Bitcoin’s potential usage as a strategic reserve has signalled a new financial era. The introduction of Bitcoin and Ethereum ETFs and an influx of capital from the likes of Blackrock and Goldman Sachs further reinforce this shift. Furthermore, the Bank of England (BOE) and the UK’s Financial Conduct Authority (FCA) have proposed a Digital Security Sandbox (DSS), and Commissioner Hester Pierce of the US SEC has proposed a joint UK-US DSS.
The industry is waiting for Web3’s “section 230 moment” to scale up blockchain infrastructure and bring many POCs to production. With Web3 becoming mainstream and poised to challenge Web2, a question remains: is the blockchain ecosystem interoperable enough to cope with it?
The urgent need for improved interoperability
The entire blockchain ecosystem is still fragmented, and the infrastructure of different blockchains is largely incompatible. This is what complicates the movement of assets and data between chains.
Whilst incremental progress is being made to solve this issue from a retail perspective, reforming an entire financial system requires a different level of connectivity. Institutional investors obviously bring significant liquidity to the crypto ecosystem, but this liquidity is siloed in individual chains and protocols.
BTC alone has grown into a market capitalisation of US$1.2 trillion, which is currently inaccessible to most institutional Bitcoin holders. The volume of crypto transactions is rapidly increasing, but the infrastructure is not expanding at the same rate. This will lead to more of the same problems — operational delays and high execution costs — on a much larger scale.
A 2023 survey conducted by the Enterprise Ethereum Alliance on blockchain technology adoption showed that interoperability is a top take away for its members. Enterprises of various industries have shown interest in bringing their IT system infrastructure to
blockchain, optimistic that interoperability will help them reach out to other blockchains. Improving cross-chain interoperability should thus be a foremost consideration for traditional institutions.
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Their growing acceptance, investment, enthusiasm and advocacy for crypto needs a clear and straightforward path to adoption. As a bare minimum, major TradFi players require seamless interoperability to embody their custodial responsibilities. They cannot afford to take risks when managing assets across multiple blockchains.
If individual traders are experiencing clunky inconveniences, imagine what those problems would look like at the enterprise level.
Without a drastically improved framework for interoperability and standardisation, they will not be able to access the full power of decentralisation.
The onus, then, lies with the Web3-native protocols, projects and ecosystems to actively work on introducing robust and scalable industry standards. With a unified blockchain ecosystem, institutions will be able to unlock liquidity pools, optimise their capital allocation and fully embrace decentralised systems. Emerging financial products such as crypto derivatives and tokenised assets will then be primed for longevity.
Sourcing standards
Developing and implementing universal standards and protocols is a critical step toward achieving the above. Projects like Cosmos’ Inter-Blockchain Communication (IBC) protocol and Polkadot’s relay chain are promising attempts. However, these efforts remain disjointed and competitive instead of prioritising the collaboration needed for a mutually beneficial outcome.
Open-source approaches, such as that adopted by the Ethereum Enterprise Alliance (EEA) to rollout their Distributed Ledger Technology Interoperability Specification, are more favourable. The EEA realised very early on that interoperability would be a prerequisite to widespread blockchain adoption and has made serious inroads to formalise best practices.
Similar work is also being conducted among more global trade associations and international organisations, such as the International Association for Trusted Blockchain Applications (INATBA), IETF, and the ISO. Whilst wheels are in motion,
practical application needs to be accelerated. A simple start would be determining fixed common interfaces and decoding functions to align across all ecosystems, reducing the need for custom implementations when verifying cross-chain messages.
Wall street must be educated
Secondly, Web3-natives must move boldly in educating major institutions on interoperability. In the same way bottom-up educational initiatives are needed to empower Web3 infrastructural developers, tailored initiatives must be made accessible
to parties from the top down. Once they understand the need for a widespread solution that will serve their long-term decentralised ambitions, they, too, can contribute relevant resources.
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Institutions need to understand the logistics of how cross-chain interoperability solutions will make their lives easier. Interoperability will impact the creation of sophisticated asset management tools and custodial services, determine capital allocation strategies, provide more scope for risk diversification, and, perhaps most pressingly, ensure that tokenised financial instruments can sustain themselves.
Evolution due, unification vital
Ultimately, without interoperability, institutional adoption will not achieve its intended impact. The clock is ticking. With increasing amounts of Web2 capital entering the crypto markets, it’s imperative that seamless cross-chain solutions are developed at a more efficient rate.
DeFi is due for its next phase of evolution, and interoperability should be a mandatory component. It’s unimaginable that the influx of institutional interest will fade completely, but it will face major barriers if the necessary solutions aren’t in place.
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