HashKey: A Comprehensive Analysis of the Current Status and Development Trends of DeFi Asset Cross-Chain

This article was published on HashKey Me, authored by Zheng Jialiang, Research Director at HashKey Capital.

Asset cross-chain has gradually revealed hidden attributes with the development of DeFi. True cross-chain has not yet taken shape, but "semi-cross-chain" models like anchored assets have already emerged in the DeFi space. The underlying logic for the rise of cross-chain assets is the disconnection between the supply of native asset platforms (Bitcoin) and the demand from open financial platforms (Ethereum), leading to a shortage of underlying assets. The first generation of cross-chain assets validated the feasibility of verification channels and use cases, while the second generation of cross-chain assets began to enrich their application scope. The brief viewpoints on asset cross-chain are as follows:

• Due to the fragmented state between blockchains, asset cross-chain is very necessary; the shortage of underlying assets will limit the development of DeFi.
• Although the digital asset market is vast, the actual usable assets are insufficient due to various segmented ecosystems.
• Asset cross-chain, on-chain native creation, and external asset onboarding are three directions to solve the asset shortage; currently, asset cross-chain has the most advantages.
• Bitcoin, as the most consensus-driven public chain, has become the preferred target for cross-chain assets, but the actual liquid Bitcoin accounts for only 20%, and this proportion will continue to decrease.
• The four functions of cross-chain assets are collateral assets, liquidity pools, derivative underlying assets, and integrated innovation.
• Other public chains will also compete through cross-chain and the Ethereum ecosystem.

The significance of discussing cross-chain assets lies in the fact that it is a direct way to financialize high-value, high-liquidity, and highly recognized assets, and for now, it is the most effective means, based on the following facts and judgments:

• Bitcoin will remain the largest market cap and most liquid digital asset for a long time, but it cannot support complex smart contracts, making it impossible to convert asset market value into underlying applications.
• Large public chains like Ethereum and Polkadot will gather a large number of applications, but there is an ecological mismatch, meaning developers are on other public chains, while most users are still Bitcoin users (including recently entered institutional investors). The threshold for directly using Ether or ERC20 tokens limits DeFi's outreach.
• Cross-chain assets or anchoring solve this problem by bringing Bitcoin's value into other public chains. This reduces users' psychological migration costs, allowing them to hold Bitcoin in a different form while participating in applications (such as earning returns).
• The endogenous asset creation of DeFi/NFT is another approach, but the qualifications and recognition for creating tokens are weaker than Bitcoin, lacking strong consensus.
• External assets like USDT are mainly used for trading, and the usage of USDC is far less than that of WBTC; the implementation of Security Tokens will take a long time.

Development of Asset Cross-Chain

In September 2016, Vitalik Buterin elaborated on the technical paths and application values of cross-chain in the report "Chain Interoperability" for R3. The recognized cross-chain technologies are divided into three categories: notary mechanisms, sidechains/relays, and hash locking. The application value is reflected in: asset cross-chain (Portable assets), atomic swaps (Payment-versus-payment or payment-versus-delivery), cross-chain oracles (Cross-chain oracles), and general cross-chain contracts (General cross-chain contracts). The difficulties of cross-chain technology mainly focus on heterogeneous cross-chain, where the consensus mechanisms, security models, cryptographic algorithms, and block times on both sides are different. The specific situation of cross-chain technology has been discussed in the market for a long time, so we will not elaborate further.

Asset cross-chain is the primary application of cross-chain. The ultimate goal of cross-chain is to achieve information sharing between all chains, but due to the explosion of applications (DeFi), asset cross-chain has emerged early, even without relying on major cross-chain platforms like Polkadot or Cosmos, but instead operating first in the form of Wrapped Tokens through smart contracts. WBTC is a representative of this type of anchored asset, simply put, it involves depositing an asset from one chain into a vault (centralized or decentralized) and the issuing institution issues an equivalent asset on another chain supported by that chain. The reasons for this phenomenon are:

• The rapid development of DeFi requires underlying assets, especially those based on the ERC20 standard.
• Cross-chain serves as a transfer station, aiming to be usable for Ethereum smart contracts, which is the most important feature, rather than the cross-chain technology itself.
• The degree of decentralization is not the first consideration; usability is the priority. USDT/USDC/WBTC are examples of this, being centralized but usable.

Maker introduced multi-asset collateral, opening the way for the linkage between DeFi and cross-chain assets. In November 2019, Maker added multiple digital assets such as BAT for collateral lending beyond ETH, and in May 2020, it introduced WBTC as a collateral lending asset. In January 2020, AAVE introduced WBTC, and in July 2020, Compound did the same. Currently, WBTC is primarily distributed among these DeFi contracts. Therefore, the substantial demand for cross-chain assets is driven by DeFi and liquidity mining.

The Disconnection Between Asset Platforms and Financial Platforms is the Underlying Reason for Asset Cross-Chain

We define and categorize native asset platforms and open financial platforms as follows. Native asset platforms refer to platforms that can generate crypto assets, with Bitcoin being the largest, along with other public chains like Ethereum. Open financial platforms refer to platforms that can execute smart contracts and run DeFi, such as Ethereum and Polkadot. We separate the roles of assets and financial functions, and there can also be overlaps between the two:

Most platforms have both roles, but the reality is that the largest asset platform, Bitcoin, and the largest financial platform, Ethereum, are disconnected. If we require the roles of native asset platforms and open financial platforms to be unified, it will hinder the growth of DeFi to some extent. Taking Ethereum as an example, as DeFi has developed to this point, the actual underlying asset used, Ether (packaged as WETH), accounts for only 4.65% of Ethereum's total supply (about 5.3 million, half of which is used in Maker), with a market cap of about 6.1 billion, only about 65% higher than that of WBTC.

To increase the usable assets of financial platforms, there are currently three main approaches:

• First, asset cross-chain, bringing in large market cap and high liquidity blockchain native assets.
• Second, introducing external assets, i.e., onboarding assets like the dollar (turning into stablecoins) or tokenizing securities (in the future).
• Third, direct asset creation on-chain.

We see that with the rise of DeFi, the underlying assets have indeed mainly followed these paths: among them, WBTC is primarily used in DeFi, while external assets USDC and USDT have been used a total of 1.43 billion in DeFi. Currently, cross-chain assets are the main source of underlying assets, apart from Ethereum's native asset Ether.

The third path, which is direct asset creation, refers to assets created natively by open financial platforms, such as DeFi and NFT:

• We observe that one similarity between DeFi and traditional financial protocols is that DeFi not only creates financial tools but also financial assets. For example, Maker creates both the lending protocol and the stablecoin Dai, as well as the governance token MKR. Synthetix has both synthetic product protocols and platform tokens SNX, as well as S assets (synthetic assets) and i assets (inverse assets). However, the paths differ; traditional finance is based on underlying assets, such as loans and equity, creating a layer of equity on top that is strongly bound to the assets. The assets created by DeFi can be unrestricted to a specific protocol or expressed merely as a governance right without direct economic attributes (relying on consensus).
• The same goes for NFTs, which can also be natively created into various assets, such as game items, crypto artworks, social tokens, etc. NFT assets are quickly being used in DeFi. NFT assets are closer to direct creation rather than being based on a protocol. In the future, many other types of Dapps can directly generate through ERC20 or ERC721.

However, the problem with DeFi/NFT native assets lies in weak consensus and high volatility, making them inconvenient to use. For example, Synthetix's synthetic assets require SNX for 700% over-collateralization, resulting in low capital efficiency, or conversely, high liquidity discounts and risk discounts.

For DeFi to develop, it cannot do without the unblocking of assets (smooth internal transfer paths) and leveraging external assets. Among the three types of approaches to increase usable assets, cross-chain assets have good scalability and high recognition, and their significance to DeFi is akin to that of USDT to centralized exchanges.

Four Uses of Cross-Chain Assets in DeFi

Taking WBTC as an example, let's look at what cross-chain assets have done in DeFi through simple statistics. Currently, the supply of WBTC is about 112,000, and we have summarized the distribution of the top 50 addresses as follows (January 21, 2021):

Collateral Assets

Collateral assets are mainly used for lending protocols, which is also the primary use of WBTC. Currently, about 50% of WBTC exists in the three major lending protocols: Compound, AAVE, and MakerDao.

Providing Liquidity

In the DEX space, WBTC mainly provides liquidity pools, which have accelerated development following the rise of liquidity mining.

• For example, providing liquidity in the SushiSwap WBTC/WETH pool, with about 8,400 WBTC, the liquidity of the WBTC/WETH pool reached 620 million, accounting for about one-third of the total pool of 2 billion, significantly larger than the 220 million of SUSHI/ETH.
• For example, providing liquidity in the Curve RenBTC/WBTC pool, with about 5,330 WBTC.

Providing Underlying Assets for Derivatives

This use has not yet gained significant volume, although the market is optimistic about the development of on-chain derivatives, the market size is still small. From the limited projects, decentralized options platforms like Hegic/Opyn/Auctus have built options pools based on Ether and WBTC.

Options are more complex than futures due to the attribute of an exercise date, requiring underlying assets with good liquidity. The options market has developed for a long time, primarily focusing on BTC and ETH, as other assets have indeed poor underlying liquidity.

Integrated Innovative Applications

Badger Dao provides us with an idea. Badger brings Bitcoin into the Ethereum DeFi ecosystem, but unlike other cross-chain assets, it does not merely serve as a channel for asset transfer; instead, it continues to derive more functions based on the DIGG (the BTC token it issues), which is not a fully pegged token but an elastic token with reward characteristics (mimicking AMPL). Other interesting features include:

• DIGG will distribute rewards to DIGG Set (one of Badger's liquidity pools) based on price changes.
• DIGG can be staked alongside WBTC in Uniswap and SushiSwap for liquidity mining.
• BTC interest-bearing token bBTC.
• Packaging native BTC to generate WBTC/RenBTC.
• One-click deposit function into liquidity pools, known as Zap.

BadgerDao further opens up the application space for cross-chain assets, and various imaginative applications will be developed, especially in collaboration with other DeFi contracts and decentralized insurance coverage (TVL has exceeded 1 billion USD). It is expected that many clones will emerge, further stimulating the industry to fully explore the application potential of cross-chain assets. Due to the scarcity of cross-chain assets, future contracts will rely more on various scenarios to compete for them.

Classification of Asset Cross-Chain

Cross-chain assets can be classified based on the issuer into centralized, decentralized, and semi-decentralized. Centralized issuance mechanisms are similar to USDC, relying on the credibility of custodians and real-name merchants. Andre Kang once summarized a diagram:

According to the issuance principle, they can be divided into anchored types and direct cross-chain types, with anchored types being predominant. Smart contracts can control anchored types, while direct cross-chain is relatively complex, and those that have gone live are mostly testnets. Essentially, centralized exchanges can also be considered a type of cross-chain, but they lack atomicity and require trust in third parties, so direct cross-chain still has market space.

Anchored Assets

WBTC

WBTC is a centralized issuance mechanism, similar in principle to stablecoins like USDC, except that it is collateralized by BTC. The minting process of WBTC involves four roles: custodian, merchant, user, and DAO member.

• Custodian - Holds the native BTC, currently only BitGo.
• Merchant - Responsible for minting or burning WBTC and facilitating its circulation.
• User - Ordinary users of WBTC, just like other ERC20 users.
• DAO Member - Controls the list of custodians and merchants, managed through multi-signature contracts.

The issuance and burning of WBTC are initiated by the Merchant, who interacts with the wrap token protocol and deposits (mints) or withdraws (burns) BTC from the custodian, obtaining WBTC or destroying WBTC. Customers who have undergone KYC/AML can purchase WBTC from the Merchant or redeem BTC.

Boring Dao

Boring is a DAO-based asset cross-chain platform. In the form of a DAO, it allows public chain assets like BTC, XRP, BCH, EOS, ZEC, and DASH to enter the blockchain network safely, privately, and freely in the form of bToken (an ERC-20 Token), seamlessly integrating into existing DeFi pools. At the same time, it has designed a series of underlying mechanisms such as tunnel mechanisms, minting mining, and Boring Farming, allowing bToken to quickly achieve cold start and solve liquidity issues for cross-chain assets. BOR serves as the governance token, enabling the entire system to operate safely, decentralized, and efficiently.

Alaya

PlatON's testnet Alaya officially launched its financial infrastructure asset cross-chain system in December 2020. The Alaya cross-chain system allows users to directly anchor assets from Ethereum, such as Ether and USDT, onto Alaya.

RenBTC

RenBTC is a relatively decentralized model of anchored assets, originally a trading dark pool, later transformed into an asset cross-chain. Users can deposit BTC into the RenBridge gateway to mint RenBTC on Ethereum. The RenBTC protocol operates through a decentralized network known as Darknodes, utilizing technologies such as Shamir's secret sharing and MPC. The main difference between WBTC and RenBTC is that anyone can mint RenBTC, not just merchants. However, the degree of decentralization of RenBTC has faced scrutiny. Currently, RenBTC's issuance is second only to HBTC and WBTC.

Other decentralized projects include tBTC, pBTC, etc., with similar underlying principles.

Cross-Chain

Thorchain

Thorchain enables direct trading through cross-chain, achieving direct asset exchange, often compared to a cross-chain Uniswap. It is also permissionless and non-custodial. Thorchain, being a cross-chain asset exchange pool, can serve as a conversion layer for anchored assets, such as converting BTC to WBTC, BTC to RenBTC, with the token Rune acting as the settlement currency in between. Thus, Thorchain can also be seen as an aggregator of cross-chain assets, meaning that WBTC and RenBTC can also be issued in the market through Thorchain apart from their initial issuance (i.e., the aforementioned or certified node issuance). Thorchain currently has only launched the cross-chain trading protocol Asgard, supporting the exchange of three assets on BTC and Binance Chain (BNB, AWC, RUNE). It previously launched the automated market maker BEPSWAP based on Binance Chain, equivalent to Uniswap on Ethereum.

Kava-Hard Protocol

Kava launched the Hard Protocol in 2020, a cross-chain DeFi protocol based on Kava, supporting cross-chain transactions for Bitcoin, Binance Chain, and Ripple. On October 15, the upgrade of Kava 4 Gateway was launched alongside Hard Protocol. In addition to cross-chain, assets like BTC, XRP, BNB, BUSD, KAVA, and USDX can also be borrowed and mined. Kava 5 is expected to launch in early 2021, along with the V2 version of Hard Protocol.

Near-Rainbow Bridge

Near launched the Rainbow Bridge in September 2020, a cross-chain interoperability bridge that enables asset flow between Near and Ethereum. Users do not need to trust anyone; they only need to trust the decentralized client, making it a trustless cross-chain.

Since both Near and Ethereum are Turing complete, they can track the movements of assets on each other's chains. The implementation of the Rainbow Bridge has some prerequisites:

• Near hopes Ethereum will pass EIP665, but before that, users must trust that the gas fees for each block within four hours cannot grow at a rate exceeding 2 times. However, passing EIP665 may be difficult.
• At any time, 2/3 of the nodes on Near must be honest.

Near is currently still testing on Ethereum's testnet Ropsten and Near's testnet and has not yet opened to the public. Some native projects have emerged, but they are still in the early stages.

Blockstack 2.0

Blockstack updated its latest mainnet version 2.0 in January 2021, known as Stack 2.0. Blockstack is a project strongly bound to Bitcoin, initially using Proof of Burn as its consensus mechanism. Version 2.0 changed the consensus mechanism to Proof of Transfer, allowing miners to deposit native BTC as a base asset into Stack and receive STX tokens. Stack 2.0 effectively creates an application layer for Bitcoin. It can not only achieve cross-chain asset transfers but also facilitate more applications around cross-chain, similar to a Layer 1.5.

Moonbeam

Moonbeam aims to directly replicate the Ethereum development environment on Polkadot, representing a larger layer of application than asset cross-chain, essentially a direct "migration" of the ecosystem. All protocols and applications can be replicated on Polkadot through Moonbeam, not just asset migration, but asset reproduction, such as AAVE on Ethereum becoming pAAVE on Polkadot. All of this depends on the development of the Moonbeam parachain.

Cosmos

Of course, the most powerful asset cross-chain is hoped to be realized in Cosmos and Polkadot. On January 28, Cosmos's "Stargate" upgrade was conducted, and the Cosmos SDK v0.40 version has been released, with the IBC module set to be implemented, but its usage remains unknown.

Synthetic Assets

Synthetic assets can also be considered a type of cross-chain. Most synthetic assets are not created out of thin air; they are created by collateralizing a portion of assets to generate credible assets. Essentially, due to over-collateralization, they also reduce liquidity, such as Synthetix. Synthetic assets do not necessarily cross chains directly, but they can collateralize cross-chain assets and utilize cross-chain assets to enhance functionality.

Badger Dao

BadgerDao is a decentralized organization that aims to bring Bitcoin into DeFi, designing a series of functions around BTC. Currently, there are three products: a decentralized governance organization, the liquidity pool Sett (aggregator), and the elastic pegged asset DIGG based on Bitcoin. In addition to DIGG, Badger will also launch the interest-bearing asset bBTC based on BTC.

DIGG has a fixed total supply of 4,000 (adjusted down from 6,250), with 600 in circulation, and its price is adjusted based on the mechanism of Amplforth. Strictly speaking, DIGG is a synthetic asset. However, synthetic assets also have advantages; for example, cross-chain assets prioritize price stability (stable peg) as the primary task, while synthetic assets, especially those with elastic supply, can be paired with features like airdrops and liquidity mining, and the price adjustment mechanism will also be adjusted through the distribution of liquidity pools. BadgerDao's impressive cold start and diverse products have rapidly increased its locked value. However, strictly speaking, DIGG resembles a very pure form of "creation out of thin air."

Competition and Outlook for Cross-Chain Assets

Major Competition Comes from the Battle for Underlying Assets

Supply Side:

• The competition for cross-chain assets lies in the battle between open financial platforms and asset provision platforms. The deflationary nature of Bitcoin will lead to increasing scarcity. Moreover, as the narrative of Bitcoin as a store of value is accepted, its scarcity will continue to rise. Glassnode has reported that 78% of circulating Bitcoin has low liquidity, and this proportion will continue to increase (in 2020, one million BTC became low liquidity).

• Each public chain will match cross-chain asset protocols, whether native or based on smart contracts. Platforms that can safely and efficiently replicate other assets will receive support from public chains, such as Near's Rainbow Bridge, Moonbeam on Polkadot, and WBTC and RenBTC on Ethereum.
• As previously mentioned, the supply of native assets from DeFi or NFT, as well as external assets, will alleviate the pressure on on-chain asset supply. However, due to issues of consensus, credibility, and recognition, the utility of one dollar's worth of BTC and one dollar's worth of other assets is completely different (e.g., whether it can be accepted as collateral, the level of over-collateralization, liquidity discounts under large-scale liquidations, etc.).

Demand Side:

• Cross-chain has completed the means, and demand mainly lies in applications such as DeFi, NFT, and gaming. Ethereum remains the primary destination for cross-chain assets.
• The faster DeFi develops, the more liquidity is split into smaller pools, and the launch of Layer 2 will intensify the demand for liquidity. DeFi itself dissipates liquidity, leading to exponentially increased demand for underlying assets due to over-collateralization and liquidity pool mechanisms.
• Competition will diversify; for instance, Gemini has considered bringing Filecoin to Ethereum. The increasing aggregation of assets on open financial platforms will create a siphoning effect, where the strong become stronger.
• The evaluation of asset cross-chain primarily balances security, efficiency, and economy, as well as the measurement of various explicit and implicit costs.

Outlook

• Although the prevailing view was that cross-chain was not very useful and centralized exchanges could achieve cross-chain, the emergence of DeFi mining has made on-chain asset interoperability a necessity.
• The existence of on-chain native applications has found a place for asset cross-chain, and the scale of open finance is not only related to the overall market value of crypto assets but also to the freely circulating crypto assets.
• The underlying assets of open financial platforms do not necessarily have to be the largest, but they need to have strong execution functions and security mechanisms. Asset shortages can be addressed through asset cross-chain.
• Achieving cross-chain or asset issuance does not necessarily allow a public chain to stand out, just as before DEXs emerged, no matter how good the asset was, it would enter CEXs, which captured the most value, with fee revenues higher than those of on-chain transactions.
• Currently, the only assets that are truly needed for cross-chain are BTC and ETH. In the future, as the ecosystems of other public chains improve, multi-chain interoperability will become an essential feature.
• The first generation model of cross-chain assets is basically set, focusing on creating a safe and efficient channel. The second generation has begun to emerge, opening up the application scenarios for cross-chain assets.