The Role Of Interoperability In Decentralized Finance (DeFi)

Decentralized finance (DeFi) is one of the most popular sectors in the blockchain industry in 2019. It’s no surprise considering the financial sector spent $552 million on blockchain technology, with blockchain solutions to grow 75% through to 2022.

Although the DeFi community is growing with emerging services like decentralized loans, prediction markets, and exchanges, these blockchain networks currently operate in isolation. With an increasingly high number of players entering the burgeoning blockchain industry, it is concerning that blockchain networks are unable to communicate with one another.

Interoperability and cross-chain communication in DeFi is one of the hardest challenges when it comes to blockchain technology. Different blockchain networks have different communities, consensus, and hashing algorithms which make standardization and collaboration tricky. But we can only unlock blockchain’s true value in DeFi if we can continuously improve user experience and leverage the network effect by creating interoperable blockchain solutions.

Cross-Chain Technology and the User Experience

In an interoperable ecosystem, if another user sends you a digital asset or token from a different blockchain network, you should be able to identify, recognize, and interact with it, without the need of an intermediary. Unfortunately, blockchain networks are highly fragmented and disconnected. It becomes an increasingly significant problem as the industry grows since each blockchain network is highly specialized with specific capabilities.

Specialization is only effective when there are cross-chain communication and interconnectedness between blockchain networks. A lack of interoperability with highly specific blockchain networks creates a clumsy user experience.

For example, a user looking to transact on the Ethereum network with Bitcoin tokens has to access a centralized cryptocurrency exchange to convert their Bitcoin into Ether. The continued process of exchanging tokens for use on a specific blockchain network is not only time-consumptive but expensive, and highly frustrating experience over time.

One startup looking to bridge blockchains together is the Cosmos Network. Their goal is to be the internet of blockchains by connecting a network of independent blockchains together called zones. A central Hub connects these zones, which allow each zone to communicate with one another effectively. The Tendermind Core, which contains the consensus algorithm and peer-to-peer network protocol, based on the Byzantine Fault-Tolerant Consensus Model powers the Cosmos Network.

Despite its reputation as one of the most powerful and interoperable ecosystems for connected blockchains, just last month, the Cosmos Network suffered from a critical security vulnerability. While the team has patched the vulnerability, Cosmos validators had to undergo an emergency hard fork and system-wide upgrade.

Interoperability and the Network Effect

In 2016, a number of cryptocurrency experts believed that the token economy and blockchain industry would grow significantly quickly based on the network effect. They were confident that token adoption and the exploitation of network effects would solve the chicken and egg problem (building a base of customers despite having no product) that many startups faced.

While the blockchain industry is growing substantially, it’s currently too early for the network effect to kick in. The industry required and still requires further maturation. The blockchain industry needs a larger quantity and better quality apps, a higher number of engaged users, a smoother user experience, and more significant security measures to name a few. To achieve this result, we need clearer standards across blockchain networks.

According to a Deloitte study, “standardization could help enterprises collaborate on application development, validate proofs of concept, and share blockchain solutions.” While we mentioned the front-end and explored user experience earlier, on the back-end, interoperability enables businesses and developers to build applications and infrastructure effectively. The growth and proliferation of these developments can lead to the network effect, resulting in higher growth and which could eventually lead to the replacement of many existing legacy systems.

Wanchain, for instance, is a blockchain network keen to replace legacy banking systems around the world with blockchain-based solutions. Just like how traditional banks are the infrastructure to today’s financial ecosystem, Wanchain’s goal is to build a distributed-bank to connect and exchange value between different blockchain ledgers in a distributed manner.

On Wanchain, any institution or individual can provide services such as loan origination, credit payments, asset exchanges, and transaction settlements on the Wanchain blockchain.

While only 0.5% of the population use blockchain technology today, 77% of global financial service companies are planning to adopt blockchain into their systems by 2020. The blockchain industry may not have interoperable solutions. However, the finance sector is keen to get started. Not only do finance companies benefit the most from blockchain, they are also significantly more mature than other industries exploring the new technology.

The Opportunity for Interoperable Blockchain Solutions

While interoperability is touted as one of the hardest challenges to solve, it’s also now an extremely lucrative, emerging new opportunity. In addition to Cosmos and Wanchain, Polkadot, a heterogeneous multi-chain framework platform is also another recognized interoperability solution.

Polkadot works by plugging other networks into their ‘relay chain,’ which functions like a hub where the parachains (other blockchain networks or data structures) connect. The chain also coordinates communication data between the parachains. We may be looking at a polychain future, where hundreds of blockchain networks connect to industry-specific chains.

Whether chains, zones, or bridges, connect these disparate networks, interoperable solutions are a must for driving mass adoption and kicking off the network effect. With interoperable solutions, this could mean sending money from a bank’s legacy system to another bank’s blockchain ledger or even undergoing payments between a private blockchain network like the R3 Corda to a public one like Ethereum.

While conceptually simple, interoperability is extremely difficult. With that being said, Wanchain 3.0 has managed to now be interoperable with Bitcoin, Ethereum and ERC20 tokens like MakerDAO’s DAI and MKR. Wanchain will also be launching their delegated proof of stake main net soon in 2019.

Final Thoughts

DeFi is an emerging alternative to the current global financial system. As one of the most active sectors in the blockchain industry in 2019, DeFi will continue to change rapidly over the next few years. Organizations like Cosmos, Wanchain, and Polkadot, are just the few that are working towards an interoperable future where blockchain networks will no longer operate in a silo and will not have difficulty recognizing, interacting, and communicating with one another. Without successful interoperability, it’d be impossible for decentralized finance to usurp today’s centralized financial system.

Source: Crypto New Media

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