This Crypto Sector Will Be Huge & Two Projects in It I Find Most Interesting

Cross-chain communication protocols will be HUGE.

They’re key infra in a multi-chain world & can enjoy large moats.

But their tech’s complex. If you confuse marketing hype w/ reality, you may bet on wrong projects.

A look at this promising sector & 2 leading protocols in it:

(Pic above are 2 heroines in Jane Austen’s Sense & Sensibility. What’s the metaphor? Read to end & you’ll see.)

Big picture #1: Cross-chain communication is a high reward / risk bet

The multi-chain world is here.

An obvious sign is proliferation of bridges…

…combined TVL of which grew 20x in past yr.

We don’t have mature tech for cross-chain interaction (yet) & there’s been many bridge hacks. But did people stop bridging? No.

When you see users keep using a product despite its glaring weakness, pay attention. It tells you the product may be a “must have” & demand’ll likely endure.

Bridging assets is only 1st step in cross-chain interaction. 2nd-gen cross chain protocols, e.g. two discussed below, are general frameworks to allow any kind of contract logic to be passed cross chain. Asset bridging is just an application of that.

Imagine DEXes that run on multiple chains w/ one, un-fragmented liquidity pool, NFT mkt places that let you buy assets on any chain from single wallet, lending apps where you put up collateral on one chain & borrow on another.

W/ blockchains of different consensus mechanisms growing into large metaverse economies, dApps will get increasingly sophisticated in their multi-chain offerings.

Cross-chain communication protocols are backbones for that to happen. They’re high reward/risk bets b/c:

1. Large demand: inevitable as dApps seek an edge in the growing multi-chain world.
2. Lasting moat: once dApps adopt a cross-chain communication modality, switching cost is high, so user base’ll likely be sticky.
3. Less competitors: technical complexity limits # of entrants, in contrast to deFi, NFT or even gaming, where copy-paste projects are common.

Limited competition + Growing demand + High switching cost = Potential for outsized value accrual by successful protocols in this sector.

Big picture #2: Cross-chain messaging protocols beat asset bridges

The typical lock-> mint-> burn workflow that most bridges use to “move” assets cross chain is only one use case of cross chain messaging.

Anybody can build an asset bridge based off a generalized cross-chain messaging framework. The reverse isn’t true.

Bridge competition will intensify. Long-term edge has to come from:

1) covering more chains & more assets,

2) amassing deep liquidity pools to offer low slippage,

3) having large capital backing to guarantee paying users back if hacked.

But 1) has hard limits. 2) is difficult to sustain. 3) is privilege of select few.

That’s why bridge protocols w/ an eye on future, e.g. Synapse, are trying to evolve towards general cross-chain messaging to stay competitive. Meanwhile newer protocols that promise complete tooling for cross-chain interaction are gaining traction.

Two leading protocols in this vertical, Axelar & LayerZero, both closed VC rounds this yr w/ valuation at > $1 billion each.

Axelar vs LayerZero: a cross-chain beauty contest

While both aim to be all-you-need framework for dApps to operate cross chain, two approaches are different w/ distinct tradeoffs.

How they work

Axelar:

It’s a proof-of-stake chain w/ validators who also run nodes or light clients on one or more chains Axelar connects to.

Validators monitor Axelar’s smart contracts deployed on connected chains, approve requests coming through those contracts on chain A, & pass them to chain B to be executed.

LayerZero:

Instead of running a middle chain, it relies on two off-chain entities, oracles & relayers, to pass messages btw chains.

A request coming to LayerZero’s smart contracts on chain A is passed to chain B by relayer w/ txn proof, while oracle forwards chain A’s current block header. Validator on chain B checks if txn proof & block header match & forwards the request to destination app on chain B.

Pros & cons

Axelar:

Pros: Unlike LayerZero that relies on 3rd parties like oracles & their security assumptions, Axelar has fuller control of its cross-chain messaging workflow, which may have efficiency & cost advantage as network scales.

Being a layer 1 chain, there’s bigger room for greater decentralization overtime. And possibility exists for developing its own dApp ecosystem to capture additional value.

Cons: Building such a network is heavy-lifting compared to LayerZero’s setup. E.g. validators are required to run nodes for both Axelar & multiple other chains it connects to. It’ll take efforts & resources to attract & onboard validators esp from outside of Cosmos eco.

LayerZero:

Pros: Being lightweight w/ low operating cost is a main advantage. W/o needing to run nodes on connected chains, speed of incorporating new chains into network may be faster w/ lower upfront investment in short term.

Cons: The name LayerZero gives impression that it’s a foundational layer of blockchain system. ’Tis brilliant marketing but not true. The protocol sits at application layer, more akin to a layer 3 than a layer 0.

Cost advantage to large extent comes from outsourcing the burden of verifying on-chain info to 3rd parties, e.g. oracles.

But there’s no free lunch. Not only does it introduce security assumptions the protocol doesn’t control, offloading mission-critical parts of work to 3rd parties adds other operational risks & uncertainty abt cost in long run.

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Which approach is better?

Imo Axelar’s setup makes more sense in long term regarding scaling ability, economy of scale & value accrual for protocol,*if* it gets enough adoption to get to scaling stage.

But problem is higher starting cost, which affects go-to-market speed & early traction, other things equal.

LayerZero, in contrast, has deployment speed & initial cost advantage. Even if those benefits don’t scale, they build early excitement & momentum, which can feed on itself & create a flywheel of traction.

You can already see these patterns playing out by looking at two projects’ progress to date:

Traction

LayerZero was hottest thing on crypto Twitter at launch, touted by famous VCs & influencers alike as best tech since sliced bread.

It was already live on 7 chains from get go, w/ more chains expecting to get added soon on top of various partnerships w/ well-known dApps such as SushiSwap.

Stargate, 1st asset bridge built w/ LayerZero, attracted over $4 bn TVL in 2 wks. Token price flared up, at one point putting the weeks-old project at > $3.5 bn in fully diluted mkt cap.

Axelar, in contrast, is making steady progress but w/ much less sizzles. Main traction to date is in helping Cosmos chains connect to EVM chains. E.g. Bridging Luna/UST to Avalanche.

A collab w/ Osmosis as main bridging solution for the latter is in the cards. Recent grant competition for multi-chain apps to build on top also shows promises.

At end of day these two projects are not competing on who can build a bigger better bridge. They’ll be competing on being the go-to solution for dApps to become multi-chain. That competition has barely begun.

Who will win?

Again, imo Axelar’s approach has a more durable foundation to scale w/ larger value accrual in long run. But road from zero to one can be a grind, not the least b/c of higher fixed investment up front.

LayerZero is opposite— smaller scope of work allows for faster go-to-mkt & captures public imagination early. But there may be bigger scaling & decentralization challenges down the road.

The two remind me of Dashwood sisters in Jane Austen’s Sense & Sensibility.

Elinor Dashwood is steadfast, capable & prudent, but a reserved personality & not exactly a bombshell.

Marianne Dashwood is lighthearted, brave & sex appeal galore, but doesn’t always have the best foresight.

It’s Austen. So ofc in the end both sisters found perfect match & lived happily ever after.

Likewise, I believe both these projects are high quality & will find their success. But mkts & use cases they match w/ will likely be different.

I shall talk abt teams, tokenomics etc, but post’s already too long even after cutting scope by half. Also got 400+ requests to cover other cross-chain projects. (Told you it’ll be a hot sector.) Will have to wait till later. Sorry guys.

Cross-chain infrastructure war is heating up.

I'm doing a post on this covering Axelar, LayerZero, Nomad, Analog One.

What other projects do you want to see?

— Tascha (@TaschaLabs) April 29, 2022

I thank @celiawan2 for our lively chat abt multi-chain future that inspired some thinking in this post. You should check out her excellent article on bridges.

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