Wormhole product lead: Native token transfer is the future of interoperability

Author: Nikhil Suri, Product Director of Wormhole Foundation, CoinDesk; Compiler: Deng Tong, Golden Finance

Execution Cross The ability to chain transfers is critical to building a multi-chain future. To this end, “wrapped assets” emerged as a way to facilitate transfers between blockchains and have since become the most advanced solution for users and developers.

However, packaging assets has serious limitations. Interoperability protocols have been working to iterate on newer methods for transferring assets “natively” between blockchains to address user and developer concerns. The new approach not only simplifies development but also enhances usability, ultimately creating a more user-friendly DeFi environment.

The status of packaged assets

Historically, creating packaged assets has been the method of choice for developers, using For bringing assets to new blockchains, expanding the user base and benefiting from unique features on different chains. Wrapper assets are tokens that represent another token on a different blockchain, and their value is the same as the asset they represent1: 1 hook.

Packaging assets allows them to be used on networks where they would not otherwise exist, thereby Creating a new paradigm of decentralized finance (DeFi). For example, Bitcoin (BTC) can be brought onto the Ethereum blockchain by “wrapping” it as an ERC-20 token, which enables Bitcoin holders to use their tokens within Ethereum’s DeFi ecosystem.

Wrapping assets also enables the protocol to scale to new blockchains with extremely low barriers to entry. Projects deploying tokens on a single chain can deploy standard "wrapped" representations of the token through interoperability protocols that can be expanded to any new chain with the click of a button.

However, this low threshold is a double-edged sword. Because interoperability agreements deploy packaged assets on behalf of a project, these assets are irreplaceable between different interoperability agreements.

For example, users can move Ethereum (ETH) from Ethereum to Arbitrum via Wormhole Token Bridge, Axelar Token Bridging, or Arbitrum Native Bridge, but each route results in a different, non-fungible asset. This leads to fragmented liquidity, deteriorating user experience, and suboptimal markets.

Another drawback is that tokens do not always behave consistently across chains or retain their advanced functionality, since wrapper assets are owned by the smart contract that created them. This can also interfere with important administrative functions such as upgrades or ownership transfers.

Wrapped assets were the catalyst for DeFi’s initial expansion into multi-chain ecosystems and will always have a place. However, as protocols mature and become more complex, alternative solutions for coordinating the deployment of different tokens are urgently needed.

Native token transfer: a next-generation approach

A new idea that is gaining traction is native token transfers. This involves the protocol deploying its canonical token natively to multiple blockchains and using an interoperability layer to facilitate on-chain transfers. Compared to wrapped assets, native token transfers ensure projects maintain ownership, upgradeability of their tokens on various blockchains and customizability. This prevents liquidity fragmentation and means that no matter which chain a token is transferred to, it maintains its unique characteristics.

Perhaps the best new approach is native burning and minting, which involves burning native tokens on the source chain and minting equivalent native tokens on the target chain.

Take the burning and minting model as an example, Circle's Cross-Chain Transfer Protocol (CCTP), which securely facilitates USDC transfers between blockchains through native burning and minting. CCTP enables Circle to no longer rely on a packaged USDC representation, thereby enhancing user-friendliness and reducing USDC fragmentation across the crypto ecosystem.

Cross-chain liquidity networks provide another native token transfer method. These involve a market maker network or exchange protocol that will accept native tokens on the source chain and release native tokens on the target chain. For example, a user who wants to transfer Ethereum from Abitrum to Optimism can send it to the liquidity network on Arbitrum, which will route it to a market maker to complete the cross-chain transfer to the user's wallet on Optimism.

A popular example of a liquidity network model is the Wombat exchange, which uses a novel protocol to facilitate cross-chain stablecoin exchange. This model is particularly useful for tokens that cannot be minted and burned on demand, such as Ethereum or Bitcoin. At the same time, liquidity networks typically charge higher fees due to the involvement of third parties, and some routing mechanisms may be affected by MEV.

The native token transfer model decouples the token transfer process from the underlying interoperability protocol, thus providing projects with Greater flexibility. This enables builders to configure advanced validation and set threshold requirements, and choose between different interoperability protocols.

A step towards major interoperability

Native token transfer frameworks are more than just a technological evolution; they are a step toward realizing the full potential of blockchain technology. They can serve as long-term solutions, able to evolve alongside the protocols that utilize them. With wrapped assets, DeFi protocols can quickly scale to new blockchains, but must worry about token contract lock-in, liquidity fragmentation, and ownership and upgradeability.

With a native token transfer framework, protocols can still benefit from rapid scaling while focusing on what matters: configurable security and giving themselves the ability to change over time. As we move forward, interoperability will continue to play an important role in shaping a strong, user-centric DeFi space and provide projects with the sovereignty to define what works best for them.