Blockchain
Blockchain technology needs a benchmark communications standard that can be easily integrated by every network in order for a complete transition from Web2 to Web3 to occur, industry commentators say.
Many expect there will be multiple blockchains and such an ecosystem requires communication protocols similar to the Transmission Control Protocol/Internet Protocol (TCP/IP) used on the internet.
Ryan Lovell, director of capital markets at crypto price oracle solutions firm Chainlink Labs told Cointelegraph that blockchains without interoperability are like what computers are without the internet — isolated machines which cannot transfer data and value across networks.
“To realize a fully interoperable blockchain ecosystem at scale, there needs to be an open communication standard analogous to the TCP/IP, which currently serves as the internet’s defacto connection protocol.”
Lovell believed a similar standard for blockchain networks would “pave the way for a seamless, internet-like experience” for the platform and their applications.
This is particularly important given that the last bull market saw a host of new layer 1 blockchains make their mark. However, nearly all of them operate in isolation from one another.
Lovell stressed that blockchain interoperability is “crucial” for financial institutions looking to tokenize real-world assets (RWA) because it would ensure that liquidity isn’t “stifled” by only existing in a “siloed ecosystem.”
Brent Xu, the founder and chief executive of Umee — a lending platform backed by Cosmos’ Inter-blockchain Communication Protocol (IBC) — stated to Cointelegraph that before RWAs are brought on-chain, proper risk management systems need to be put in place to facilitate this interoperability.
Xu explained that financial institutions would need to tick off Know Your Client (KYC) credentials to ensure the authenticity of the RWAs before being tokenized on-chain and then make sure that it can be identified by an on-chain proof-of-reserve audit.
In order to avoid an on-chain catastrophe, he stressed the risk of cutting corners simply isn’t worth it:
“Think of the ‘08 mortgage crisis. Tremendous financial value was lost due to a broken legacy system. Imagine if this value was ported into the blockchain ecosystem, we would see tremendous value loss due to the contagion.”
Cross-chain bridges, independent layer 2 sidechains and oracles are three of the most commonly used blockchain interoperability solutions to date. The first two operate solely on-chain, while the latter feeds off-chain data on-chain.
Related: Why interoperability is the key to blockchain technology’s mass adoption
There have been issues with some of these solutions, however, most notably cross-chain bridges.
An October report highlighted that half of all exploits in decentralized finance (DeFi) took place on a cross-chain bridge, the most notable example being the $600 million Ronin bridge hack in March 2022.
Xu noted that many of these hacks have come from multi-signature security setups or proof-of-authority consensus mechanisms, which are considered to be centralized and much more vulnerable to attack.
He added that many of these interoperability solutions favored “speed of development” over security early on, which in turn backfired.
The key, Xu said, is to incorporate interoperability within the platform as it will result in a more secure end-to-end transaction than through the use of third-party bridges:
“Bridges are particularly susceptible because they provide two ends at which hackers can potentially infiltrate any vulnerabilities.”
Among the most commonly used blockchain interoperability protocols are Chainlink’s Cross-Chain Interoperability Protocol (CCIP), the IBC — which leverages the Cosmos ecosystem — Quant Network’s Overledger and Polkadot.
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