What is cross-chain transaction?
What are cross-chain transactions?
Each blockchain is a complete digital environment where all applications are connected through the underlying network. However, as the number of blockchain networks continues to grow and there is a lack of connectivity between blockchains, the demand for cross-chain infrastructure is increasing to provide interoperability for users across multiple blockchain networks.
Without cross-chain infrastructure, blockchains are like individual applications today without any connections. Perhaps one of the most important primitives for the Web3 ecosystem is cross-chain exchange, a service that enables seamless exchange of one digital asset for another. Just as decentralized exchanges were the first primitives for a single blockchain network, cross-chain exchange is expected to become a fundamental component of the interconnected, cross-chain world.
What is Cross-Chain Exchange?
Simply put, cross-chain exchange is a mechanism for exchanging tokens issued by one blockchain for tokens issued by another blockchain in a minimally trusted way.
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While users today can already access cross-chain exchange functionality through centralized exchanges, this introduces multiple friction layers (such as transferring tokens to the exchange, exchanging directly or indirectly through intermediaries such as USD, and then transferring the exchanged tokens back to wallets on different blockchains). Additionally, this process requires users to utilize custodial services and temporarily give up control of their assets. For basic operations like cross-chain exchange, this becomes a key obstacle to building a world driven by sovereign ownership of digital assets.
How Does Cross-Chain Exchange Work?
Cross-chain exchange can be achieved in multiple ways. Currently, many implementations rely on cross-chain bridges, which encapsulate and lock tokens from the source blockchain to create one-to-one representations on the target blockchain.
A simplified diagram showing how the lock and mint token bridge works
To perform cross-chain exchange, users must lock their tokens on the underlying blockchain, mint encapsulated tokens on the target blockchain, and then use a local decentralized exchange to make the purchase of the digital assets they desire. This process can be automated on the backend by a cross-chain exchange protocol, with users only needing to specify the assets they want to exchange and the digital assets they wish to receive. While this is a validated way to facilitate cross-chain exchange, users must trust the security of the underlying bridge implementation.
Chainlink Proof of Reserve (PoR) enhances bridge security by providing robust collateral data and reducing uncollateralized minting.
There are other ways to design bridge protocols. The above example is a “lock and mint” bridge model. Other bridge protocols may use a “burn and mint” approach, where tokens are burned on the source blockchain and minted on the target blockchain; or a “lock and unlock” model, where they exist natively on different blockchains. Nevertheless, cross-chain exchanges using bridge protocols follow the same framework: tokens are locked or burned on the source blockchain and an equivalent amount of tokens are obtained on the target blockchain before the exchange can take place.
Another way to facilitate cross-chain exchanges is using time-locked smart contracts, a process commonly referred to as atomic swaps.
Let’s say there are two counterparties (Alice and Bob) in an atomic swap, each wishing to exchange a digital asset to receive the other’s digital asset. Alice and Bob both lock the correct amount of tokens in the smart contract on their own blockchain. Only when both parties have put the correct amount of tokens into their respective smart contracts can they be unlocked. Alice receives the digital asset Bob originally locked, and vice versa.
Although atomic swaps are one of the most decentralized options for facilitating cross-chain exchanges, it is not a universal or scalable model. For example, atomic swaps typically require that blockchains use the same hash function, that both parties agree on quantity and exchange price, and that they are able to wait an uncertain amount of time to complete the exchange.
Cross-chain infrastructure, including bridges and exchanges, plays a critical role in enabling secure unlocking of cross-chain liquidity. As the number of blockchains in the Web3 industry continues to grow and both new and old blockchains are increasingly being used, liquidity is constrained in these digital environments. Dispersed liquidity reduces market efficiency for all blockchains, weakens the utility of digital assets, and poses a barrier to developers looking to attract users across many blockchains.
Cross-chain bridges, decentralized exchanges, centralized exchanges, and other tools make it possible to create various types of cross-chain liquidity pools – these connection points help different blockchains access or transfer liquidity from another blockchain. This is crucial for creating a unified Web3.
Chainlink for Cross-Chain Applications
Fundamentally, the cross-chain issues faced by blockchain today can be traced back to the transmission and synchronization of data between blockchains. After all, tokens are just a specific type of data stored on decentralized ledgers of blockchains.
Cross-Chain Interoperability Protocol (CCIP) is an open standard for developing cross-chain interoperability. It aims to use Chainlink’s decentralized oracle network (DONs) to achieve programmable token bridging and secure, arbitrary, and minimized trust message passing between blockchains. The core goal of CCIP is to establish a universal connection between blockchain networks, including public and private chains, to unlock isolated tokens and empower the creativity of cross-chain applications.
CCIP aims to be the cornerstone of Web3 infrastructure, an open standard that helps developers build a variety of cross-chain applications.
In the context of cross-chain exchanges, CCIP can make liquidity routing more efficient by enabling secure and seamless data transfer between various blockchains, including liquidity conditions, token balances, and more metrics. In addition, programmable token bridging enables any Web3 developer to build a cross-chain environment without having to directly manage the underlying bridging infrastructure. Cross-chain exchanges can build better user interfaces for cheaper exchanges and offer a wider range of asset choices due to unparalleled connectivity brought by adopting open standards.
Cross-chain exchanges eliminate the need for centralized intermediaries by directly exchanging value and information between blockchain networks. In short, they provide a more secure, transparent, and seamless way for users to trade assets across various blockchains.
Cross-Chain Interoperability Protocol aims to connect various blockchains and the applications built on them.
With the continuous development of Web3 and more and more applications and tokens built on the growing blockchain ecosystem, cross-chain infrastructure such as CCIP plays an increasingly important role in creating a unified user and developer experience.