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The blockchain industry is experiencing a period of rapid growth, with its recent market capitalization reaching $2.3T+—an exponential increase on its ~$700M value in December 2020. Part of this growth can be attributed to the increased size of decentralized finance (DeFi) markets, which are unlocking new financial opportunities for a global audience. Yet, while DeFi is a cutting-edge, transformative industry that has grown ~1200% year-over-year since December 2020, its current value of $240B+ still only represents about 10% of the wider blockchain industry’s total market capitalization.
Blockchain and DeFi’s immense growth over the past year.
Though multiple factors have contributed to the blockchain industry’s growth, one of the reasons for the latest surge is that more projects are leveraging real-world data and off-chain computation through Chainlink decentralized services, enabling the creation of more advanced smart contract applications across multiple chains. The mainnet launch of multiple chains and layer-2 networks in 2021 has further fueled industry growth, spurring rapid innovation by giving developers the ability to leverage new blockchain architectures to build novel smart contract use cases.
However, as users increasingly adopt new blockchains, liquidity becomes trapped across different smart contract platforms. Multiple projects have created or are building wrapped tokens that look to solve this problem. A notable example is WBTC, which was created by Bitgo in collaboration with Kyber Network and Ren. WBTC is currently the most widely used wrapped version of Bitcoin and its collateralization is made transparent via Chainlink Proof of Reserve (PoR).
The following blog post explores how wrapped tokens work, outlines how Chainlink PoR is the most time-tested and tamper-proof solution to help secure and autonomously audit wrapped tokens, and explores how Celsius is already leveraging Chainlink PoR to unlock cross-chain liquidity for DeFi users.
What Are Wrapped Tokens?
While different wrapped tokens have their own novel architectures, they are generally understood as on-chain assets pegged 1:1 to the value of another asset, be it a commodity, a real estate property, another blockchain token, or any other asset. One of the main reasons developers create wrapped tokens is to unlock asset liquidity across blockchains. Before wrapped tokens, native blockchain assets were isolated within their respective on-chain environments, since most blockchains do not feature native interoperability and often support different selections of tokens.
To overcome this hurdle, many traditional wrapped tokens backed by assets on another blockchain are created through a similar process. First, users send their token collateral to a custodian, who then mints a representation token on another blockchain. When users wish to redeem their wrapped assets, they send a request to the custodian, who burns the wrapped tokens in exchange for the user’s collateral.
Wrapped tokens can also be created to represent off-chain collateral using a similar process. However, a single institution often creates its tokens, in many cases by controlling the entire minting, redeeming, and burning process. This leads to a more opaque process, as users cannot verify real-world asset reserves directly on-chain. Furthermore, with a single party or a small number of parties controlling their issuance or supply, wrapped tokens are often centralized and subject to a single point of failure. This means users cannot audit wrapped token collateralization and verify whether or not tokens are being rehypothecated.
While some projects have opted to prepare traditional audits to offer more transparency into wrapped assets, these are typically lengthy, costly, and manual processes subject to error.
Securing and Auditing Wrapped Tokens With Chainlink PoR
As developers continue to build wrapped tokens to unlock cross-chain liquidity, a highly reliable, transparent, and decentralized standard that enables wrapped tokens to be securely audited through an automated process is required—enter Chainlink PoR.
Autonomous On-Chain Auditing Across Any Network
Rather than forcing users to trust paper guarantees made by custodians, Chainlink PoR can be deployed for automated on-chain audits that give users a superior guarantee of a wrapped token’s true underlying collateralization. As a result, users gain transparency into their risk exposure and gain confidence in the backing of their wrapped tokens.
Chainlink is blockchain-agnostic, meaning PoR can help secure wrapped tokens across any on-chain or layer-2 network. Chainlink PoR feeds are also secured by oracle nodes run by leading blockchain DevOps teams, data providers, and traditional enterprises, helping ensure robust data quality even during adverse market and external network conditions.
Circuit Breakers to Mitigate Fractional Reserves
Beyond providing users and dApps on-chain audits of collateralization, Chainlink PoR is also increasingly being used to help secure the minting, redeeming, and burning of wrapped assets. Chainlink PoR eliminates inefficient manual auditing processes by replacing them with on-chain real-time audits. This enables developers to use PoR as a circuit breaker that halts minting/burning if fractional reserve activity is detected, helping mitigate against the minting of unbacked wrapped tokens.
Once Chainlink PoR determines that wrapped tokens are undercollateralized, Chainlink Keepers can be used to halt the minting, redeeming, and burning of wrapped tokens, giving developers the ability to fix the underlying problems without putting users at risk.
Transparency Around Real-World, Off-Chain Reserves
Another unique aspect of Chainlink PoR is that its flexible architecture enables the auditing of both real-world and on-chain reserves through tailormade External Adapters. Chainlink PoR can also be monitored by anyone in real-time, allowing users to verify the current collateralization of assets.
How Chainlink PoR helps secure wrapped tokens backed by on-chain reserves.
How Chainlink PoR helps secure wrapped tokens backed by off-chain reserves.
Exploring Celsius’ Integration of Chainlink PoR
Celsius is a leading centralized finance (CeFi) protocol that recently integrated Chainlink PoR to help secure and audit wrapped versions of ADA, DOGE, and ETH currently available on Polygon, with more tokens planned for release in the near term. Not only does Chainlink PoR enable the real-time auditing of Celsius’ wrapped tokens, but it also checks the collateralization of its vault reserves to help trigger the minting, redeeming, and burning of smart contract functions.
How Chainlink PoR helps secure WADA.
One of the unique features of Celsius’ Chainlink PoR-powered wrapped tokens is that strategies in its custom-designed Enzyme vault help offset user costs, meaning users can bridge their assets cross-chain without incurring major fees. While the Enzyme vault is initially managed by Celsius, it is planned to be controlled by a community DAO in the future to help further decentralize the wrapped tokens and remove single points of failure.
By integrating Chainlink PoR to create fully auditable wrapped cross-chain tokens, Celsius has effectively created a high-performing and decentralized CeDeFi application that unlocks liquidity across the blockchain space. The Cardano, Dogecoin, and Ethereum communities can now seamlessly lock up their tokens to access a wide range of DeFi applications on Polygon, including lending and borrowing protocols, prediction markets, and yield farms. In its V2 integration, Celsius plans to use CCIP to further decentralize their wrapped tokens and unlock cross-chain liquidity across the entire DeFi space.
Check out Celsius’ announcement or watch this short explainer video for technical details around Celsius’ integration of Chainlink PoR:
“Celsius’ integration of Chainlink PoR will mark another large leap towards creating hybrid CeDeFi systems that combine CeFi’s functionality and performance with DeFi’s decentralization and transparency guarantees. Celsius has a long history of leveraging Chainlink’s industry-leading oracle network because it provides tamper-proof real-world data and off-chain computation that creates an unrivaled user experience for our community. We also look forward to our near-term integration of CCIP to unlock even greater cross-chain functionality that will power more advanced smart contract applications.” — Alex Mashinsky, Founder and CEO of Celsius Network
Sergey Nazarov, Co-founder of Chainlink, stated, “We’re pleased to continue to support Celsius and the broader blockchain ecosystem by helping secure wrapped cross-chain tokens that unlock more advanced smart contract use cases. Chainlink Proof of Reserve replaces lengthy, opaque audits with automated, transparent audits backed by cryptographic truth, empowering users to verify asset collateralization in a way that outmatches traditional solutions.”
- Chainlink Proof of Reserve: Bringing Transparency to DeFi Collateral
- The Future of Asset Management Using Smart Contracts and Blockchain Oracles
- Blockchain in Insurance
The post Using Chainlink Proof of Reserve to Unlock Cross-Chain Liquidity With Wrapped Tokens appeared first on Chainlink Blog.
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