Dragonfly Partners: Interpreting Cross-Chain Infrastructure Axelar and the Globalization of Blockchain Economy

Written by: Haseeb Qureshi, Dragonfly Capital

Compiled by: Aididiao

With the popularity of cross-chain bridges, cross-chain capital flow exceeded $25 billion in March, reaching its peak. It feels like a return to the 1990s of traditional finance, where cross-border investments surged, and capital that was once locked within national borders began to flow freely around the world.

Percentage of cross-border investment in global GDP, Source: The Economist

TVL as of April 2022 (now lower), Source: Dune Analytics

In the context of globalization, blockchain interoperability has become not just a theoretical characteristic but a key practical element for the blockchain economy to achieve "cross-chain globalization."

Just as economic globalization has brought about new business models, cross-chain globalization will also give rise to new applications in Web3, with cross-chain information transmission networks becoming the core infrastructure behind the new growth cycle.

Cross-chain bridges acting as banks

Blockchain interoperability is a broad concept that can take two specific forms.

The first form is a bi-directional asset bridge. Here, the "bridge" is not a transportation facility built by civil engineers in the real world, but rather an asset flow channel with banking functions.

On one hand, banks absorb assets, and on the other hand, they issue liabilities. To ensure that banks have sufficient solvency, their assets must match their liabilities.

The main function of a bi-directional asset bridge is to maintain sufficient support and continuously process deposits and redemptions. Cross-chain bridges absorb assets on one side and issue liabilities on the other; to ensure sufficient solvency, their assets must match their liabilities.

Currently, the vast majority of cross-chain bridges are bi-directional asset bridges. It is important to note that most of these asset bridges are sponsored by project parties, such as Polygonbridge, Avalanche bridge, and NEAR Rainbow. Almost all of these asset bridges are directly connected to Ethereum.

It is not surprising that for emerging blockchains, bridges are crucial for the inflow of assets and users. Similar to canals and railways in the real world, they are often public infrastructure built with state support and financial subsidies. Due to the high construction and maintenance costs of public infrastructure, and the dispersed or even non-profitable returns, private investors generally do not invest directly. However, state subsidies and support for public infrastructure align with national interests. This is also why project parties not only build cross-chain bridges but also provide financial support.

For example, after the Wormhole bridge was hacked for $325 million, Solana and Terra's capital provider Jump Capital filled the funding gap, acting as a backer for the project. The Ronin Bridge suffered an attack due to a multi-signature breach (the largest on-chain hack in crypto history), resulting in a loss of nearly $625 million, and the Axie Infinity team also guaranteed that all victims would be compensated.

Bi-directional asset cross-chain bridges primarily compete based on the scale of their balance sheets (including the implicit balance sheets of project parties). The largest and most well-funded cross-chain bridges can ultimately win users' trust, while user experience and efficiency are also crucial.

Currently, users are not particularly concerned about the degree of decentralization of cross-chain bridges; they care about whether their assets will be secure if the bridge is hacked.

Since project-sponsored cross-chain bridges have greater implicit balance sheet support, individuals cannot compete on equal footing. In fact, you will see that almost all of today's TVL is in "officially sponsored" bridges.

Broadly defined information transmission cross-chain bridges

In the long run, will project-sponsored bi-directional asset bridges win?

Bi-directional asset bridges allow capital to flow freely, but they alone cannot create a global interoperability system. Most of these cross-chain bridges cannot achieve complex interactions and can only facilitate simple remittances.

What can ultimately realize a global interoperability system is broadly defined information transmission cross-chain bridges.

Cross-chain information transmission refers to the ability to call contracts on another chain, such as using Compound on Ethereum from Avalanche, or depositing Yearn deposits into Solana liquidity pools. Cross-chain information transmission supports not only asset transfers but also many other interactions. Currently, most cross-chain activities are a combination of multi-signature and trusted third parties, making it impossible to achieve this kind of cross-chain composability. When blockchains can interact with each other in a trustless manner, it will enable more cross-chain commercial activities.

In the early days, both Cosmos and Polkadot had ambitions to become the "interstate highway system" of blockchains. However, they have evolved into specialized systems focused on internal ecosystem connections, leaving connections outside their ecosystems to others. The only way to achieve true cross-chain composability is to directly address the challenging cross-chain messaging problem, which Axelar is striving to tackle.

Axelar is a universal interoperability layer that connects L1 blockchains through a decentralized network. Developers can make simple asynchronous calls via Axelar's SDK, seamlessly invoking contracts on another supported chain.

Currently, many cross-chain bridges can perform the simplest form of cross-contract calls, but Axelar aims to achieve more complex cross-chain composability and business forms. For example:

1. Enable blockchain developers to easily call and interact with applications on other chains.
2. Allow DApps to easily scale to multiple chains at minimal cost.
3. Enable users to seamlessly interact with applications across multiple ecosystems.

Ultimately, from the user's perspective, the goal is that they do not necessarily need to know which chains their application's backend involves. This is the experience people have long enjoyed using the internet: when a website makes an API call to a third-party server, users simply experience a seamless application. Today, this fragmented feeling is very apparent, whether you are using Solana, Ethereum, or Avalanche. In the future, the user experience of Web3 will approach that of current internet products, where you only know the application you are interacting with, without touching the more complex logic behind it.

If you have been following this field for a long time, you may be familiar with LayerZero and its Stargate Finance. In fact, LayerZero and Axelar operate at the same level of the entire stack, so what are the differences between the two? Why do I have more faith in Axelar?

Axelar is a mature PoS network with a native token, and all its nodes support other blockchains (Ethereum, Avalanche, Cosmos, etc.). When viewing the state of the underlying blockchains it connects to, Axelar nodes synchronize queries with local blockchain clients and reach consensus on the current state of other chains. When executing cross-chain transactions, nodes jointly manage threshold signature accounts on each chain, allowing them to perform operations or host funds. The robustness of its PoS validators ensures Axelar's security, and the project was founded by former leaders of Algorand with backgrounds in cryptography and mathematics, making their expertise in cryptography and distributed systems world-class.

LayerZero's construction approach is very different; it does not attempt to be the entire interoperability stack. Instead, it is simply a set of contracts that designate two roles: "relayers" and "oracles." Oracles are responsible for reporting the actual state of the underlying blockchains, while relayers are responsible for the actual cross-chain transmission of messages and proving the validity of those messages, with the specific third-party relayer or oracle depending on the user. LayerZero itself is a neutral information bus and transmission standard, not responsible for relaying or oracles.

In its white paper, LayerZero claims that they will default to using Chainlink as their oracle, but currently, LayerZero's Stargate Finance uses a three-party signature composed of FTX, Sequoia, and Polygon as the oracle, with LayerZero Labs executing the relay.

Correctly transmitting cross-chain messages and accurately reporting multi-chain states are at the core of the difficulties in cross-chain interoperability. Axelar directly addresses this issue and provides a complete solution.

LayerZero, Wormhole, Synapse, and many other companies are attempting to solve the cross-chain interoperability problem. For a long time, it has been one of the barriers to breakthroughs in blockchain technology, but I believe Axelar has the opportunity to achieve a breakthrough and solve this technical barrier.

Broadly defined cross-chain information transmission networks have strong potential network effects, potentially more powerful than the positive cycles we see in the rise of alternative L1s. A true cross-chain universe can achieve diverse applications, assets, and composability across all DApps.

Conclusion

Ultimately, all technological implementations aim to improve user experience; achieving a smooth and intuitive user experience is crucial for the globalization of the blockchain economy. To realize the user experience expected in Web2, developers need infrastructure and tools to eliminate friction in the cross-chain world, and a project-supported centralized cross-chain bridge will become a necessary stepping stone.

In the 1990s, the growth of foreign direct investment drove the rise of global multinational companies. I believe that with the optimization of cross-chain interoperability, Web3 is at a similar turning point. In the future, you will no longer be limited to applications on a specific chain but will directly access the entire Web3 world available globally.