Are Omnichain Fungible Tokens the Future?
In 2022, LayerZero launched the OFT standard with the goal of improving interoperability between major blockchains. Could this change the future of DeFi?
Overview
What are OFTs?
Within the DeFi community, it is a widely accepted ideology that the future lies in cross-chain technology, and LayerZero’s new standard represents a significant step in achieving that goal. To further the development and growth of DeFi, it is imperative we simplify liquidity between different blockchains.
Previously, LayerZero facilitated the transfer of tokens between blockchains. However, with the implementation of their OFT standard, they have elevated their service to a whole new level. Think of Omnichain Fungible Tokens similarly to ERC-20 tokens, in the sense that they are composable with any app on an EVM. OFTs on the other hand can be composable in any dApp on any chain that LayerZero has integrated, through the use of contract-to-contract communication, all without the hassle of bridging.
Although bridging may appear straightforward on the surface, enabling the transfer of tokens between different blockchains, a closer examination shows that this is not the case. In reality, bridging services lock your tokens on their native chain and then generate a wrapped version of those assets on the target chain. This process can be extremely costly and risky in the long run. Additionally, it results in liquidity being spread across several chains due to the inherent interoperability of these services.
However, Omnichain Fungible Tokens offer a solution that eliminates the need for multiple tokens on different chains. By burning the original OFT on one chain and minting an equivalent amount on the destination chain, the protocol ensures that the total supply remains the same, regardless of the network. This approach simplifies token management and ensures consistency across all chains.
How does it Work?
There are two types of traditional cross-chain bridges that are commonly used. The first one involves a middle chain consensus that verifies and transfers messages between the chains, while the second one runs a light node on-chain.
Both of these approaches have their drawbacks and are not the most efficient ways of cross-chain communication. The middle chain approach relies on a single point of failure to ensure that messages are received, validated, and forwarded between the chains. In the event that the consensus is corrupted, there is a risk of losing liquidity. On the other hand, the on-chain light node approach is more secure as it transmits messages between chains using transaction proofs that are validated against block headers. However, it is expensive to operate, costing millions of dollars per day per pairwise.
What’s the solution? Well, Ultra Light Nodes (ULN) were introduced to correct this very issue. ULNs combine the cost efficiency of middle chains with the security of on-chain light nodes, addressing the drawbacks of both approaches. With ULNs, validation similar to on-chain light nodes can be performed, while block headers are streamed on demand using decentralized oracles. This results in a more secure and cost-effective cross-chain communication solution.
LayerZero’s innovative approach uses an Oracle and a Relayer to act as cross-chain validators, removing the bloated load previously associated with moving assets between chains.
As LayerZero is a configurable User Application (UA) chain endpoint that runs on a ULN, it is able to utilize the Oracle and Relayer to divide the communication responsibilities between chains during a transaction, all without involving a third party. In doing so, LayerZero can guarantee that any transaction occurring on the receiver’s chain corresponds to a valid and committed transaction on the sender’s chain.
Benefits of OFTs
Solves De-pegging Risks
As mentioned earlier, when utilizing LayerZero, tokens can be used across any compatible blockchain that they have integrated. This is hugely beneficial when it comes to solving de-pegging risks as bridged assets are on multiple chains (ETH becomes WETH for example) which come with their own inherent problems.
Security
LayerZero uses an innovative solution to overcome previous security constraints by breaking up responsibilities between the Oracle and Relayer. This enables failure points to be minimized and isolated. In traditional middle chain systems, this type of risk model does not exist as third-party validation is used to execute a transaction, which can result in liquidity draining.
Liquidity
The utilization of bridge services by users often results in liquidity fragmentation across multiple chains. This is an extremely bad onboarding experience as the knowledge involved with bridging, and different chain connectivity can be very intimidating. To resolve this issue, LayerZero unifies liquidity across all chains. In practical terms, this means that users who transfer assets from one chain to another can rest assured that they will receive those assets on the target chain, and the liquidity providers (LPs) will receive fees from all incoming transactions on the target chain, regardless of the source.
Governance
Governance can be conducted across multiple chains without the need to swap or transfer all assets to another chain where the governance is situated.
State Sharing
LayerZero has developed a robust interface that enables applications to operate seamlessly across various blockchain networks and avoid being limited to specific solutions. This is extremely beneficial for platforms that can benefit from a single interface and codebase for cross-chain pairs such as Sushiswap (who has to write code when they want to sync with Mainnet).
Summary
LayerZero’s Omnichain Fungible Token (OFT) standard offers a new approach to improve liquidity between different blockchains and enhance interoperability. By eliminating the need for multiple tokens on different chains, the OFT standard ensures consistency across all chains. LayerZero achieves this through the use of Ultra Light Nodes (ULN), which provide a cost-efficient and secure cross-chain communication solution.
The benefits of using OFTs are numerous, including solving de-pegging risks, increased security with minimized failure points, unified liquidity across all chains, conducting governance across multiple chains without the need to transfer assets, and state sharing for seamless operation across various blockchain networks.
The future of DeFi lies in cross-chain technology, and LayerZero’s OFT standard represents a significant step in achieving that goal. With this innovative solution, new dApps can participate in an Omnichain future and won’t just be confined to EVM or Non-EVM.
