The cryptocurrency industry has experienced a number of hacks recently, but most of the biggest are related to bridges, which allow users to transfer assets between blockchains. With the sheer number of alternative layer 1s and layer 2 solutions, some are concerned that bridge hacks could bring down all of DeFi. Let’s look at the validity of these claims, what can be done to mitigate them, and some of the long-term forecasts for DeFi.
During the most recent bull run, some of the best performing cryptocurrencies were smart contract platforms like Solana, Avalanche, and Binance Smart Chain. These chains blew up in popularity after Ethereum’s transaction fees became prohibitively expensive and prevented retail investors from making transactions without spending hundreds of dollars in fees. These alternate chains promised lower fees and faster transaction times and experienced a consequential surge in DeFi activity.
Naturally, the value brought to these chains has to come from somewhere. However, transferring assets between blockchains is not natively supported. Let’s use an analogy to understand this better. Imagine each blockchain is its own country, with its own infrastructure, measurement standards, and regulations.
This year alone, blockchain bridges have been hacked for around $2 billion, a staggering number given the relatively small size of the cryptocurrency industry. It has made some users unsafe with the idea of having blue-chip assets like Ethereum on any chain other than the main chain. Each time a bridge is hacked and Ethereum is stolen, it hurts the both value of the impacted chain and Ethereum. It creates a “shared security model” where all of the interconnected blockchains are only as secure as the weakest link.
Earlier this year, Ethereum creator Vitalik Buterin expressed concern over these cross-chain applications that facilitated the transfer of native assets from one blockchain to another. He noted that even in the case where a blockchain is entirely centralized, there is no way for a hacker to steal funds directly from your wallet. However, if you hold bridged assets, those funds can be stolen by anyone who hacks the bridge.
Interestingly enough, layer 2 rollups are potentially safe from the perils of cross-chain transfers. As Vitalik notes, since L2s like Optimism and Arbitrum inherit the security guarantees of Ethereum, so “holding assets issued on Optimism wrapped on Arbitrum is still perfectly safe.” This could mean that in the future, each blockchain and its layer 2s will operate independently of other blockchains. This system would ensure that users cannot lose their funds due to a hack or 51% attack, but comes with the downside that a coin issued on a chain like Solana could not be used in Ethereum protocols and vice versa.
Another potential solution to the issue would be for DeFi protocols and stablecoin issuers to expand their blockchain reach. If Circle issued USDC on almost every major blockchain, there would be no need for bridges and thus no risk for hacks. This logic could also be expanded to DeFi tokens like UNI and AAVE.
Overall, the problem of how to make blockchains interoperate with one another while still ensuring each has its own sovereignty is difficult and has yet to be fully solved. Hacked bridges pose a danger to all blockchains they are connected to and their integration within DeFi could cause mass liquidations or black swan events. In the future, bridge security will need to be improved significantly for the multi-chain vision to become reality. In a future article, we will look at Cosmos and Polkadot and how they are taking a different approach to interoperability.
By Lincoln Murr