The Intelligent Insurer #75: Increased interoperability encourages adoption but brings new risks
As the blockchain industry matures and more protocols emerge, there is an increasing need for these protocols to interact seamlessly. Although not fully evolved, several projects are tackling the blockchain interoperability issue as the industry pushes for mainstream adoption. At the same time, the growing intertwining of blockchain protocols exposes the industry to new risks.
The latest Intelligent Insurer will analyze the current state of blockchain interoperability. We will also examine the risks that the industry faces as projects become more intertwined and how investors can continue to protect themselves.
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The present state of blockchain interoperability
The blockchain industry is teeming with projects that offer diverse use cases. Some are creating sound money alternatives to the present fiat system. Others are creating Metaverses and digital art. Dozens of new blockchain networks are emerging each year — each competing to create the “best” blockchain.
These networks argue that their products are more secure, scalable, and better compared to rival alternatives. For a long time, this increased competition among blockchains resulted in what Ethereum software developer Consensys calls balkanization — a situation “where protocol interoperability is deprioritized as companies race to demonstrate their own blockchain’s use case quicker than their competitors.”
Regardless of whether the claimed qualities are true or not, these projects represent disconnected blockchains. Most of these projects operate in isolated ecosystems as they address a unique set of needs. However, inadequate interoperability results in fragmented liquidity and slow-paced innovation, preventing the industry from reaching its full potential. As the adverse effects of siloed blockchains become more evident, developers are becoming aware of the importance of interoperability.
Different projects are currently addressing the growing need for more interoperability. Proofs of concept such as BTC Relay, projects like Wanchain, bridges like Wormhole, and many more, are evidence of the surging demand for interoperability. Some blockchain networks are built from the ground up with interoperability in mind.
Achieving large-scale interoperability on Cosmos
Cosmos is one of the most prominent interoperability blockchains in the industry. It is the first permissionless platform to enable interoperability between different blockchain networks. Called the “internet of blockchains” by its developers, the Cosmos network is an ever-expanding ecosystem of interconnected apps and services. Its goal is to enable an ecosystem of networks that can share data and tokens without centralization.
Cosmos provides developers with open-source tools, including a Software Development Kit (SDK), to build decentralized and sovereign blockchains called zones. By default, Cosmos SDK tools use the Tendermint Byzantine Fault Tolerance (BFT) consensus protocol to secure the network. Tendermint BFT allows developers to build zones from scratch without coding. The network minimizes complexity by offering developers common blockchain functionality such as staking, governance, and more. Developers have the freedom to pick and choose these functionalities as they see fit.
Each zone can function independently, but they are all tethered to the Cosmos hub, which maintains a record of activities in the zones. Cosmos uses the Inter-Blockchain Communication (IBC) protocol to ensure that the heterogeneous blockchains can communicate securely. All these tools and features create an interoperable and highly scalable blockchain ecosystem. The network is powered by its native cryptocurrency, ATOM, used for fees, staking, governance, and more. At the time of writing, ATOM is trading at $7.79.
Systemic risks arise as protocols become more intertwined
Although the blockchain ecosystem is not fully interoperable yet, the protocols and platforms pushing for increased interoperability are rapidly evolving. However, as more blockchain applications and platforms become intertwined, the digital asset industry becomes vulnerable to systemic risk.
In an interoperable system, one part of a failed project can take down a chunk of capital, crippling the industry. For instance, when the Terra ecosystem collapsed, it dragged down the digital asset market. Terra was interoperable with other protocols and all the protocols it worked with suffered collateral damage from the collapse. Additionally, the protocol held 80,000 BTC, which it liquidated in a failed attempt to protect its ecosystem. A prominent entity selling such a large amount of BTC within a short time frame puts immense selling pressure on Bitcoin’s price.
Therefore, while interoperability remains a need within the industry, developers must focus on creating protocols with good fundamentals and high security. It will reduce the chances of a large-scale collapse that could potentially cripple the digital asset market. Adequate transparency is also necessary to enable all connected chains to be aware of what is going on in each chain.
In a world where one project’s collapse can create a domino effect on the entire market, it is wise to have adequate safeguards in place. Investors must not neglect the importance of adding a digital asset insurance product to their portfolios. These insurance solutions, such as the ones provided by Insured Finance, offer the best way to mitigate risk and protect assets.
About Insured Finance
Insured Finance is a decentralized, peer-to-peer insurance marketplace. Users can request customized insurance on a wide variety of digital assets, thereby ensuring full protection. Those fulfilling requests can earn premiums and earn a competitive return on their capital. Claims are fully collateralized and settled instantly.