deposit their assets into the pool in exchange for liquidity provider tokens representing their share of the pool;
• Then users can perform cross-chain asset swaps facilitated by the liquidity pool;
• After the swap is executed the user receives the asset on the destination blockchain; the transfer is quick and seamless;
• To maintain equilibrium the liquidity providers rebalance the pool by adjusting deposit amounts; as an alternative the protocol itself may use algorithms to adjust the rates and ensure liquidity is maintained on both sides;

The key components of the Liquidity pool method include:

• Cross-blockchain intercommunication - ensuring seamless asset flow between blockchain protocols;
• Automated Market Makers (AMMs) - used to determine the price of assets based on supply and demand;
• Liquidity Provider (LP) Incentives - earn rewards for contributing to the liquidity pool, the more liquidity provided, the higher the reward share;

Examples of Liquidity pool bridges:

• Thorchain (RUNE)
• Moonbeam
• AnySwap (now Multichain)
• RenBridge

Benefits of blockchain bridges

Blockchain bridges assist in the further evolution of all blockchain and crypto systems by solving the crucial problem with interoperability. When that is resolved and blockchain protocols start interacting with each other, there are quite a few benefits that can be observed:

 1. Improved liquidity;
 2. Expanded trading and exchanging scope;
 3. Enhanced DeFi and dApp adoption;
 4. Improved digital economy efficiency;
 5. Increased transaction throughput;
 6. Refined personal user experience;
 7. Progressing development of next-gen cross-chain apps;
 8. Creation of an interconnected ecosystem with higher potential;
 9. Advanced handle on rapid market changes;
 10. Rising levels of innovation and collaboration within the blockchain ecosystem;
 11. Reduced costs in fees;

Issues and limitations

While blockchain bridges enable interoperability among otherwise isolated blockchain ecosystems, they do come with several limitations and issues:

 1. Security risks - bridges rely on smart contracts so that means they rely on their security; if the smart contract has bugs or flaws, it can compromise the bridge mechanism;
 2. Scalability - many blockchain bridges can handle only a limited number of transactions, which can lead to bottlenecks;
 3. Liquidity issues - when assets are transferred across different chains, liquidity can become fragmented, affecting trading and price stability;
 4. Regulatory uncertainty - blockchain bridges may face issues around regulatory compliance, leading to legal challenges;
 5. Hacker attacks - bridges have been specifically targeted by hackers, with several high-profile attacks in 2022 and 2023;
 6. UX - the process can be cumbersome and unintuitive for end users;
 7. Lack of standardization - there is still lack of standardization due to multiple and various in functionality and security bridges;
 8. Dependence on the underlying blockchain - bridges are often only as secure and reliable as the blockchains they are built on;
 9. Upgrades - if the governance structure behind the bridge is flawed or slow, it could hinder necessary upgrades.

Conclusion

Bridges are a critical cogwheel in the blockchain machine and its future development. Enabling an interconnected cross-operable blockchain system may resolve most issues currently faced by protocol networks. By breaking down the restricting walls among blockchains its users can become more empowered and more inspired to continue trading on and building on top of this decentralized technology. 

Despite their existing limitations, blockchain bridges are getting a lot of attention and use. And at Vaultody we support all wrapped assets that run on the blockchain networks adopted in our product.