Understand cross-chain DeFi in one article

Cross-chain DeFi is a financial application that spans various blockchain ecosystems, and its data and tokens can flow freely between different blockchains.

The Web3 ecosystem has ushered in the multi-chain era, forming a prosperous decentralized application economy among hundreds of blockchains, L2 and application chains. Although these rich on-chain ecosystems have promoted trust minimization to become a new industry standard, they have also dispersed assets and applications across isolated networks.

Cross-chain DeFi is a new paradigm of decentralized finance. The bottom layer is to use cross-chain interoperability to realize cross-chain applications, so that messages and tokens can freely circulate between various networks

This article will briefly introduce cross-chain DeFi and its operating mechanism, and discuss how Chainlink CCIP will promote the wave of cross-chain innovation.

**What is cross-chain? **

Let’s first briefly explain why cross-chain interoperability protocols are the most missing link in DeFi and the blockchain economy. The blockchain itself cannot interact with external systems, so the blockchain cannot communicate with other chains or Web2 infrastructure. Nowadays, the number of blockchains is huge, and hundreds of blockchains have been deployed, and this number will continue to grow in the future. Therefore, it is of great significance to make these on-chain environments interoperable.

The cross-chain interoperability protocol is the key infrastructure to ensure the free flow of data and tokens between various blockchains. Cross-chain interoperability can improve the integration of the Web3 ecosystem and enhance the connectivity between existing Web2 infrastructure and the Web3 economy.

If cross-chain interoperability cannot be achieved, each blockchain will become an island, unable to share resources or information with each other, including assets, applications and market liquidity. Cross-chain technology can connect these isolated islands, achieve interoperability for applications, and integrate liquidity scattered in various networks.

Bottleneck of DeFi

DeFi has huge potential to create a financial system without conflicts of interest based on encryption technology. However, without robust cross-chain connectivity and interoperability, this vision will be difficult to achieve. The key challenges DeFi needs to face to achieve cross-chain are as follows:

Liquidity Restricted:

Liquidity is crucial for DeFi protocols. If the liquidity pools in each blockchain network are isolated from each other, the ecology will be fragmented and liquidity will be locked in their respective pools and cannot be linked. The greatest potential of DeFi is to create a unified liquidity pool based on standards such as homogeneous tokens and non-homogeneous tokens. If cross-chain interoperability cannot be achieved, liquidity will be restricted to their respective platforms, the market will become isolated islands, and innovation will be hindered.

Asset Orphaned:

Blockchains are inherently unable to communicate with the external environment, meaning assets on one chain cannot interact with assets on another chain. This will lead to ecological fragmentation, DeFi cannot be adopted on a large scale, and it is impossible to create native and composable financial applications. In the multi-chain structure, the liquidity of the application (such as automatic market maker AMM) will be dispersed in various blockchain environments. Since the applications deployed on each blockchain can only be allocated a portion of the liquidity, traders have to suffer greater transaction slippage, and the application's transaction fee income will also be reduced.

Reduced capital efficiency:

Funds are restricted to their respective pools, which means funds can only capture opportunities on one chain, not across all networks. Therefore, the market efficiency will be reduced, which will also hinder the development and adoption of DeFi applications.

Not scalable:

Since applications are scattered across various blockchain environments, the scalability of the entire ecosystem is also limited.

Operation mechanism of cross-chain DeFi

To create a cross-chain smart contract, it is necessary to be able to securely transfer data, tokens, and messages between environments on each chain. Cross-chain smart contracts deploy multiple smart contracts on different blockchains, and can communicate between chains. These smart contracts are brought together to form a unified application.

Cross-chain smart contracts are an emerging area of innovation that can be implemented through various solutions. At the lowest level, cross-chain smart contracts allow developers to decompose applications into multiple modules and deploy each module in different networks to perform different tasks. At the same time, these modules will always remain synchronized and jointly support a specific application scenario. This modular idea allows developers to make full use of the advantages of each blockchain. For example, they can use blockchains with higher security to ensure application security, and use blockchains with higher throughput to achieve low latency. .

Cross-chain smart contracts can easily achieve interoperability among contract codes scattered across various blockchain networks. Doing so can unify the user experience on each chain. Therefore, cross-chain smart contracts can not only solve the problems of the current multi-chain paradigm, but also activate a new series of smart contract use cases.

Advantages of cross-chain DeFi

If the DeFi ecosystem can achieve secure cross-chain interoperability, it can have more advantages than the multi-chain model.

Improve liquidity:

By connecting various blockchain networks, funds can enter larger liquidity pools, thus improving liquidity. Once cross-chain is achieved, funds will no longer be restricted to a certain network. This will close liquidity gaps, improve market efficiency and reduce trading slippage.

Improve capital efficiency:

Assets can easily cross-chain, which means that the utilization rate of funds will be improved. And funds can also enter more agreements and applications to make profits.

Increase resistance to attack:

With resources and assets spread across networks, there is less risk of single points of failure or targeted attacks.

Improve user experience:

Since applications are scattered in various blockchain environments, the scalability of the entire ecosystem is also limited.

Types of cross-chain DeFi applications

Borrowing

Users of cross-chain decentralized currency markets can deposit collateral assets into the lending market on one blockchain and then borrow other assets in the market on another blockchain. Users can place mortgage assets on a more secure blockchain, borrow token assets on a blockchain with higher throughput, and put the assets into applications on this chain to generate revenue.

Cross-chain money markets can also unify yields across markets, thus creating more advanced hedging tools and lower lending rates for lenders in illiquid money markets. Users can also borrow token assets on another blockchain with a lower interest rate, and then cross-chain the assets back to the chain where the loan was originally made.

Trading Platform

Users of cross-chain decentralized exchanges (DEX) can search for liquidity across token pools on different blockchain networks, thus solving the problem of liquidity dispersion in the multi-chain model. In this way, liquidity on all blockchains will be activated, users can enjoy lower transaction slippage, and liquidity providers on each chain can obtain higher transaction fee income.

Users of cross-chain DEX can also exchange native tokens of another blockchain on one blockchain without using packaged assets or centralized trading platforms. For example, users can use cross-chain smart contracts to exchange ETH on Ethereum for SOL on Solana.

Stake Pledge

Users can perform cross-chain equity staking, staking assets on one chain, and then receive benefits on another chain. Doing so can broaden the coverage of the staking mechanism and better ensure the security of the blockchain network and Web3 services. The protocol's equity pledge mechanism can cover multiple blockchain environments to attract more funds and users.

Revenue Aggregator

Cross-chain revenue aggregation can deposit user funds into DeFi protocols on each chain. In this mode, users can obtain higher returns without manually transferring assets across chains. The cross-chain revenue aggregator can greatly improve the user experience of multi-chain yield farming. Users do not need to manually cross-chain, so it can greatly improve liquidity.

Chainlink’s role in the cross-chain DeFi ecosystem

In order to better meet the market demand for safe and reliable cross-chain interoperability standards, Chainlink launched the Cross-chain Interoperability Protocol (CCIP) to seamlessly transfer data and tokens between different blockchains and integrate with existing Some Webs interact with enterprise infrastructure. CCIP’s first partners include Synthetix (cross-chain synthetic assets) and Aave (cross-chain governance), and have been adopted by various DeFi applications to create innovative cross-chain use cases and drive the adoption of smart contracts.

Chainlink CCIP opens up cross-chain applications and a range of innovative smart contract use cases

CCIP is the most secure, reliable and easy-to-use interoperability protocol that can be used to create cross-chain applications and services. Developers can use the Arbitrary Messaging (arbitrary message sending) function to flexibly create their own cross-chain solutions. Not only that, but CCIP can also realize the function of Simplified Token Transfer. Therefore, the protocol can use its audited token pool contract to transfer tokens across chains without writing customized code. CCIP also adds additional security mechanisms, such as the flexibility to set the upper limit of the amount of cross-chain tokens. In addition, a Risk Management (active risk control) network has been set up separately, which is responsible for monitoring the validity of all cross-chain transactions.

CCIP is driven by Chainlink's decentralized oracle network. Chainlink's oracle network has achieved outstanding results, safeguarding tens of billions of dollars in assets, and realizing more than $8 trillion in chain transaction value. CCIP shares the same infrastructure as Chainlink's existing services, so few new trust assumptions need to be added. If the dApp has already integrated Chainlink Price Feeds, then there is no reason not to choose CCIP for cross-chain interaction.

CCIP has the potential to transform traditional single blockchain or multi-chain applications into powerful cross-chain dApps, realizing various rich application scenarios such as DeFi, NFT, identity solutions and governance.

If you also want to integrate Chainlink CCIP, please check the official website product page. If you want to learn more about the underlying architecture and code of CCIP, please check out the CCIP developer documentation.

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