Over the past year and a half, Decentralized Finance applications have taken the cryptocurrency domain by storm. Hundreds — if not thousands — of protocols offering interest rates, token rewards, and liquidity incentives have been launched, attracting millions of users and billions of dollars worth of capital. The massive influx of users, however, created an unsustainable network demand for the Ethereum ecosystem, which led to absurdly high fees for miners to include transactions on the blockchain. These fees rendered DeFi applications virtually unusable for the average user.
As a solution, DeFi protocols began building out support for alternative blockchains that were (in theory) more scalable than the Ethereum base layer. “Layer 2” blockchains — such as Polygon — that integrate with Ethereum, as well as alternatives such as Binance Smart Chain have emerged as solutions. While these alternatives do offer a viable solution for the fee problem, they leave a new problem in their wake: fragmented liquidity.
It is difficult and costly for experienced DeFi users to move funds across chains. It is near impossible for newcomers to do so — let alone understand these problems, to begin with. While the fee problem has been solved, these separate solutions have effectively split liquidity into segregated markets that are isolated from one another. There may be liquidity for a trading pair on Polygon — but not on ETH or BSC, for example. This poses a significant new challenge for the industry.
Cross-chain bridges to the rescue
The self-evident and almost natural solution to the problem of liquidity fragmentation is a cross-chain bridge. Cross-chain bridges can enable liquidity to flow seamlessly between blockchains and increase capital efficiency in the system. Such bridges can operate between two blockchains, between a blockchain and a side chain, or even between two side chains. This interoperability allows the transfer of tokens, data, and even smart-contract instructions between independent platforms. With cross-chain bridges, projects can also migrate assets deployed on one network to dapps on other networks.
These bridges and their use cases can very well extend beyond just the transfer of assets as they open a new world of opportunities — where these bridges establish a secure decentralized communication network that can send signals from one blockchain to another. Think of them as building blocks of inter-blockchain communication networks.
Router Protocol as a bridging infrastructure
Router Protocol is a cross-chain bridge that supports this exact function. It will have ParaRouter contracts deployed on various blockchains which will communicate with each other via a Central Router. All funds that move through the protocol are first transferred into stablecoins on the source chain and then swapped into the user-desired asset on the target chain.
For cross-chain swaps, the protocol needs to plug into an AMM, which is where Dfyn fits into the equation. The Dfyn DEX acts as Router Protocol’s liquidity reserve, powering the cross-chain transfers and swaps that facilitate the movement of liquidity across chains. As a blockchain-based DEX, all transactions are recorded on-chain — giving users complete and total visibility of what’s happening behind the scene.
On chains with Dfyn nodes, Router will prioritize integration with Dfyn. However, it will not be the only AMM which Router Protocol will leverage. In the spirit of decentralization, Router Protocol will integrate as many AMMs as it can to effectively offer the best prices to the users. To facilitate cheap and ultra-fast cross-chain transfers, Router Protocol will also maintain its own single asset reserves for stablecoins and popular assets such as ETH and MATIC.
What makes Router stand apart is its behavior as a liquidity aggregator — meaning it can access already-existing liquidity on any target chain. If for some reason there is little to no liquidity of stablecoins assets on a destination chain, Dfyn will be used as Router’s emergency liquidity reservoir.
The problem of liquidity fragmentation has become harder to ignore as more siloed ecosystems emerge across the DeFi space. To solve this issue, multiple bridging technologies have come to the fore.
Connext is a cross-chain liquidity network that facilitates atomic transfers from Ethereum and other EVM-compatible chains to L2 systems. It functions through its state channel nodes, which front liquidity and route across its off-chain network to facilitate swaps. It operates similarly to off-chain L2 networks, such as the lightning network.
Some pain points in the Connext Protocol include:
a) Lack of a scalable rebalancing mechanism — At the moment, each Connext router has individual liquidity pools on each chain. Low liquidity means that large-scale transfers would move a disproportionate amount of funds to one side of the bridge. Since there is no involvement of arbitrageurs, Connext Routers are themselves required to move funds back across the bridge. This process can be time-consuming and expensive.
b) Liquidity aggregation — Scaling the number of state channel nodes and aggregating liquidity across them is a significant hurdle for Connext.
c) Data availability problem — Since Connext is fundamentally a state channel, one of its major drawbacks is that it requires the users to maintain their latest off-chain state at all times. Both the user and the router node need to be 100% available during the transaction to monitor the transfer of assets.
ThorChain is another cross-chain DEX that utilizes a mechanism similar to Bancor to source its liquidity. Instead of stablecoins being the medium of exchange (as is the case with Router Protocol), all liquidity in ThorChain’s BEPswap is bonded to RUNE — ThorChain’s native token.
While bonding to RUNE minimizes the number of pools that must be routed through to complete a trade of two non-RUNE assets, it has some clear vulnerabilities. First, many users may not wish to be exposed to RUNE price movements. Second, a low amount of liquidity for RUNE could make trade slippage very high. Third, routing through multiple pools means trading fees are paid multiple times — making BEPswap and ThorChain an inefficient method of moving assets cross-chain.
O3 Swap (PolyNetwork as the bridging infrastructure)
O3 is a cross-chain protocol that utilizes the PolyNetwork router as its underlying bridging infrastructure. PolyNetwork operates very similarly to Router Protocol, but with a few differences. Both protocols utilize cross-chain communication services to conduct their cross-chain swaps and transfers and facilitate the automatic rebalancing of reserves via arbitrage trades.
Due to the nature of PolyNetwork routing, the scope of trades available for O3 swap is limited. PolyNetwork itself keeps no liquidity reserves, which means O3 must provide its own liquidity. While O3 aggregates AMMs on the source chain, it does not have any mechanism to interact with PolyNetwork bridge on the destination chain, rendering it incapable of aggregating any AMMs on the target chain. For this reason, on the destination chain, O3 cannot provide user-desired assets. Another significant drawback while using O3 is the additional 0.3% fee that O3 charges on top of the PolyNetwork fee and the AMM fee, making the whole transaction quite expensive.
Hop Protocol is a generic token bridge that facilitates transfer of tokens across rollups and their underlying layer 1 network. Hop relies on third-party entities known as Hop Bonders (akin to Connext Routers) to provide up-front liquidity at the destination chains on demand. Some major concerns that a user might face while using Hop protocol include:
(a) No support for direct L2-to-L2 transfers: All the L2-to-L2 transfers on the Hop protocol have to be propagated through the underlying layer-1 blockchain (Ethereum). Even though a single L1 transfer accounts for hundreds of swaps bundled together, the Hop protocol does not relieve the layer-1 bottleneck entirely since propagating a Transfer Root through layer-1 can be a slow process.
(b) Asset Fragmentation: Hop protocol doesn’t give its user the original tokens on any of the rollups. Instead, the users are given representative Hop tokens on the rollups which they can redeem for the original tokens only on layer 1. Hop tokens might not have any real liquidity or exposure on the rollups which can be a real cause of concern for the end-users.
© No support for cross-chain swaps: Hop Protocol currently only supports like-to-like transfers leading to reduced flexibility for the users.
Comparing and Contrasting
Clearly, the table above speaks for itself. Across various parameters, other than perhaps Thorchain, no other project really addresses the overall opportunity space in as comprehensive a manner as Router.
Access to viable liquidity is perhaps the most crucial function of a cross-chain bridge and DEX. Without ample liquidity, trades become expensive and traders incur extremely high slippage. Router Protocol achieves the best of both worlds by aggregating liquidity from preexisting AMMs no matter where the liquidity originates. By doing this, it allows for the best market rates in a way that its competitors do not.
It’s not enough to simply source ample liquidity — it must also be maintained. Most current cross-chain protocols are not sustainable or scalable in their current form because they require manual rebalancing to maintain sufficient liquidity on all sides of the bridge. Thorchain, though unique, requires all liquidity to route through RUNE tokens. Router Protocol relies on arbitrageurs to maintain sufficient liquidity levels, while using stablecoins as the medium of exchange — protecting the capital involved and ensuring no value loss due to volatility-driven slippage.
About Router Protocol
Router Protocol is building a suite of cross-chain liquidity infra primitives that aims to seamlessly provide bridging infrastructure between current and emerging Layer 1 and Layer 2 blockchain solutions.
Telegram announcements: https://t.me/router_ann