In 2023, blockchain technology has firmly strengthened its position and has become an important component for many industries and areas of life. However, the development of the blockchain also leads to new challenges related to the isolation of various blockchain networks, which prevents the smooth functioning of the digital economy. That’s how blockchain bridges appeared - innovative solutions aimed at overcoming the boundaries between different blockchains and establishing reliable and efficient connections. In today's article from Notum, we'll take a look at what blockchain bridges are, how they work, what is the difference between custodial and non-custodial bridges, and what are their advantages, disadvantages, and risks for the entire blockchain ecosystem.
Blockchain bridges (or inter-chain bridges) are technological mechanisms that connect different blockchain networks and help them interact. Each blockchain network is usually independent and operates on its own, having unique protocols and rules. That is the reason why different networks cannot communicate directly with each other. This is where blockchain bridges are needed, as they are created to solve the problem of the isolation of blockchain networks and establish mechanisms for transferring information and digital assets between different networks. They provide interoperability, which allows users and developers to transfer data and assets across different blockchains, even if they have different protocols and structures.
Typical use cases for blockchain bridges are the exchange of digital assets between different cryptocurrencies, the transfer of smart contracts and data between public and private blockchains, and the integration between blockchains and traditional financial systems. However, it is important to know that blockchain bridges also come with some problems, such as security, decentralized network management, and coordination between different blockchain network rules.
Now, with blockchain bridges, various blockchain networks can cooperate and interact on a new level, which positively affects efficiency and transparency, and helps to more widely use blockchain technology. This provides new opportunities for the development of decentralized applications and a favorable environment for the development of the digital economy.
How Do Blockchain Bridges Work?
As you know, blockchain bridges allow to connect different blockchain networks that operate on different protocols and have different sets of rules. The main idea of blockchain bridges is to create a communication channel between two or more blockchains so that participants can transfer assets or information between these networks. This provides interoperability between different blockchains, which can be especially useful for increasing the efficiency and empowerment of dApps. The main elements and mechanisms of blockchain bridges include:
- Locking. Users of one blockchain lock their assets in the "lock" of the smart contract on this blockchain.
- Confirmation. Blockchain event is registered and confirmed by its network.
- Notification. After confirming a transaction on this blockchain, the event information is sent to a bridge that is connected to another blockchain.
- Unlocking. Upon receiving event information from the first blockchain, users of the second blockchain can unlock their assets on their blockchain.
Also, there are bridges that allow the two-way transfer of assets and information between blockchains. This makes the two-way exchange process more flexible. An example of a popular blockchain bridge is the bridge between Ethereum and Binance Smart Chain (BSC). This bridge allows the movement of ERC-20 tokens between the Ethereum and BSC blockchains, which improves accessibility and convenience for users of both networks.
Types of Blockchain Bridges
At the moment, blockchain bridges can be divided in two categories: custodial and non-custodial. Let’s talk about each of them, as well as their advantages and disadvantages.
Custodial Blockchain Bridges
Custodial bridges are operated and maintained by centralized entities or intermediaries. When users transfer assets or data from one blockchain to another using a custodial bridge, they must trust the centralized operator to facilitate the transfer securely and honestly. These operators often act as custodians of the assets during the transfer process. “The centralized authority is in charge of funds deposited on the bridge and ensures that tokens are minted at a 1-to-1 ratio on the requested chain.” – Chainport.
Advantages of Custodial Bridges:
- Simplicity. Custodial bridges are usually easier to set up and use since the centralized entity handles the technical complexities of cross-chain transfers.
- Faster Transactions. As the custodian controls the transfer process, transactions can be processed more quickly and efficiently.
Disadvantages of Custodial Bridges:
- Trust Dependency. Users must place trust in the custodial entity, which goes against the principles of decentralization and can be a single point of failure.
- Security Risks. The custodian controls the private keys of the assets, making them vulnerable to hacking or mismanagement.
- Centralization. Custodial bridges introduce centralization aspects, which might contradict the decentralized nature of some blockchain networks.
Non-custodial Blockchain Bridges
Non-custodial bridges, on the other hand, operate without the need for a centralized intermediary. They achieve cross-chain interoperability through smart contracts or decentralized protocols that facilitate the movement of assets or data directly between blockchains without any third-party involvement.
Advantages of Non-custodial Bridges:
- Decentralization. Non-custodial bridges align with the principles of decentralization, as users retain control over their assets and data during the transfer process.
- Trustless Transactions. Users don't need to trust any central entity since the process is handled by code and smart contracts.
- Enhanced Security. Private keys remain with the users, reducing the risk of hacks or mismanagement associated with custodial solutions.
Disadvantages of Non-custodial Bridges:
- Complexity. Non-custodial bridges can be more complex to develop and use since they rely on smart contracts and decentralized protocols.
- Slower Transactions. Due to the decentralized nature, non-custodial bridges might face speed and efficiency challenges, especially in comparison to centralized counterparts.
Thus, custodial blockchain bridges offer simplicity and speed but require trust in a centralized entity, while non-custodial bridges prioritize decentralization and security but might involve more complexity and potentially slower transactions. However, both types of bridges play important roles in enabling interoperability between blockchain networks and expanding the capabilities of the overall blockchain ecosystem.
Risks of Using Blockchain Bridges
Even though blockchain bridges allow the transfer of assets and data between different blockchains and play a crucial role in achieving interoperability and enhancing the overall functionality of blockchain, both custodial and non-custodial ones come with their own set of risks. First, we should pay attention to general risks, applicable to both types of bridges. For example, using blockchain bridges often involves paying transaction fees on both the source and destination blockchains, which can be costly. Also, during periods of high demand, blockchains can become congested, leading to delays or higher fees for bridge transactions. Moreover, cross-chain transactions might fall under different regulatory frameworks, leading to compliance challenges and potential legal issues for users. And, of course, user error can also take place. That’s why they must ensure they follow the correct procedures when using bridges. Any mistake, such as using the wrong address or not confirming transactions, can result in the loss of funds.
Now let's look at the risks of custodial and non-custodial bridges separately.
Custodial Bridge Risks
- Centralization. Custodial bridges are managed by centralized authorities, which means users must trust them with their assets. If the custodian is compromised or acts maliciously, it can lead to potential loss of funds.
- Security Vulnerabilities. Centralized bridges may be vulnerable to security breaches and hacking attempts. If attackers gain access to the custodial bridge's infrastructure, they can steal users' assets.
- Lack of Transparency. As users do not control the assets directly, they might not have complete transparency about the inner workings of the bridge, which could lead to concerns about the custodian's actions.
Non-Custodial Bridge Risks
- Smart Contract Vulnerabilities. Non-custodial bridges often rely on smart contracts to facilitate asset transfers. These contracts can be susceptible to bugs and coding errors, potentially leading to loss of funds.
- Asset Lockup Risks. When using a non-custodial bridge, assets are usually locked on the source chain while the transfer takes place. In case of issues with the bridge, assets might be temporarily locked or even permanently lost.
- Oracles and Data Manipulation. Non-custodial bridges might require oracles to obtain information from external sources. Manipulation of these oracles can result in incorrect data being used, leading to unintended consequences and financial losses.
Custodial and non-custodial bridges have become an indispensable tool for enabling interoperability between different blockchains and solving the problem of isolated blockchain ecosystems. Each type of bridge has its own unique advantages and disadvantages, which depend on the requirements and specific goals of the users. Custodial bridges offer a high level of security and trust, as control of the assets remains in the hands of the custodial participant. However, such centralization may introduce certain risks, such as loss of independence and vulnerability to attacks on that participant. On the other hand, non-custodial bridges aim to provide more decentralized and autonomous interaction between blockchains. This allows for greater flexibility and openness, but can come with security and trust challenges, especially when handling large volumes of assets.
Despite their differences, both types of bridges play an important role in the development of the blockchain ecosystem. Each user must independently evaluate their own needs and risks to choose the most suitable type of bridge for their needs. In the future, further developments in bridge technology can be expected to improve their efficiency, security, and decentralization. Continued advances in cryptography, smart contracts, and communication protocols will enable ever more integrated and secure interactions between different blockchains, facilitating wider adoption of blockchain technology and the growth of the blockchain ecosystem in general.
Disclaimer: Notum does not provide any investment, tax, legal, or accounting advice. This article is written for informational purposes only. Cryptocurrency is subject to market risk. Please do your own research and trade with caution.