The Impact of Cross-Chain Interoperability in DeFi

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Imagine a world where emailing was only possible within isolated platforms Gmail to Gmail, Yahoo to Yahoo and so on. Consequently, a Gmail account holder wont be able to email someone who uses Yahoo and vice versa.

Though hypothetical, this situation underscores the severe limitations originating from the lack of interoperability or the capacity for cross-platform interactions. These concerns arent exclusive to communication-oriented platforms but permeate almost every other domain, including finance. As with emails, being unable to transfer funds from accounts in one bank to those in another would be devastating.

Over the years, legacy financial systems have achieved considerable degrees of interoperability and integration. Fintechs evolution has been a significant catalyst in this regard. Nevertheless, the centralized nature of traditional finance is so fundamentally flawed that interoperability alone cannot bring the much-needed structural change.

Reimagining finance holistically is the need of the hour, which the emergent blockchain-cryptocurrency sector is addressing in many ways.

Having secured a market capitalization of $2.76 trillion despite its nascency, this industry is presently the forerunner in making global finance more transparent, secure and borderless. In its bid to become viable alternatives to legacy systems and processes, blockchain-based protocols have strived for seamless and broad interoperability since their early days.

In 2016, for example, Vitalik Buterin authored a report on blockchain interoperability, describing it as the next level of development. Before this phase in the technologys evolution, blockchains were necessarily and predominantly siloed, unable to facilitate the exchange of data and value across ecosystems. The situation has improved significantly since then, surfing the tide of innovations like sidechains and bridges.

Today, blockchains not only interact more but also scale better. Furthermore, recent developments in the realm of blockchain-based decentralized finance (DeFi) have strengthened the quest for interoperability. But some glaring concerns remain to be overcome, especially concerning lending and borrowing protocols in DeFi.

Underutilized assets the trouble with DeFi lending

DeFi protocols have significantly contributed to the outstanding growth of blockchain cryptocurrency markets, with over $112 billion in total locked value at the time of writing. Despite their phenomenal success in general, DeFi lending protocols still face considerable obstacles due to siloed ecosystems with limited interoperability.

In most cases, liquidity remains locked off in individual protocols, isolated and inaccessible to other networks. Due to this condition, crypto assets often lay idle in users wallets as there is limited scope for their use say, within a single platform and in secondary marketplaces. Mechanisms like yield farming and staking address this issue to some extent, but when it comes to lending protocols, the problem persists.

Presently, the provisions for real-time lending and borrowing across blockchains are limited. Exacerbating the problem, most existing solutions for cross-chain token transfers are highly complicated for ordinary users, resulting in low user experience and accessibility. At times, this affects the supply-demand metrics of crypto assets, which in turn has negative impacts on market dynamics.

In culmination, these limitations hinder DeFis establishment as the go-to alternative for lending and borrowing. Financial inclusion, which is among the foremost outcomes of adopting DeFi, also takes a blow in the process. On the bright side, promising innovation is already underway to integrate cross-chain functionalities with decentralized and non-custodial lending protocols.

Cross-chain interoperability liberating DeFi lending

Recently, the World Bank and the International Monetary Fund (IMF) published a joint report titled ‘Blockchain Interoperability,’ highlighting a crucial change in the general mindset of the domains stakeholders. Initially, competitive motives triumphed over other organizational approaches, but alongside the increasing clamor for cross-chain interoperability theres been a steady shift towards greater collaboration.

Particularly in the aftermath of a global pandemic and the consequent realization that economic devastation begins with isolation, interoperability has become all the more essential. Similarly, like ourselves, blockchains need to interact with each other for their enrichment and sustained growth. Assets need to move freely yet securely across ecosystems. It is through interoperability in crypto-based lending that we can foster optimal capital access for small minus big (SMBs) companies, thus challenging the monopoly of behemoths.

DeFi innovators are increasingly recognizing this need and are thereby leveraging multi-chain interoperability to transform decentralized lending. Some protocols utilize non-custodial smart contracts and synthetic assets to facilitate cross-chain communication.

These assets represent value locked in one chain, which can then be used on another, without actually moving the underlying asset. In the process, oracles facilitate collateralization via real-time data and information transfers across the chains involved.

Implementing cross-chain bridges and atomic swaps is another means to interoperability arguably more effective and secure than synthetic assets. These technologies allow lenders and borrowers to transfer assets across blockchains in real-time, which substantially broadens their access to liquidity.

In other words, assets locked in one network can be directly utilized inanother without hampering the economic prospects of either. Deep reserves of crypto-assets need no longer remain underutilized, as there are unprecedented possibilities for their use.

As more and more lending protocols become natively interoperable, the experience for end-users will become increasingly more seamless. Such improvements are crucial, especially in this age of digital transformations. Collaboration is key to success for individuals as well as businesses.

Finally, the mainstream adoption of DeFi lending depends greatly on its ability to interact smoothly across chains, which further entails the optimal utilization of assets and resources and that too, in a decentralized and community-oriented manner, contrary to the historical injustice of the financial status quo.

Ankitt Gaur is the founder and CEO of EasyFi.Network, a layer-2 DeFi lending protocol for digital assets powered by Polygon Network. He is a serial entrepreneur and a global consulting professional, enabling enterprises across the globe to adopt and benefit from progressive technologies.

Featured Image: Shutterstock/Coleman photographer