Finance is not, and has never been, a static concept.

For centuries, finance took a physical form, with transactions and asset ownership recorded on paper and trading taking place between humans in a physical location. The conduits of finance remained fundamentally unchanged until the mid-20th century when trading volumes on Wall Street grew so significant that brokerages were forced to adopt mainframe computers and convert the financial system into an electronic format just to keep up with the paperwork.

In an electronic format, financial transactions and asset ownership are digitized, but ultimately recorded across a fragmented collection of databases managed by different centralized intermediaries, particularly between different industries and asset classes. This database fragmentation necessitates constant and continuous reconciliation between institutions in order for each to maintain a consistent view of the assets and transactions relevant to them and their clients. These, often manual, processes naturally lead to human errors, increased costs, and settlement delays.

Furthermore, databases that record asset ownership are often disconnected from databases containing materially relevant information about assets, such as contractual agreements involving the asset (e.g., has the asset already been pledged as collateral) and key risk information needed to price the asset properly. Because no single database provides a complete picture of the state of an asset, information asymmetry arises between asset issuers and purchasers, typically favoring the issuer who has more information at hand.

This is the financial system we deal with today.

A fragmented collection of siloed databases, controlled by a never-ending series of rent-seeking intermediaries, for which it is effectively impossible for anyone to achieve a complete global view of the entire system.

The primary consequence of such an opaque, inefficient system is that its participants, including financial regulators, are unable to properly identify, measure, or mitigate systemic risks. The net result is an amplification of the destructive boom-and-bust cycles, where society ultimately pays the bill when bailouts are inevitably required. The 2008 financial crisis had no single root cause, but opacity around systemic exposure to toxic assets played a key role.

Tokenization embodies the belief that we can do better.

Tokenized Finance Was Always Inevitable 

It’s easy to see tokenization as being a radical departure from the status quo of finance. But history shows that the real radical change was the aforementioned shift from a physical paper format to electronic digital format. Tokenization is simply an obvious, yet powerful optimization.

Practically speaking, tokenization is the consolidation of the global financial system and its fragmented collection of databases into a single shared network. In a tokenized financial system, blockchains serve as the golden source of truth for the state of any asset or agreement. These distributed ledgers not only record and verify asset ownership, but also serve as a programmable execution layer and immutable data storage layer.

Through this perspective, the value proposition of tokenization becomes clear:

• Information asymmetries are eliminated as all participants have access to the same comprehensive datasets about assets at the same time as everyone else.

• Expensive and error-prone database reconciliations are no longer necessary, as one only needs a copy of the shared public ledger to anchor their internal records, reducing costs for consumers.

• Rent-seeking intermediaries lose their relevance as any contractual agreement involving an asset can be codified as an autonomous smart contract, with predefined triggers and outcomes executed exactly as written.

• Multi-day settlement delays become a foreign concept as transactions finalize in less than a second via a shared ledger that is available 24/7/365, including during weekends, holidays, and maintenance periods.

• End-to-end transaction costs are reduced as assets can be embedded with custom logic, from automatically distributing dividends to bond holders to automatic rebalancing of a fund when predefined valuation triggers are met.

• Financial transactions that were previously impractical or too costly, such as micropayments and payment streams, become feasible for anyone and everyone on a global scale.

• Entirely new categories of digitally-native asset classes can be created in the future that cannot be possibly foreseen today, derived from the unique attributes of blockchains and tokenization.

Tokenization is the superior way to represent assets.

While the benefits of tokenization are clear, the reality is that nothing is ever as simple as it seems. There are a number of key roadblocks that need to be first overcome in order for tokenized finance to achieve its full potential.

Roadblock #1: Blockchain Fragmentation

The idea that all the world’s financial transactions can be recorded on a single blockchain’s ledger is completely unrealistic. This stands from both a technical perspective—no single blockchain can scale to handle all the world’s transactions while maintaining the properties that make blockchains unique—and from a practical perspective—it’s extremely unlikely that everyone, including all institutions and nation states, will align on and agree to use the same blockchain.

Already today, there are hundreds of distinct public and private blockchain networks, each of which can be considered its own database silo given the lack of native interoperability. As the cost and complexity of launching a blockchain continues to trend towards zero (e.g., due to the proliferation of services such as rollup-as-a-service providers), it is extremely probable that the number of blockchains will continue to grow and multiply.

Is the fragmentation of the multi-chain ecosystem no different than the fragmentation of database silos in the existing financial system? Is the “single shared network” vision of tokenization thereby unachievable?

This is where cross-chain interoperability comes into play. By serving as a universal communication layer between distinct blockchain networks, protocols like Chainlink CCIP enable the multi-chain ecosystem to operate as if it were one unified network. Assets and data can seamlessly flow between different blockchain networks, just as easily as data packets are sent between servers in the existing Internet today.

For tokenized assets, cross-chain interoperability isn’t a nice-to-have, but rather a fundamental requirement. A tokenized asset that is restricted to one blockchain ledger means that the total addressable market for that asset is confined to that one chain environment—likely a small fraction of the total available liquidity that would be willing to purchase the asset.

Any such financial asset will be easily overshadowed by an equivalent product that is available cross-chain, given its superior accessibility and liquidity profile. From the perspective of an asset issuer, it makes little difference what underlying blockchain a counterparty wants to use, as long as they are willing to pay.

In addition to direct chain-to-chain interoperability, Chainlink CCIP also serves as a blockchain abstraction layer, enabling institutions to connect to any public/private blockchain using their existing backend infrastructure and established banking messaging standards. Rather than manually integrating with the hundreds of blockchains networks, institutions only need to integrate with CCIP once to access any blockchain environment their counterparties may operate on.

This blockchain abstraction capability was highlighted in an industry collaboration between Swift—the interbank messaging network used by 11,000 banks globally—Chainlink, and more than a dozen financial institutions and market infrastructures including DTCC, Euroclear, and Clearstream.

“The collaboration between Swift, Chainlink, and the financial community represents significant progress towards enabling interoperability between traditional financial systems and emerging blockchain networks … By leveraging existing Swift infrastructure and Chainlink CCIP, the collaboration demonstrated the ability to transfer tokenised value efficiently and securely across public and private blockchains, using standardised messaging formats and proven business processes.” — Swift

Cross-chain interoperability is also key to unlocking more advanced tokenized asset workflows such as cross-chain delivery vs payment (DvP)—a settlement process in which payment is made before or at the same time as the delivery of the purchased asset. In a recent collaboration, ANZ Bank—an Australian institutional bank with $1+ trillion AUM—demonstrated how Chainlink CCIP enabled the purchase of a tokenized carbon credit issued on one blockchain with ANZ-issued stablecoins issued on another blockchain.

Through a single transaction, enabled by CCIP’s Programmable Token Transfers, participants were able to complete a cross-border, cross-chain, and cross-currency DvP transaction involving multiple currencies and assets.

“We’re excited to drive financial innovation at ANZ by providing our clients with seamless access to tokenized assets through an easy-to-use platform. Chainlink CCIP played a key role in abstracting away the blockchain complexity of moving tokenized assets across different chains and ensuring atomic cross-chain DvP.” — Lee Ross, Technology Domain Lead, ANZ

Roadblock #2: Offchain Data Access

Eliminating information asymmetry via tokenization requires that all relevant data about an asset be recorded onchain and be accessible to all parties. However, blockchains do not natively have access to external data resources or the offchain systems where data originates.

If market participants still need to reference a fragmented collection of traditional databases to gather materially relevant information about assets, then the vision of blockchains being the “golden source of truth” will fail to materialize.

This blockchain oracle problem, as it’s commonly referred, is the key limitation of blockchains that Chainlink was originally built to solve. Since its launch on mainnet five years ago, Chainlink Data Feeds have become the standard for onchain financial market data. Securing over $60 billion in DeFi TVL at its peak and over $12 trillion in transaction volume, Chainlink Data Feeds prove not only can blockchains serve as a golden source of truth for onchain financial markets, but that the Chainlink oracle network model is well suited to bring any type of financial data onchain.

More specifically, Chainlink enables asset issuers to bring key data relevant to a particular asset onchain, including standing settlement instructions, corporate actions, proxy voting, dividends and interest, net asset values, and more. This data, once recorded onchain, can be referenced by any offchain market participant, as well as onchain financial protocols that execute predefined actions based upon these data inputs.

When combined with CCIP, onchain data can be transferred alongside a tokenized asset as it moves cross-chain, ensuring the asset continues to be updated with materially relevant information, even as it exchanges hands and moves across networks.

As a practical example of this onchain data connectivity, the Depository Trust & Clearing Corporation (DTCC)—the world's largest securities depository and primary infrastructure in the U.S. for clearing, settlement, and asset servicing—recently published the results of a Smart NAV pilot where Chainlink CCIP was used to deliver net asset value (NAV) data onchain to support the tokenization of mutual funds. In collaboration with 10 market participants, including JP Morgan, BNY Mellon, and Franklin Templeton, the DTCC and Chainlink proved the feasibility and industry value of delivering a blockchain-based price and rate dissemination solution.

“The Smart NAV pilot demonstrated CCIP’s ability to serve as an abstraction layer between DTCC and the potentially infinite number of blockchains we may need to integrate to at some point in the future. Rather than building bespoke connections, we were able to validate an approach where DTCC systems integrate to a single CCIP endpoint which can then relay the data to virtually any destination blockchain.” — DTCC

Chainlink as Essential Infrastructure for Tokenized Finance

The true value of Chainlink for tokenization is not just its cross-chain capabilities, its onchain data capabilities, or its blockchain abstraction capabilities, but the fact that it serves as a universal platform providing all of the services that a tokenized economy needs, but that blockchains alone do not provide.

Compared to combining a hodgepodge of solutions from across different single service vendors—each varying in quality, reliability, cost, and composability—adopting the Chainlink platform provides a future-proof solution for institutions where services can be seamlessly composed out-of-the-box.

Simply put, Chainlink makes tokenized finance a practical reality.

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The tokenization of every financial asset in the world is inevitable.

While this may have been a controversial claim in years prior, the crypto industry is no longer alone in saying this. Larry Fink—Co-Founder and CEO of BlackRock—now speaks regularly to the inevitability of tokenization and the benefits it can provide to the global financial system. As the world’s largest asset manager, BlackRock’s AUM ($10.5T) is over 4x larger than the market capitalization of the entire crypto asset class ($2.5T).

In other words, a single institution who manages more capital than what the entire crypto industry is worth is telling the world that the global financial system and all of its assets will exist in a tokenized format on crypto-rails. This is a signal that cannot be ignored.

This tokenized reality is approaching faster than most realize. Blackrock’s BUIDL fund—a tokenized basket of US government securities on Ethereum Mainnet—now sits at over $460 million, quickly becoming the largest tokenized fund issued on a public blockchain in just a few months.

And yet, in a crude twist of irony, at the time when a growing number of the world’s largest financial institutions are recognizing the value of asset tokenization for capital markets and even launching tokenized financial products, the average person (retail) still largely considers crypto to be a “speculative casino” with no real world utility or value proposition to society.

And honestly, it’s not hard to blame them.

No different than next morning’s hangover after a bender, the crypto exuberance of 2021 ultimately ended with the collapse of a $40B ponzi scheme, the bankruptcy of nearly every retail-facing lending platform, and the widely-reported collapse of the FTX fraud. Tens of billions in retail capital evaporated overnight, never to be seen again.

2024 has introduced a breath of fresh air with the court-enforced launch of spot Bitcoin ETFs in the United States, the subsequent approval of spot Ether ETFs, and an election cycle where crypto is a bipartisan discussion point. And yet even so, the negative perception surrounding crypto has not worn away.

So what, if anything, can resolve the information asymmetry that exists between institutions and retail regarding asset tokenization?

Enter stablecoins.

Digital Dollars: The Intuitive Pitch For Crypto

Crypto is an extraordinarily difficult concept to succinctly explain to the masses. The industry is a patchwork of numerous fields across cryptography, distributed systems, game theory, economics, political science, and beyond. Most people do not understand how the financial system actually works (they don’t need to) and so therefore the problems that crypto aims to solve are largely foreign.

Imagine explaining what the Internet is to someone who has no concept of what a computer is.

As a result, there is no single universal explanation of crypto. Instead, what often happens is that the crypto-curious are overwhelmed with monologues about the historical failures of central banking and fiat monetary debasement, while ingesting a near-lethal dose of industry jargon that is incomprehensible to all but the already crypto-pilled.

But stablecoins…

People understand stablecoins.

Stablecoins are a powerful construct as they take a concept that people already intimately know and interact with on a daily basis (US dollars) and add a spice of something they don’t (blockchains). This not only creates a curiosity gap, but makes the core differences and benefits of crypto more immediately apparent since people have a baseline mental model to compare stablecoins against.

By sidestepping the entire existential “what even is money” question that inevitably arises when explaining crypto-native assets like Bitcoin and its derivatives, the existence of stablecoins puts forth a core point: Crypto is the superior way to represent assets.

Practically speaking, stablecoins allow anyone to transfer dollars to anyone else in the world with just an internet connection. Transactions are settled in under a second and for less than a penny in fees. No rent-seeking intermediaries, no bank accounts required, no oppressive capital controls, no multi-day settlement delays, no bullshit.

For anyone who lives in a country with a hyper-inflating local currency, has tried to make a cross-border remittance payment, or simply wants to make a financial transaction on a weekend or holiday, the benefits of stablecoins are immediately obvious.

Once you start regularly transacting dollars in the stablecoin format (digital dollars), going back to using traditional banking services feels absurdly archaic. It’s akin to going from fiber gigabit internet back to 56K dial-up.

Money should not have business hours. Stablecoins are 24/7/365.

In terms of market demand, the data speaks for itself. Stablecoins have objectively achieved product-market fit as no matter what metric you look at—monthly active users, transaction volumes, circulating supply—they’re breaching all time highs.

By way of comparison, stablecoins collectively are the 16th largest holder of US treasuries at ~$145 billion. More than Norway, Saudi Arabia, and South Korea. Being one of the largest and fastest growing purchasers of US government debt, along with the fact that stablecoins reinforce the global dominance of the dollar, present a solid case that the United States will only become more favorable to the existence and growth of stablecoins over time.

The Merging of Fintech and Stablecoins

One might think stablecoins aim to replace existing Fintech payment apps, but this couldn't be further from the truth. By launching their own stablecoins, existing Fintechs can not only benefit from the cost and speed advantages afforded by blockchain-based settlement, but also eliminate fragmentation in the payments industry.

The fact that you cannot send money from a Venmo wallet to a Cash App wallet, or other combinations of common payment apps, is simply absurd. On the other hand, stablecoins can be transferred between any two parties, regardless of the wallet software used. The user experience improvement is undeniable and will come to be expected by consumers.

Furthermore, given their open and programmable nature, stablecoins (issued by Fintechs) can be seamlessly integrated within existing DeFi protocols and onchain finance applications. This positions existing Fintechs particularly well to serve as an interface layer for consumers who wish to interact with onchain applications, such as to earn yield, while still having access to dedicated customer support.

Just like with tokenized assets, this reality is approaching faster than people realize. 

Look no further than PayPal USD (PYUSD)—a $400M+ stablecoin, launched by the largest payment processor globally, that is available today across multiple public blockchains. PYUSD is already integrated across the DeFi economy, including both decentralized exchanges and lending platforms.

“PayPal USD is designed to reduce friction for in-experience payments in virtual environments, facilitate fast transfers of value to support friends and family, send remittances or conduct international payments, enable direct flows to developers and creators, and foster the continued expansion into digital assets by the largest brands in the world.” — PayPal

Beyond Fintechs like PayPal directly issuing stablecoins, we’re also seeing established payment card networks such as Visa publish comprehensive research on improving stablecoin payments and actively engage in live pilots that enable Visa card payments to be settled in Circle’s USDC.

“By leveraging stablecoins like USDC and global blockchain networks like Solana and Ethereum, we're helping to improve the speed of cross-border settlement and providing a modern option for our clients to easily send or receive funds from Visa’s treasury,” — Cuy Sheffield, Head of Crypto, Visa.

Simply put, stablecoins are here to stay. They’re becoming increasingly ingrained within the existing payments industry, thereby amplifying their utility by making it easier for consumers to spend stablecoins and for merchants to accept them.

Transitioning Finance Onchain

With the above context in mind, my advice for helping onboard someone to crypto: Get them to download a crypto mobile wallet (e.g. Coinbase Wallet), have them generate a private key, and provide some stablecoins to transact.

While the end-to-end UX of crypto today is by no means perfect, even in its current state, transacting stablecoins is a night and day difference compared to a traditional international bank wire transfer. The technical complexity will only continue to be abstracted away, making crypto’s core benefits even more apparent.

This is ultimately where the Trojan horse effect comes into play. Once someone gets first-hand experience of the tangible benefits crypto brings, they will start to demand that every aspect of finance work like stablecoins do. Globally accessible, fully transparent, minimally extractive, always online, and resistant to manipulation.

What starts as improving the way dollars are transferred, morphs into transforming the global financial system into an onchain format based on smart contracts and tokenized assets.

The possibilities of what a completely onchain financial system could look like are limitless.

• Payment processing solutions that enable merchants to accept any fungible or non-fungible asset as payment, while only receiving their preferred currency (e.g., paying for groceries with stocks, Bitcoin, or tokenized digital art, while the recipient receives USD stablecoins).

• The ability to support online creators, independent publications, or a social cause with micropayments and real-time payment streams that can be transparently tracked end-to-end (e.g., supporting cancer research via streaming $0.000004 per second (~$10 a month) to an organization with an onchain auditable budget).

• Autonomous robo-taxi networks that collect their own revenue and automatically pay for expenses such as electricity consumption, toll fees, mechanical repairs, and upgrades (any service to be fully automated via AI will need an onchain economic system).

• The creation of truly global capital markets, where anyone with just an internet connection can gain access to the same investment opportunities and yields as the largest, most wealthy entities in the world.

These are only just high-level concepts. Much like it was nearly impossible in the early 90’s to predict exactly which Internet-enabled use cases would scale to a global level, the same is true of creating an onchain financial system.

Ultimately, stablecoins are the first stepping stones towards a fully tokenized economy. They’re not only one of the first crypto-powered use cases to achieve true product-market fit, but they also serve as an indispensable tool for succinctly showcasing the core value proposition of crypto and tokenization to novices.

So the next time someone asks you what crypto is all about, skip the hour-long lecture and simply point them towards digital dollars.

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In early 2019, I started the ChainLinkGod account — primarily to absorb knowledge and share breadcrumbs about Chainlink with a small but dedicated community of enthusiasts. It soon became clear to me just how vast the knowledge gap was about Chainlink within the broader crypto community. Oracles were a novel concept at the time and their full potential was understood by few. There was a clear need for someone to bridge this knowledge gap and, in effect, make Chainlink more approachable for a broader audience.

Who better than an anonymous green frog?

I didn’t imagine at the time that a small city’s worth of people would follow and listen. I’ve engaged in more debates online than I care to admit, some worthwhile and others not. But in the process, I found myself helping guide many community members on their own Chainlink journey, while at the same time learning more than I ever have before about distributed systems, game theory, economics, cryptography, and beyond. I truly could not imagine what my life would be like today if I hadn’t tossed aside my original career path of software engineering.

Now in 2024, cleared of rotting deadwood left behind by FTX, Terra, and 3AC, I see our industry as being better positioned than ever before. Blockchains are rapidly scaling as L2 rollup adoption accelerates, Bitcoin ETFs are legitimizing crypto as an asset class, onchain finance has continued to prove resilient despite volatility, and a growing number of financial institutions are tokenizing assets and moving steadily toward production.

In parallel, Chainlink has proven itself to be not only one of the most essential pieces of infrastructure in crypto — powering nearly every single tangible smart contract vertical — but has established a strong position in enabling some of the largest financial institutions in the world to adopt blockchain networks. Chainlink is no longer a niche tool for price feeds, but the industry-standard platform for connecting the world to blockchains.

Given this evolution of Chainlink, it was only natural for the ChainLinkGod identity to also evolve. Pseudonyms within the crypto community are common, for various personal reasons, and this fact is no different within the Chainlink community. During the early days, a frog identity served as a collective identifier that, in effect, signaled one was a Link Marine. While the CLG pseudonym has served me well over the years, speaking as Zach Rynes presents an opportunity to scale my voice and educate the new wave of entrants just now learning about crypto.

The Human Behind The Frog

In early 2020, just over a year after creating ChainLinkGod, I became a Chainlink Community Ambassador — serving as an educational resource for the community and as a bridge between the Chainlink Labs team and the community. Over time, this collaboration naturally expanded with me working more closely with the Chainlink Labs team, such as contributing educational content and consulting on various projects, among other endeavors.

In parallel, I continued to independently run the ChainLinkGod account and related properties like The CLG Podcast, where I’ve shared my own personal thoughts and opinions on Chainlink and the broader crypto ecosystem.

Shifting from Community Ambassador to Community Liaison simply reflects an evolution of what I have already been doing — breaking down the technical nuances of Chainlink into simpler terms and supporting the team on communication strategy where relevant. With this shift of identity, CLG will continue to be independently run by me and solely reflects my own personal thoughts.

The Network Effects of Community

The origins of the Chainlink community are rooted in the deep understanding that not only are smart contracts the ultimate format for any contractual agreement, but that Chainlink oracles are a fundamental requirement for scaling this industry to a global level for real-world use cases. In no other ecosystem do I see a community as dedicated to a common vision and seeking out the truth in all matters. While no protocol is perfect and Chainlink has yet to reach a finalized state, with much more work to be done, there’s no doubt in my mind that the community’s support has been critical to getting Chainlink to where it is today and will continue to be.

Through engaging with both the community and the team in different ways over the past number of years, I’ve seen the definitive power that the community has around strengthening the network effects of Chainlink. There are multiple positive flywheel effects where, as community enthusiasts spread awareness and advocate for the technology and vision behind Chainlink, the more that developers are pulled into the ecosystem and start building new applications using Chainlink. Then, every new Chainlink integration by a project that is amplified by the community generates broader awareness for that application and helps that newly Chainlinked protocol establish an initial user base. These community-driven network effects are not imaginary or hypothetical, but already exist today.

By the community helping establish Chainlink as an industry standard today, the protocol becomes perfectly positioned so that when institutions start leveraging crypto infrastructure in production to settle trillions of dollars worth of tokenized assets, the use of the Chainlink platform is a foregone conclusion. While the exact timelines for when such an institutional inflection point is impossible to know for certain, Chainlink will only succeed with the support of a growing global enthusiast and developer community.

The Future of Crypto

I became interested in crypto because I saw how this technology presents a viable path towards re-establishing trust in society — between individuals, and between individuals and institutions. I believe a growing number of people are coming to the same conclusion as well and will need guidance and want to have deep-level conversations about a variety of industry topics. My goal is to support those individuals and help connect the dots on how the Chainlink platform provides the plumbing to make it all possible.

I want to thank everyone who helped me on my own crypto journey over the years, from the community to my colleagues. I look forward to helping connect the world to blockchains.

For more content, follow me on Twitter @ChainLinkGod and listen to The CLG Podcast on Spotify and YouTube.

Originally published on Medium on March 18, 2024.

What is the fundamental goal of crypto? Is it to facilitate short-term token speculation via capital rotation games and inflationary rewards? Or is it to improve how society functions by creating a more transparent, accessible, and efficient global economy? 

Most crypto-native readers would probably agree that it’s some variation of the latter. However, when looking at the current state of crypto, it’s easy to see why it has a poor reputation amongst the general public. Unbounded speculation reigns supreme, whereas tangible real-world use cases that benefit the average consumer have so far been few and far between. 

What needs to change in order for crypto to move beyond its speculation-centric phase and begin delivering real utility to a broader audience?

It is my belief that the tokenization of real-world assets (RWAs)—blockchain-based digital tokens that represent physical and traditional financial assets—is the fuel that’s needed to propel the crypto industry into the mainstream. With $867T in traditional markets ready to be disrupted by blockchain-based technologies, the opportunity to systematically improve global economies is real. 

This blog is my thesis on RWAs. 

The Current State of Onchain Finance

The core value proposition of public blockchains is to solve coordination problems by serving as a decentralized, credibly neutral settlement layer that any application can be permissionlessly deployed upon. Blockchain applications operate exactly as programmed without human intermediation, are auditable by anyone in real-time, and can be seamlessly composed into other blockchain applications. 

The initial application of blockchains was the creation and movement of tokens, which represent a unit of value (e.g. BTC). However, it was the creation of DeFi (decentralized finance), also referred to as onchain finance, that showcased the true potential of public blockchains. In particular, onchain financial applications benefit from the following properties:

• Atomic settlement: The combination of cryptography and decentralized consensus leads to strong finality guarantees of economic transactions—mitigating double-spend attacks and fraud in a tamper-resistant manner, thereby increasing capital efficiency and reducing systemic risks. 

• Transparency: Public block explorers and data dashboards provide granular and clear insight into the risk exposure and collateralization of the onchain finance ecosystem as a whole. Furthermore, the source code of applications are open-source and can be reviewed by anyone.

• User control: Non-custodial asset management is achieved through private keys, allowing onchain applications to interface with assets in a trust-minimized manner. Decentralized autonomous organizations (DAOs) also allow for collective ownership of assets and applications.

• Reduced costs: Onchain finance applications operate more efficiently and autonomously since the need for intermediaries is minimized. This facilitates low switching costs for moving capital across applications, creating an efficient market for app-level fees. Scaling technologies also make microtransactions feasible by reducing network-level fees.

• Composability: Having a common settlement layer for running autonomous code allows for permissionless composability between new and existing onchain finance applications. Developers don’t have to worry about being deplatformed, further incentivizing collaboration. 

Many of the financial primitives that exist within the traditional financial economy have already been recreated in an onchain format, benefiting from the above properties. Such examples include:

• P2P payments (Lightning Network, Flexa)

• Spot trading (Uniswap, Curve)

• Lending markets (Aave, Compound)

• Derivatives (GMX, dYdX)

• Synthetic assets (Synthetix, Alchemix)

• Asset management (Yearn, Beefy)

• Insurance (Nexus Mutual, Unslashed)

Despite the public’s perception of crypto, the onchain finance ecosystem has proven its resiliency, even when faced with periods of extreme market volatility, rapid deleveraging events, and the collapse of centralized crypto institutions such as FTX. DeFi, as of writing, has over $47B in total value locked ($180B at its peak), daily trading volumes in the billions of dollars, and daily revenue generation in the millions of dollars. 

It’s clear that onchain financial systems offer tangible benefits over the status quo. However, there is one major limiting factor that prevents onchain finance from reaching a global scale: Much of DeFi is currently a circular economy that has little-to-no connection to the existing global economy of traditional businesses and services. The historical rapid growth of DeFi is largely connected to the rise of capital rotation games and unsustainable yields fueled by inflationary token rewards. This is the equivalent of using a supercomputer to play minesweeper: pure untapped potential.

There is an exception, however: stablecoins.

The Growth, Dominance, and Sustainability of Stablecoins

Stablecoins are a type of crypto asset that aims to keep its price pegged to the market value of an external asset, such as a fiat currency or commodity. In the majority of cases, this is the price of the US dollar. There are many mechanisms to achieve price stability, but the most widely used implementation is for a centralized institution to issue a token collateralized by US dollars held in custody offchain. The result is the tokenization of USD. 

Over the past few years, the supply of stablecoins has exploded, with over $132B of stablecoins currently circulating on public blockchains, an increase of 2,222% from three years ago.

Stablecoins provide a superior version of the dollar, one that is natively digital, programmable, composable, and atomically settled. More importantly, USD-collateralized stablecoins do not require a constant inflow of capital or speculation to sustain themselves. With direct redeemability and full collateralization, the supply of stablecoins can scale up and down as the market requires without issue. 

Stablecoins formally entered the market in 2014 with the introduction of Tether (USD₮). Tether was initially deployed on the Bitcoin blockchain and was created to address the inability of centralized crypto exchanges (CEXs) to obtain formal banking partners. In supporting Tether, CEXs were able to increase market liquidity by providing increased access to fiat on/off-ramps while also meeting market demand for USD-denominated trading pairs. Tether also enabled investors to reduce their exposure to crypto’s volatility without needing to return to the traditional financial system. 

The launch of the Ethereum blockchain and the rise of the onchain finance ecosytem saw the usage of stablecoins expand, with stablecoins getting composed into onchain applications, primarily as a method to generate yield. While this yield was often generated from crypto leverage traders and inflationary rewards, stablecoins connected the onchain finance ecosystem back to the traditional financial economy—expanding the value proposition of crypto by orders of magnitude. 

The most common type of stablecoins (USD-collateralized) are not without their trade-offs, however, specifically because they introduce trust requirements in the centralized issuer (e.g., custody, issuance, redemptions) and permission controls for regulatory compliance (e.g., KYC/AML checks during issuance/redemption and onchain blacklists). Moreover, “USD-collateralized” stablecoins are often not backed by dollars alone, but also in part by other assets including cash equivalents (e.g. US treasuries, commercial paper), secured loans, corporate bonds, and more. However, the most trusted stablecoins are backed entirely by cash and short-term US treasuries.

USD-collateralized stablecoins continue to improve in terms of transparency and reporting. Moody’s, a leading credit rating agency, is developing a scoring system for stablecoins based on the quality of their reserves attestations. Tether has derisked its reserves by eliminating commercial paper and phasing out secured loans. Circle’s USDC provides monthly reserve reports with attestations from leading global accounting firm Grant Thornton.

Attempts have also been made to create decentralized stablecoins. However, the collapse of undercollateralized algorithmic stablecoin TerraUSD showcased the difficulty and risk of straying from the tried-and-true USD-collateralized stablecoin model. Other decentralized (overcollateralized) stablecoins, such as MakerDAO’s DAI, have begun to incorporate other USD-collateralized stablecoins and real-world assets (RWAs) as collateral in order to maintain a $1 peg at scale. 

Ultimately, the introduction and adoption of stablecoins within onchain finance has proven that there is real appetite for tokenized RWAs. I’d even venture to say it points to the start of a greater mega-trend around RWAs.

RWAs: The Assets People Want in a Superior Format

Most people are not financial experts and do not care about the intricacies of how the financial industry operates, and yet society depends on financial assets. Fiat currencies are used for commerce and savings; they are what people earn and spend. Commodities are used for consumption and the manufacturing of goods; they are what people need to live and survive. Securities are used to raise capital and create businesses that provide goods and services; they are what allows society to grow and thrive.

But the financial economy is not static. Starting in the Babylonian empire in 3000 BC with clay tablets to track debts before evolving into paper formats, finance has entered an almost purely digital era. Despite these transformations, the recording of financial events still takes place across siloed ledgers that must be reconciled. This results in significant inefficiencies, such as increased costs and lengthened settlement times. The lack of interoperability and the resulting fractionalized liquidity present an opportunity for the next era of finance to be around asset tokenization. 

The tokenization of real-world assets and their use in onchain finance provides a number of advantages over the status-quo, many of which derive from the properties that make public blockchains and onchain finance valuable.

• Increased efficiency: A blockchain’s ledger serves as the golden source of truth, reducing friction during post-trade reconciliation. Atomic settlement also removes the need for delayed T+2 settlement, as assets can be simultaneously delivered with payment.

• Reduced costs: Self-executing autonomous protocols reduce the need for intermediaries at every step. Early results show an up to 90% reduction in the cost of bond issuance when using blockchain-based record keeping and an up to 40% reduction in fundraising costs. 

• Increased transparency: Public blockchains are auditable in real-time, opening up the ability to verify the quality of asset collateral and systemic risk exposure. Disputes around record keeping can also be mitigated through public dashboards showcasing onchain activity.

• Built-in compliance: Complex compliance rulesets can be programmed directly into tokens and applications offering services involving tokens. Privacy-preserving KYC tools can be implemented to shield user privacy while remaining compliant with the relevant regulations.

• Liquid Markets: Tokenizing assets within private markets (e.g., pre-IPO shares, real estate, carbon credits) increases the accessibility of historically illiquid markets—a market with trillions of dollars worth of largely inaccessible assets. 

• Innovation: With assets and application logic existing within a common settlement layer, rather than in disconnected environments, entirely new financial products can be created. From fractionalized real estate funds to liquid revenue-sharing agreements, tokenization increases the ability to build products that were previously infeasible.

How RWAs Are Tokenized and the Challenges Involved

To leverage the aforementioned benefits, RWAs can be generated in one of two token formats. The first format is non-native tokens, where onchain tokens are issued to represent RWAs that exist and are managed offchain by a custodian. This is the most common type due to the infancy of RWAs and the ability to leverage existing financial infrastructure around asset custody. All existing USD-collateralized stablecoins have adopted this token format. 

The second format is native tokens, where an onchain token is issued and serves as the RWA itself, meaning it does not represent any type of offchain asset. For example, bonds that are directly issued onchain as tokens are native RWAs, while a bond that is issued and held offchain could be tokenized as a non-native RWA.

It’s important to note that RWAs can be issued on either private or public blockchains. Private chains—where only certain verified participants can operate the chain and view its contents—offer increased control over the ledger’s entries but come with additional trust requirements, limited composability, and walled-garden access, negating many of the benefits that public blockchains bring to RWAs. However, there is a place for each type of blockchain, with the potential for many RWAs to be initially issued on private blockchains and eventually flow onto public blockchain networks. 

While RWAs on public chains provide many benefits for both institutions and investors alike, there are also a number of challenges that must be considered to realize their potential:

• Regulatory clarity: The primary blocker for many financial institutions interested in tokenizing assets, particularly on public blockchains, is the lack of regulatory clarity. Certain jurisdictions, such as the EU, Switzerland, the UK, and Japan, have made tangible progress in establishing clear frameworks, while others, like the United States, are still largely a work in progress. 

• Permissions: In order to comply with existing and upcoming financial regulations around public blockchains and asset tokenization, token issuers often must add permissions through the implementation of KYC/AML checks (such as during issuance/redemption or at time of transfer)—deviating from the norm in DeFi. 

• Identity: The need for granular permission controls necessitates robust solutions to determine user identities and risk profiles. Decentralized Identifiers (DIDs), Verifiable Credentials (VCs), and other identity solutions are a prerequisite for most institutions stepping into RWA tokenization. 

• Connectivity: The multi-chain ecosystem continues to expand, resulting in a growing collection of blockchains that institutions must plug into to access and issue RWAs. Standards such as the Cross-Chain Interoperability Protocol (CCIP) enable institutions to not only connect their existing backend systems to blockchains, but also bridge RWAs across public and private blockchains, enabling cross-chain Delivery versus Payment (DvP) workflows.

• Proof of reserves: Since RWAs represent offchain assets, onchain finance applications have limited insight into their true collateralization. Oracle solutions such as Chainlink Proof of Reserve address this challenge by delivering collateralization data onchain.

We are still in the early days of RWAs on public blockchains, but none of the above challenges are insurmountable. Continued industry collaboration, across both DeFi and TradFi, will chip away at these barriers over time in order to eventually arrive at a viable solution for onchain finance. 

The Current Traction and Real-World Opportunity of RWAs

The potential market opportunity for RWAs has generated increasing interest, as demonstrated by the deployment of pilot tests by both traditional institutions and crypto-native projects. According to a 2022 Celent survey, 91% of institutional investors have signaled their interest in investing in tokenized assets. Below are a few examples of how institutions are actively engaging in the tokenization of RWAs on public blockchains.

Institutional Interest in Real-World Asset Tokenization

Recently, Swift collaborated with Chainlink and more than a dozen of the largest financial institutions and market infrastructure providers on how firms can leverage their existing Swift infrastructure to efficiently instruct the transfer of tokenized value over a range of public and private blockchain networks using CCIP. Participants included Australia and New Zealand Banking Group Limited (ANZ), BNP Paribas, BNY Mellon, Citi, Clearstream, Euroclear, Lloyds Banking Group, SIX Digital Exchange (SDX), and The Depository Trust & Clearing Corporation (DTCC).

The collaboration showcased how Chainlink CCIP could be used as an abstraction layer to enable financial institutions to connect their backend infrastructure to any public or private blockchain, as well as instruct the transfer of tokenized RWAs between different blockchains efficiently and securely.

In a recent industry case study, it was showcased how the Australia and New Zealand Banking Group (ANZ)—a leading institutional bank with $1+ trillion in total assets under management—successfully demonstrated cross-chain tokenized asset settlement with Chainlink CCIP. Using the ANZ Digital Asset Services (DAS) portal along with CCIP as an abstraction layer, the case study demonstrated how ANZ customers could use CCIP to securely transfer ANZ-issued stablecoins cross-chain to purchase nature-based assets.

Another example of financial institutions exploring the usage of RWAs is the Singapore Central Bank’s Project Guardian, which explored the use of DeFi for wholesale funding markets in late 2022. Under the first pilot, DBS Bank, JP Morgan, and SBI Digital Asset Holdings conducted foreign exchange and government bond transactions against liquidity pools composed of tokenized Singapore government securities bonds, Japanese government bonds, Japanese Yen (JPY), and Singapore Dollars (SGD). 

The pilot used forked permissioned versions of the Aave lending protocol and Uniswap exchange operating on the public Polygon mainnet. The pilot resulted in JP Morgan executing its first DeFi transaction on a public blockchain, the trading of $100,000 tokenized Singapore dollar deposits (the first issuance of tokenized deposits by a bank) for tokenized yen issued by SBI Digital Asset Holdings. 

The main objective of the pilot was to “test the feasibility of applications in asset tokenization and DeFi while managing risks to financial stability and integrity.” Utilizing a public blockchain showcased how open, interoperable networks can mitigate challenges such as fragmented liquidity and walled garden ecosystems. Furthermore, W3C Verifiable Credentials issued by trusted financial institutions demonstrated how compliance controls could be integrated within onchain applications involving RWAs. 

“The live pilots led by industry participants demonstrate that with the appropriate guardrails in place, digital assets and decentralised finance have the potential to transform capital markets. This is a big step towards enabling more efficient and integrated global financial networks.” – Sopnendu Mohanty, Chief FinTech Officer, MAS

Additional pilots under Project Guardian are now in motion, with Standard Chartered Bank leading an initiative to explore the issuance of tokens linked to trade finance assets, while HSBC and United Overseas Bank are working on native digital issuance of wealth management products.

As another example of institutional interest, Siemens recently issued a €60 million digital bond on the public Polygon mainnet. With a maturity of one year, the digital bond was issued in accordance with Germany’s Electronic Securities Act (eWpG) and was purchased by DekaBank, DZ Bank, and Union Investment. By issuing the bond on a public blockchain, Siemens was able to remove the need for paper-based global certificates and central clearing, allowing the bond to be sold directly to investors without needing a bank to function as an intermediary.

“By moving away from paper and toward public blockchains for issuing securities, we can execute transactions significantly faster and more efficiently than when issuing bonds in the past. Thanks to our successful cooperation with our project partners, we have reached an important milestone in the development of digital securities in Germany.” – Peter Rathgeb, Corporate Treasurer at Siemens AG

DeFi Interest in Tokenizing Real-World Assets

Interest in tokenizing RWAs is also strong in the existing onchain finance ecosystem, with a number of dApps having tokenized hundreds of millions of dollars worth of assets. Not only does tokenizing assets increase their addressable market, but yields in the traditional financial system (e.g. ~4% from US treasuries) are now consistently higher than existing DeFi projects (~2% from DeFi collateralized lending). This gives onchain finance protocols access to sustainable revenue opportunities. 

MakerDAO is a DeFi project that has arguably made the most progress in terms of RWA adoption. Currently, the protocol has $680M+ worth of RWAs backing the decentralized stablecoin DAI. By introducing RWAs as collateral, MakerDAO was able to scale the amount of DAI issued into the market, harden its peg stability, and significantly increase protocol revenue (~70% of its revenue in Dec ‘22 came from RWAs).

The bulk of MakerDAO’s RWA collateral (~$500M) comes in the form of US treasury bonds managed by Monetalis (MIP65). These assets provide the protocol a source of yield on otherwise idle USDC collateral. MakerDAO also launched a vault backed by $100M worth of loans originating from a community bank in Philadelphia called Huntingdon Valley Bank (HVB). HVB used MakerDAO to support the growth of its existing businesses and investments around real estate and other related verticals, and served as the first commercial loan participation between a US-regulated financial institution and a decentralized digital currency. In a separate vault, Société Générale borrowed $7M from MakerDAO in a position backed by €40M worth of AAA-rated bonds tokenized as OFH tokens.  

A number of other protocols have also made significant strides in terms of RWA adoption, including:

• Ondo Finance—a platform for tokenized RWAs—recently tokenized short-term US treasuries, investment grade bonds, and high-yield corporate bonds. Ondo also launched Flux Finance, a lending protocol for borrowing permissionless stablecoins against the tokenized US treasuries. 

• Backed—a Swiss-based startup for tokenized RWAs—recently launched its first product, bCSPX, representing tokenized S&P 500 ETF shares. Backed Tokens are freely transferable across wallets and enable 24/7 capital market trading. 

• Maple Finance—a blockchain-based credit marketplace with nearly $2B in total loans issued—is planning to expand to receivables financing, which can scale up to $100M in size, as well as support US treasuries and insurance refinancing. 

• Centrifuge—an onchain ecosystem for structured credit—is focused on securitizing and tokenizing previously illiquid debt, with $298M in total assets already financed. Its tokenized assets have been integrated across DeFi, including $220M of RWAs on MakerDAO.

• Goldfinch—a decentralized credit protocol—has $101M in active loan value. The platform allows for the creation of junior and senior tranches for assets focused on emerging markets, enabling risk/return profiles to be fine-tuned.

It is worth noting that RWAs have also been explored in the context of security token offerings (STOs), with 18 companies having raised a total of $380M in 2018. However, most STO offerings have historically been viewed as a limited implementation of RWAs given their focus on fundraising (i.e., an alternative to initial coin offerings or ICOs). With STOs representing more niche securities that are usually only available on permissioned platforms, their adoption has not reached the same level as RWAs on public blockchains.

Furthermore, while unsecured lending protocols have faced defaults in recent months after the collapse of FTX, (e.g. Alameda and Orthogonal Trading), this is the expected risk associated with undercollateralized loans and does not represent a failure of the credit protocols themselves. The risk simply means the yield must reflect the probability of defaults, the same as within traditional finance.

A Note on Trust Assumptions

Given that tokenized real-world assets depend on the existence of traditional financial institutions, their trust properties will likely never be the same as a onchain finance ecosystem dealing solely in crypto-native assets. Most institutions will not feel comfortable deploying trillions of dollars worth of assets on public blockchains without the necessary guardrails and permissions required to mitigate both operational and regulatory risks. Scaling onchain finance to a global level with tokenized RWAs means meeting institutions in the middle. 

In parallel, it is also likely that fully permissionless onchain finance protocols, focused on crypto-native assets with little-to-no RWA interaction, will continue to exist. Such protocols can provide immense value by serving as a sandbox for financial experimentation and as an “opt-out” censorship-resistant alternative for financial services. However, without RWA support, such an ecosystem is unlikely to provide the full utility desired by average consumers.

The power of public blockchains is that they can support and serve both tokenized RWAs and crypto-native assets at the same time. It is ultimately the choice of the consumer regarding what type of assets they want to hold and what applications they wish to deploy their assets into. While tokenized RWAs, and the additional trust assumptions involved, may not be for everyone, it would be a mistake not to capitalize on the opportunity that exists. 

The Path Forward

The tokenization of real-world assets provides immense opportunities for existing financial institutions and the early-stage onchain finance ecosystem. While the token-speculation use case has helped stress test existing DeFi protocols, the ecosystem is now at a stage where it needs to evolve and begin providing real utility for society. There remain many challenges ahead to realizing the true potential of RWAs, but the market opportunity presented is in the trillions, and someone will capture it.

Looking to understand the tokenization opportunity? This industry report provides a comprehensive overview of the growing tokenization market, with contributions from BCG, 21Shares, Paxos, Backed, and Chainlink. Access now.

Additional Readings:

• Connecting blockchains: Overcoming fragmentation in tokenised assets

• Cross-Chain Settlement of Tokenized Assets Using Chainlink CCIP

• Institutional DeFi: The Next Generation of Finance?

• Relevance of on-chain asset tokenization in ‘crypto winter’

• Digital assets in action: Current use cases for Financial Institutions

For more content, follow me on Twitter @ChainLinkGod and listen to The CLG Podcast on Spotify and YouTube.

Originally published on the Chainlink Blog on February 18, 2023.

Web3 represents a fundamental evolution of the Internet as we know it today, replacing centralized gatekeepers and intermediaries with decentralized protocols and community-retained ownership. The properties inherent to Web3 are highly attractive to crypto-natives who live and breathe crypto. However, we must also acknowledge the following point: 

Web3 is still a niche industry that has not reached mainstream adoption. 

While the underlying technology backing Web3 is very real, there is a reason why your grandma is probably not yet an active Web3 user. And while limitations around blockchain scalability are most often cited for the lack of adoption—usually with a reminder of just how early we truly are—I believe that’s only one of a number of reasons why Web3 is not on the mind of the average consumer. 

In this blog post, I’ll provide my own perspective around the six major reasons why Web3 has not yet reached mainstream adoption and what can be done to realize this technology’s true benefits for society.

1. Esoteric Techno-Babble

Web3 can be a difficult concept to explain to newcomers, particularly because there is no universal definition. Everyone has their own interpretation of its most valuable properties. This inevitably leads to questions such as: “Why should I care about Web3?” and “How can Web3 benefit me in my daily life?”

Various properties of Web3 are commonly mentioned—decentralization, censorship resistance, immutability, transparency, etc. Such explanations often include overly technical breakdowns of Web3 infrastructure, littered with industry jargon and techno-babble. 

Although such explanations can be useful in understanding the core values of Web3 and its underlying technical implementation details, these are all simply a means to an end. The real question that must be answered is: How can these esoteric concepts and intangible values ultimately translate into Web3 applications that the average consumer can understand and is interested in engaging with?

Naturally, to answer such a question, one must be able to point to clear real-world use cases.

2. Circular Circus Contagion

The first major Web3 application was the creation of digital tokens (e.g. Bitcoin) with predefined monetary policies and built-in peer-to-peer payment capabilities—all without the need for a centralized middleman. While digital tokens are attractive to many, tokens that exist to be simply transferred from one person to another are fairly limited in their utility, with clear trade-offs in terms of volatility and limited acceptance by merchants compared to traditional currencies.

Without an obvious systemic failure in the traditional financial system, the value proposition of minting and transferring tokens alone isn’t sufficient. This realization is ultimately what led to the creation of the next clear Web3 use case: Decentralized Finance (DeFi). DeFi extends the utility of digital tokens beyond simple value transfer to also include their use in financial primitives that consumers are already accustomed to, such as lending, borrowing, exchanging, and hedging. 

However, given that many DeFi applications are still primarily focused on tokens, a circular economy of speculating on tokens whose value is in part derived from monetizing speculation is created. This is not a surprise given that Web3 natives who already hold tokens are the clear initial product-market-fit of DeFi products, but if a consumer isn’t already an owner of a crypto token, DeFi seems more akin to a casino than an alternative financial system. 

Tokenized Assets To The Rescue?

This isn’t to say that all of DeFi today is purely circular in nature. Stablecoins, a type of token pegged in value to another asset such as a fiat currency, have enabled the creation of what can be considered “programmable dollars,” which can be transacted globally and settled in seconds. Digital dollars are far more relevant to the average consumer today, as their lives already revolve around acquiring, saving, and spending such currency.

There are $140B worth of stablecoins today that can be used within DeFi applications, enabling the DeFi ecosystem to become more useful and relevant to consumers, such as through the creation of on-chain savings accounts. In applying the valuable properties of Web3 to assets that consumers already use today, the “why” of Web3 becomes more self-evident.

Beyond stablecoins, I believe this general approach of on-chain financial skeuomorphism—where existing real-world financial primitives are emulated and re-implemented on-chain—provides a clear path to introducing Web3 applications to the general population in a manner that is actually relevant to their daily lives. 

In particular, tokenized real-world assets (RWAs), of which stablecoins are a subset, present an opportunity to short circuit the circular speculation loop that exists in DeFi. They can encapsulate real estate, corporate/government bonds, revenue-sharing agreements, commodities, and any other asset within the traditional financial economy. Tokenized RWAs are not without trade-offs though, specifically in terms of decentralization and trust-minimization. However, Web3 applications that support RWAs can expand Web3’s value proportion by an order of magnitude. 

3. Hyper-Financialization

While DeFi, stablecoins, and RWAs provide immense opportunities for expanding Web3 into the mainstream, something to consider is that the average consumer doesn’t really care that much about finance. They may not use many financial services or care about the technical nuances of how financial products are settled on the backend. At the end of the day, they just want to engage in commerce, such as using their credit card to purchase some groceries. If the primary pitch of Web3 is based on hyper-financialization, then a large segment of the total addressable market will be missed entirely. 

This is where much of the confusion regarding Web3 is derived. If Web3 is a “decentralized version of the existing Internet,” where are all the typical Internet use cases we’re used to? What about messaging, social media, video streaming, online commerce, or the blog you’re reading right now? 

Non-financial use cases of Web3 are still in their nascent stages, but some clear use cases are appearing. For example, a Web3 implementation of a social media platform can take the form of a decentralized protocol where users are able to truly own their own online profile, including all of the content they’ve produced and their following/follower social graphs. Their profiles can then be ported across a variety of frontend interfaces with different content moderation policies.

Lens Protocol by Aave is one example of a decentralized social graph protocol that is aiming to achieve exactly this. With interactions stored on the Polygon PoS blockchain, a user’s social graph can be ported across applications. The ability to own your own social identity is a powerful Web3 primitive that can directly address concerns with existing platforms that feature manipulative content selection algorithms and oppressive de-platforming tactics. 

Decentralized social media may or may not be the definitive killer non-financial Web3 application. Instead, it could be the creator economy, gaming, the metaverse, DAOs, or any other number of use cases. What is clear, however, is that we must expand our industry beyond pure hyper-financialization. 

4. User-Experience Landmines

From a theoretical perspective, Web3 provides a far superior user experience (UX) over the status quo of the Internet. Rather than having to manage a plethora of unique usernames and passwords for each website or entrusting a centralized service provider, Web3 enables users to authenticate themselves via a single private key that can be universally used across any Web3-enabled application. Not only can this vastly simplify the user experience, but users can truly own their data and directly access applications without approval from centralized middlemen. 

When it works, it works really well.

However, that’s only “When it works”. In practice, users have to navigate different non-compatible authentication standards, manually handle private keys and seed phrases, download and learn how to use new browser extensions or mobile wallets, and adapt all of this to conform to different blockchains with their own set of standards. The result is often frustration and confusion.

Seed phrases? ChainIDs? Gas prices? Token approvals? Reverted transactions? Finalization? These are all fairly esoteric and highly technical concepts that a Web3-native user needs to understand if they want to interact with an on-chain Web3 application today. Even once these concepts are well understood, interacting with Web3 apps often feels like walking on eggshells in the hopes that something in the interaction flow (hardware wallet -> Web3 extension -> frontend website -> RPC node -> blockchain) doesn’t break. 

The poor UX of Web3 today is not the fault of any particular project or protocol. There are many ongoing efforts to unify the experience. However, it cannot be denied that the user experience of Web3 today is less than optimal. Secure private key management is also a serious responsibility, something which consumers have little to no parallel to in the Web2 world. Unfortunately, it doesn’t help that there’s no “reset password” equivalent if access to your seed phrase is lost. 

With interfaces like the one below so common in Web3, it’s no wonder why the dropoff for new users is so high. 

Overcoming this UX hurdle requires a first-principles approach of minimizing the technical nuances and risks that users are exposed to. I believe this will ultimately result in the creation of Web3 “super apps” that abstract away the various complexities inherent to Web3 infrastructure and present users only with what they need to see in order to interact in the Web3 world. Coinbase and Robinhood are just two examples of consumer-facing organizations leveraging their experience to create frictionless Web3 wallets.

In particular, Coinbase integrated a Web3 browser built directly into its main mobile app. The browser uses secure multi-party computation (MPC) to enable private keys to be generated in a distributed manner. The result is a “semi-custodial” wallet system in which a user’s private key is split across three entities, and any two portions are required to sign off on a transaction. With the user and Coinbase each holding one portion of the key, the third portion can be held as a backup in a cold-storage solution or with a trusted third party. If a user loses access to their device (and therefore their portion of the key), a recovery mechanism can be employed to regain access to the wallet. 

While not as trust-minimized as a pure self-custodial solution, this type of compromise significantly improves the user experience and can be a safer solution for many users prone to accidental key loss. Other solutions, such as social recovery, also present a viable path to creating the type of UX that users are already accustomed to within the Web2 world. 

5. The Dial-Up Era of Web3 Throughput

One of the most commonly referenced limitations of Web3 today is the limited scalability and high latency of widely adopted public blockchains. As I discussed in a previous blog post about the true trust model of blockchains, scalability is commonly thought of as being equivalent to increasing transaction throughput. However, a more holistic interpretation of scalability is increasing transaction throughput while maintaining a low verification cost of the blockchain’s ledger. Higher-throughput blockchains do exist, but there is still a ceiling to their transaction throughput and they often come with trade-offs in terms of decentralization, security, or reliability.

As Vitalik Buterin once said, “The Internet of money should not cost five cents per transaction.” Given the gas costs of using Ethereum over the past few years, this is a little ironic, but most people would generally agree that it is a valid statement. Even with clear tangible use cases and an improved UX, the next billion users cannot be onboarded into Web3 if transactions take eons to finalize and cost an arm and a leg. 

Since this is one of the more obvious roadblocks to Web3 mass adoption, many blockchains are hyper-focused on improving scalability, whether through parallelized compute, modular rollups, sidechain clusters, or other methods. Many of these solutions are still in their infancy, but I have high confidence that scalability is a technical challenge that can and will largely be overcome in the next few years. What is more unclear is what a highly scalable Web3 ecosystem might look like: a multi-chain world of independent L1s/sidechains, a multi-rollup world of layer-2 solutions, or high-throughput server-farm layer-1 blockchains? Maybe all three will coexist?

6. The Elephant In The Room

When discussing the roadblocks facing Web3, one must also address the elephant in the room: A lack of clear legal frameworks and guidance regarding crypto-assets, decentralized applications, and decentralized organizations is limiting the ability of Web3 to reach global scale. As with any new technology that radically disrupts existing industries, growing pains are inevitable, but not everything can be completely solved solely by technical means.

Without clear legal frameworks or policy guidelines, traditional institutions and organizations do not have the clarity they are used to and desire in order to feel comfortable engaging with and deploying resources into the Web3 ecosystem. Once such frameworks and guidelines are in place—achieved via industry collaboration to avoid stifling innovation—it’s far more likely that institutions and organizations will really begin their plunge into Web3 as service providers or Web3 gateways for their existing client bases.

To be clear, I am not advocating for any particular legal framework or policy guideline, but rather acknowledging the reality that Web3 mass adoption is largely tied to clear and reasonable guidance being in place. What form this will take is dependent on a large number of variables. Stifling innovation is not a viable or positive outcome for the Web3 ecosystem, but Web3 being perceived as a “wild west” environment is not conducive for long-term growth either. 

Looking Ahead

Web3 represents a paradigm shift in the trust properties of applications, shifting power away from centralized intermediaries and towards deterministic and transparent software. But as with any innovative new technology, there are various roadblocks that must first be overcome before global adoption can be achieved. While there are many more bottlenecks facing mass Web3 adoption than was laid out in this blog, by addressing these aforementioned challenges head-on, Web3 will be better positioned than ever to scale its benefits across many aspects of society.

For more content, follow me on Twitter @ChainLinkGod and listen to The CLG Podcast on Spotify and YouTube.

Originally published on the Chainlink Blog on November 26, 2022.

Blockchains are a radical new computing model where data and applications are secured not by centralized intermediaries but by a decentralized network of computers. Due to their permissionless nature, blockchains enable anyone to opt-in and begin independently verifying the integrity of computations, resulting in a checks and balances system between users and network operators. 

From the creation of new digital currencies with programmatic monetary policies (e.g. Bitcoin) to the execution of programmable trust-minimized applications (e.g. Ethereum), blockchains are rapidly entering the public consciousness as a new form of digital infrastructure, often referred to as Web3. However, while the overarching value proposition of blockchains is recognized by many, the nuances regarding the underlying trust model of blockchains are often misunderstood.

This article will serve to explain how the trust model of blockchains differs from traditional computing by looking at the role of self-verifying full nodes, with particular reference to how they keep block producers (e.g. miners/validators) accountable and how decreasing the cost of verification is at the heart of blockchain scalability. 

The Limitations of Traditional Computing Models

The computing model used by most applications today involves a client-server model where requests are sent to a centralized database server. The participants within the traditional computing model can be broken down into the following:

• Clients: End-users who generate requests, often via a personal device, which are sent to a centralized database server over the Internet via TCP/IP and await a response. Clients trust the database server to faithfully respond to requests.

• Database Servers: A remote computer, often in the form of a centralized cloud provider, that provides information or access to particular services. The backend database server is often a collection of computers which a traditional institution centrally manages.

Often referred to as “Web2,” this computing model empowers developers to quickly launch and scale applications on-demand. Users are also provided with a seamless user experience due to low-latency and high-throughput computation facilitated by data centers. While applications hosted on centralized databases provide immense value to billions of users around the world, they carry certain limitations. 

Most notably, end-users have no way to verify that the computation involved in producing a response to a request is legitimate or that the database entries have not been manipulated over time. Such applications effectively operate in a black box, meaning users must fully trust that third-party intermediates will act in their best interests. 

The trust assumptions associated with centrally hosted applications can negatively impact users, who can experience financial censorship, social media deplatforming, leaks of their personal data, manipulative content selection algorithms, increased reconciliation costs, corrupted data and data loss, and an overall lack of accountability. The end result is a breakdown in societal trust and an increase in the cost of economic coordination.

The Blockchain Computing Model 

Rather than trusting the good faith of centralized intermediaries, blockchains introduce trust-minimization and credible neutrality by using:

1. Cryptography to authenticate data/asset ownership and validate transaction integrity;

2. Decentralized consensus to establish the ordering of transactions and enforce the protocol’s rules;

3. Financial incentives to ensure the immutability of the network’s ledger and its ongoing operation. 

Importantly, blockchains are open networks—anyone in the world can join as either an active contributor or a passive listener. This allows end-users to verify for themselves that any output produced by the network is valid and that ledger entries have not been tampered with. The transparency of blockchains also mitigates risks around opacity, eliminating information asymmetry and ensuring information regarding risk exposure is available to all participants. 

The Different Roles of Blockchain Participants

To ensure the proper operation of a blockchain, there are various (often overlapping) categories of network participants that each play a crucial role.

• Block Producers (BPs): Entities responsible for ordering and packaging transactions into discrete data structures called blocks which are then proposed to the network to validate. If two valid blocks are produced at the same block height, BPs are responsible for determining which version of the chain is canonical (e.g. longest chain rule). A consensus algorithm is used to determine which BP is responsible for generating the next block in the chain of blocks, with Proof of Work (miners) and Proof of Stake (validators) being the two most popular models.

• Full Nodes: The heart of a blockchain network. Full nodes download and self-verify each block proposed by BPs. If the block is found to be valid (i.e. protocol rules have been followed), then the block is added to the full node’s personal copy of the ledger and state changes are applied. Any invalid blocks not in line with the protocol’s rules are ignored and consequently discarded without any state changes occurring. 

• Archive Nodes: Entities that store all of the same information as full nodes but also compute and store previous states of a blockchain. Archive nodes are useful for querying arbitrary historical data, such as a user’s account balance at a specific block height in the past. Note that a full node can be converted into an archive node at any time without having to download any extra information from the network. Archive nodes typically have high hardware requirements and are commonly run by service providers (e.g. block explorers).

• Light Clients: A limited form of a full node where only the headers (i.e. small unique cryptographic fingerprints) of blocks are downloaded. Light clients can verify a transaction was included within a block, but because they do not download or execute all transactions within blocks, they implicitly trust that the majority of block producers are honest. Light clients, also known as Simple Payment Verification (SPV) clients, were first described in the original Bitcoin whitepaper. 

• RPC Providers: Full nodes that facilitate read/write access to a blockchain that other network participants connect to. RPC (Remote Procedure Call) nodes are often used by those who do not or cannot run their own full node or light client, significantly reducing the friction of accessing a blockchain. Any user connected to an RPC provider implicitly trusts the honesty of the provider as no self-verification work is done.

• End-users: The average user who wants to make transactions on a blockchain network. This category can include participants who run a full node or light client, as well as those connected to an RPC provider. Blockchains exist to serve the end-users, otherwise there is no other reason for the network to exist.

While each of these network participants plays a key role in blockchain ecosystems, full nodes operate at the heart of a blockchain network as they are the entities responsible for maintaining full replicas of the network’s ledger. Other network participants, such as block producers and light clients, connect to full nodes to stay informed on the state of the network. The resulting network topography is illustrated below.

The Limited Powers of Block Producers

A common misconception about blockchains is that since block producers are responsible for generating new blocks containing transactions, then they must unilaterally control a blockchain. Put another way, the belief is that if a majority of BPs are corrupted/colluding (commonly known as a 51% attack), then the network is wholly compromised and everything of value can be irrevocably destroyed. In reality, BPs have a limited scope of power, where only specific types of malicious activity can take place. 

What block producers can do:

• Censor Transactions: Individual BPs determine which transactions are included in blocks they create, allowing them to selectively ignore specific transactions. While colluding BPs can prevent transactions from being included in blocks they create, there only needs to be one honest BP in order for a transaction to be included within a valid block.

• Rewrite the Chain: If the majority of BPs collude (e.g. a 51% attack), then previously created valid blocks can be forked out of the network through a process called block reorganization (reorg), where a new chain of blocks becomes the canonical chain. Note that some blockchains have a notion of “economic finality” via a checkpoint system, with reorgs of blocks older than the checkpoint resulting in a chain halt which requires resolution via social consensus. 

What block producers cannot do:

• Change the Protocol’s Rules: BPs cannot arbitrarily change the protocol’s rules such as adding/removing functionalities (e.g. opcodes), increasing/decreasing the maximum allowed block size or block time interval, or increasing/decreasing the block rewards issued for producing blocks. 

• Steal User Funds: BPs cannot spend coins/tokens from addresses for which they do not have the private key, as the cryptographic signatures of such transactions would be invalid. Note that while chain reorgs can lead to double-spend attacks, this involves simply removing a transaction from the chain’s ledger that was signed by the private key holder, not falsifying a transaction signature. 

To understand why the power of BPs is inherently limited, it is important to understand the relationship between BPs and self-verifying full nodes. 

How Full Nodes Keep Block Producers Accountable

While BPs ensure the liveness of a blockchain by proposing new blocks, they do not determine the validity of blocks on behalf of the network. Rather, it is the role of full nodes—which store a personal copy of the blockchain’s ledger—to independently validate each block and execute all the transactions contained within to determine whether the protocol’s rules are being followed. 

The result is a checks and balances system where full nodes hold BPs accountable by only accepting valid blocks and ignoring blocks that do not conform to the protocol rules. As such, BPs are economically incentivized to only produce valid blocks, as otherwise they would waste economic resources by producing invalid blocks and forfeit any block reward and transaction fees they could have earned. Even if other BPs build valid blocks on top of an invalid block, these blocks will all be ignored by full nodes, resulting in such BPs effectively forking themselves off the network. 

Full nodes are operated by key economic actors within a blockchain’s ecosystem, including cryptocurrency exchanges, stablecoin issuers, oracles, layer-2 validators, RPC providers, custody wallet providers, large crypto asset holders, and average users alike. By self-verifying a blockchain’s ledger, these key economic actors cannot be tricked into accepting invalid blocks. Full nodes do not need to coordinate/communicate with each other to determine if a block is valid either. Rather, by following the protocol’s rules when checking blocks, they will all arrive at the same conclusion regarding block validity. 

With many blockchains, the protocol rules are determined by the community off-chain in a process known as social consensus. This typically involves a formalized process (e.g. Ethereum Improvement Proposals or EIPs), where the community debates the merits of any protocol rule change on various social channels. Once rough off-chain consensus is achieved, blockchain core developers write a new version of the blockchain software client, which implements these changes. Full nodes and BPs can then choose whether or not to run this new software to upgrade the network via a hard fork (non-backward-compatible change) or a soft fork (backward-compatible change). 

If a hard fork upgrade is contentious, then the network may experience a chain split where two different versions of a blockchain are created and individually maintained. Once a split occurs, each blockchain will have a shared history from the genesis block up to the specific block height at which the split occurred. This was seen with the Bitcoin/Bitcoin Cash hard fork in 2017, when differences arose on how to scale transaction throughput. It was also seen in the Ethereum/Ethereum Classic hard fork in 2016, when differences arose on how to handle The DAO hack.

In contrast to off-chain consensus, other blockchains have chosen to handle upgrades via on-chain governance, with a Decentralized Autonomous Organization (DAO) governed by token-holders determining protocol rule changes. Either method of facilitating protocol upgrades presents its own unique benefits and challenges, and the method used depends on the needs of the community. 

Low Hardware Requirements for Full Nodes

If the hardware requirements for operating a full node are too high (e.g. non-consumer hardware is required), then fewer entities will be capable of or willing to run a full node, instead, relying on centralized solutions to read/write to the blockchain. This can result in a blockchain network becoming more vulnerable to exploitation from BPs.

To support a healthy network of full nodes, many blockchains purposely limit the transaction throughput of the network to that of the lowest spec computer that the community desires to self-verify the ledger. Low hardware requirements not only help those who wish to run a full node during normal operations, but also make it easier to spin up a new self-verifying full node if the blockchain is actively being attacked by a colluding group of BPs. The exact hardware requirements necessary to stay fully synchronized to the network vary from blockchain to blockchain, however, a common target goal is average consumer hardware.

The following logic describes how low hardware requirements lead to the core value proposition of blockchains: 

Low hardware requirements → low cost to verify blocks → more entities can run full nodes → stronger resistance to BP attacks → increased network security → superior credible neutrality → increased adoption

While the minimum hardware requirements capable of running a full node are not explicitly defined in the rules of a blockchain protocol (improvements in hardware/software efficiency is perpetually occurring), the transaction throughput rules of a blockchain (commonly determined by the size and frequency of blocks) are tuned to target a specific range of device specifications. 

Although targeting average consumer hardware is a common approach, some blockchains opt to target beefier server-grade hardware as the minimum hardware requirements for verification in order to increase transaction throughput. This comes with the acknowledgment that while fewer entities may be able to self-verify the ledger using self-hosted equipment, a sufficient number of key economic actors may still have the resources necessary to run a full node. 

Reducing the Costs of Blockchain Verification

Everyone in the world running their own full node to self-verify a blockchain is an idealistic goal. However, in practice, the time and resources required to spin up a full node may introduce too much friction for many end-users. As blockchains become more widely adopted, users familiar with trusting centralized service providers may find the process of setting up a full node too cumbersome, and would rather be able to immediately start interacting with on-chain applications. 

As a result, most end-users of widely used blockchains today do not run their own full node, but rather connect to and implicitly trust RPC providers to relay transactions to the network and inform them on the current state of a blockchain. Such users may not enjoy the full self-verification benefits of blockchains and the security of the network is not as strong as it could be, however, it is still an order of magnitude improvement in trust-minimization over traditional computing models.

A middle-ground solution to this problem could entail the integration of light clients into blockchain wallets. While this would be an improvement over the status quo by reducing trust in RPC providers, light clients still implicitly trust that the majority of BPs are producing valid blocks and that all of the transaction data within a block has been made publicly available.

In order for light clients to verify the work of BPs without simply downloading and executing the entire block (i.e. running a full node), technical improvements in light client implementations can increase their trust-minimization properties, resulting in what can be considered “trust-minimized light clients”. These technical improvements can include:

• Fraud Proofs: A cryptographic proof generated by full nodes that can be sent to light clients to prove that a block is invalid and violates the protocol’s rules without the light client needing to re-execute the entire block. 

• Validity Proofs: An alternative to fraud proofs where a zero-knowledge proof is generated, allowing block producers to directly prove to light clients that blocks are valid and follow the protocol’s rules.

• Data Availability Sampling (DAS): A probabilistic sampling technique that verifies that all of the data in a block has been made available to the network without light clients needing to download the entire block.

As additional trust-minimization techniques are created and deployed successfully in production, the cost and friction of verifying the work of block producers without downloading and executing entire blocks improve, leading to more secure blockchain networks. Notably, the methods of creating trust-minimized light clients can even enable more scalable blockchain networks to emerge.

Scaling Blockchains While Retaining Self-Verification

Scaling a blockchain is commonly thought of as being equivalent to increasing transaction throughput. However, a more holistic interpretation would be increasing transaction throughput while maintaining a low verification cost. Thanks to the properties of trust-minimized light clients, the throughput of a blockchain network can be increased (e.g. increasing block size and/or block interval time) yet still retain the low verification costs required to keep BPs accountable. 

Furthermore, layer-2 scaling solutions such as rollups leverage similar techniques as trust-minimized light clients by using cryptographic proofs to prove transaction validity without the blockchain network needing to execute every transaction. In this case, the blockchain operates an enshrined trust-minimized light client for the layer-2 rollup. Combined with transaction batching and storage of transaction data on-chain for data availability, transaction throughput can be increased by multiple orders of magnitude with minimal to no additional verification costs imposed on the underlying blockchain.

Conclusion 

Blockchain are highly secure, credibly neutral, and transparent append-only ledgers that offer a new paradigm for computing. By incorporating a checks and balances system between block producers and full nodes, a blockchain can serve the needs of its community and evolve over time while also remaining resistant to manipulation. While more work needs to be done to lower verification costs, blockchains in their current state still offer an order of magnitude increase in trust-minimization over traditional computing models. 

For more content, follow me on Twitter @ChainLinkGod and listen to The CLG Podcast on Spotify and YouTube.

Originally published on the Chainlink Blog on August 23, 2022.

Bull markets optimize for narratives, bear markets optimize for fundamentals. While this statement is an overgeneralization, it serves as foundational logic for how participants think and react in different market environments. It’s true for most any financial market, but can be seen most clearly within crypto, which operates at a speed and acceleration 100x that of any other current or historical market.

2022 is clearly in a bear market, not just because most crypto tokens are down 80–90% from their previous all-time-highs, but because the attention of market participants has shifted from hype-fueled ponzinomics to sustainable revenue, sound economics, and the need for crypto to solve real-world problems. Bear markets are when the free-flowing money stops and the question “why are we building all of this again” starts to creep back up. Look no further than the engagement on my recent thread about real-world assets and the general sentiment.

While the cyclical nature of bull market narratives and bear market fundamentals is truly nothing new — for neither crypto nor any other financial markets — it’s worth exploring what exactly happened during the previous bull market exuberance. In this blog, I’ll provide my perspective on the reflexive nature of capital rotation games and the largely unsustainable growth strategies employed by blockchain projects in 2021.

The Supply/Demand Mismatch of Blockchain Bandwidth

It’s clear that one of the most dominant problems facing the crypto industry is the blockchain scalability problem, an inhibitor to any future growth that crypto may have. “The internet of money should not cost five cents per transaction” after all, something which Vitalik still affirms to this day. A throughput of 15 transactions per second with $xx — $x,xxx in transaction fees is clearly not suitable for the vast majority of people.

While this issue has reared its head in various ways over the years, with it initially being the Ethereum community dunking on the Bitcoin community for their network’s high transaction fees in 2017, the script has since been flipped. After DeFi summer in 2020 and going into early 2021, the issue of network congestion and high gas costs became clear as Ethereum became increasingly unusable for the masses.

The above tweet perfectly encapsulates the core sentiment and frustrations that many had with Ethereum during 2021. They were priced out and felt that the Ethereum community didn’t care about them, but rather cared more about the ideals around decentralization, self-verification, and monetary premiums. Depending on your frame of reference, some would call this “out of touch with reality” while others would call it “differing priorities.”

In an ideal world, scaling a blockchain is as easy as simply increasing the size of blocks, reducing the time between blocks, and calling it a day. Here’s Elon Musk eloquently stating his scaling roadmap for reducing transaction fees 100x on the Dogecoin blockchain.

Just make the blockchain faster, tune the parameters to eleven, who knew it was this easy! Of course, in reality, it’s not this simple as such an approach leads to centralization due to the increased hardware requirements to run a full node, which breaks the security model of blockchains. Scaling while maintaining the properties that make blockchains useful is a difficult problem.

How Ethereum Was Going to Meet the Retail Demand

Ethereum’s roadmap to scalability is an ever-shifting one. But in 2021, with execution sharding and Plasma obliterated from the roadmap, an all-in focus on rollups was taken in order to meet the demand for blockspace, while still maintaining Ethereum’s decentralization. Rollups separate execution from consensus and data availability, allowing an existing layer-1 blockchain like Ethereum to settle a higher volume of transactions without increasing the hardware requirements of running a full node.

However, the guesstimations about how long it would take for rollups to rollout and reach scale were widely out of sync with the difficulties of the problem at hand. This misaligned messaging around timelines occurred from both the teams developing rollups as well as the Ethereum community at large (yours truly included). Rollups were in fact not at all ready to meet retail user demand in 2021. Even as of writing, in mid-2022, rollups are still not quite ready to meet the level of demand that comes along with global scale.

But this explanation is so nuanced and retail users don’t really care. Decentralization? Full node hardware requirements? Multi-year scaling roadmaps? Retail users in 2021 just wanted faster and cheaper transactions so they could continue gambling on speculative tokens with ease. Not meeting this very real (at the time) market demand would mean leaving a lot of money on the table. Were these users simply to stop using blockchains and wait for Ethereum to scale? Of course not, demand simply needed to be offloaded somewhere in the meanwhile.

The Mass Exodus of Retail to Greener (Cheaper) Pastures

Scaling Ethereum is akin to replacing both engines of a 747 in mid-flight with the population of a moderate-sized country and the capital value of a mid-sized US bank on board. But what if we didn’t have to scale Ethereum at all or care about that whole “maintaining decentralization” thing? It would sure make the problem a whole lot simpler, wouldn’t it? All of Ethereum’s code is open-source, the DeFi primitives have mostly all been established, and plus people are bidding on all these largely valueless governance tokens…

And thus, the Layer-1 Chain Rotation Thesis™️ was born. It was remarkably simple: fork Ethereum’s code, make the blocks bigger and faster (thanks Elon), fork all the core DeFi dApps, pay people to use it, and wow you got yourself a cutting-edge next-generation blockchain that is both cheaper and faster than Ethereum! If the timing aligns, then you’ll see an influx of capital and all the speculation that comes along with hyper-growth.

This approach was so simple and effective, that it was done again and again and again. Each time a new deployment with a money printer popped up, retail users, mercenary capital, and other market participants happily rotated to the new chain to collect the free money. Each chain usually had a new trick up its sleeve, commonly in the form of a different narrative or a slight technical improvement, but fundamentally the same thesis was at play.

During a crypto bull run mania, this dynamic was a win-win for all participants. Blockchain core devs could bootstrap the adoption of their chain (and profit in the process), retail users were once again able to interact with DeFi applications (and profit in the process), and mercenary capital was able to put their assets to work (and profit in the process). If everyone making a profit with there being no losers sounds unsustainable to you, well that’s because it was. The L1 chain rotation thesis was crypto hyper-reflexivity to the max. What goes up must come down, but more on that later.

The 12 Easy Steps To Joining the L1 Chain Rotation Cycle

To understand how and why this blockchain growth strategy was so effective, let’s look at the steps involved. If we were still in a bull market, this explanation could have served as a playbook, but for now, it’s relevant to view these steps in the framing of a post-mortem retrospective analysis.

1. Launch (fork) a new blockchain and create a token

The first step is the most obvious; fork the Go implementation of the Ethereum protocol known as geth. Geth is not only free and open-source software but has also been extensively battle-hardened via years of in-production usage. Why reinvent the wheel where there’s already an underpaid development team that has built the core technical foundation for you?

Naturally, this new deployment of Geth needs a native coin that users can use to pay transaction fees and to support block producers via block rewards. A native coin is also needed to fund the money printer you’ll eventually turn on to attract users and to support the core development team who needs to get paid for the hard work of forking Geth.

Thus you can’t just fork Geth, but you need to initiate a token sale in order to distribute the initial native coin supply to yourself (free), VC investors (~100x lower than public sale price), and maybe some users as well (whatever is left over). Regulators are generally too caught up with their busy work of virtue signaling about “investor protection” and poking at legitimate projects to pay attention to you.

To be perfectly clear, there isn’t anything inherently wrong with forking free and open-source software or initiating a token sale, but these are simply required steps in joining the layer-1 chain rotation cycle that can hopefully accelerate your blockchain’s growth and make you, your investors, retail users, and everyone else some money in the process.

2. Promote your “unique” speed and cost advantages

After forking Geth, there’s little need to keep the blocksize and blocktime parameters the same as Ethereum Mainnet. After all, the reason this new chain exists is to be cheaper and faster than Ethereum. After thanking Elon for his infinite blockchain scalability wisdom, there are also some other neat marketing tricks you can employ.

When your new blockchain is launched, the blocks will be empty and so will the state trie. This means transactions will cost next to nothing (sub-cent) and they’ll be included on-chain with the next block (confirmations in seconds). You can now make some comparison charts between your new chain and Ethereum, showcasing someone would have to be a masochist to still be using Ethereum.

Never mind that demand for blockspace will eventually exceed supply (which is when the fee market for transactions kicks in), or that state bloat will eventually grind your chain to a halt if not checked (due to the growing disk IO bottleneck). Those are future problems, for future you, but for now, it is technically true that your blockchain is faster and cheaper than Ethereum.

Similarly, because blocks and the state trie are empty, the hardware requirements for running a full node will be low, even lower than Ethereum. Naturally, this will change over time as blocks fill up and the state trie grows faster than Ethereum, but in the meantime, you can say you’ve solved scalability without compromising decentralization and self-verification.

Naturally, some people will try to call out your shortcuts to increasing throughput, but they can be easily dismissed as “maximalists” or simply ignored because they’re clearly NGMI. If that doesn’t work, then some more advanced tactics are needed. This is when marketing becomes more akin to gaslighting and Twitter becomes the primary battleground.

Find and own a catchphrase such as “Consensus is the bottleneck, scalability is a lesser engineering problem,” “Decentralization is the cost to destroy all replicas,” or just call those who do not align with you “poor” and that “their size is not size.” Throw in a “The future is multi-chain” for good measure as well.

Congrats, you’ve successfully solved the blockchain scalability problem with zero trade-offs! Also, because you’ve launched and distributed a token, you now have a community of financially incentivized token holders who will parrot your narratives and defend your blockchain against FUDsters at any costs. Don’t forget to regularly point out how expensive Ethereum is.

3. Fork and deploy core DeFi primitives

By this point, you’ve probably grown a niche community, but so far there isn’t actually much to do on your new blockchain. Retail users want applications they can use to speculate on tokens, requiring key DeFi primitives like non-custodial exchanges, money markets, overcollateralized stablecoins, derivative platforms, and so on. Once again, look towards Ethereum where there is a growing ecosystem of free and open-source smart contracts that can be easily forked and deployed on your new chain.

However, a blockchain core dev team deploying their own forked dApps to their own forked blockchain doesn’t look like much of an ecosystem, so you’ll want other teams to deploy these dApps. This can be easily achieved in one of two ways. The first is awarding grants to opportunist developers whose innovative idea is to create the “The [XYZ] dApp of chain [ABC]”.

To give some credit, forking and improving an open-source protocol can indeed be a net positive for the industry by pushing the boundaries of what’s possible. But oftentimes, the idea is as simple as forking an established protocol, deploying it on a new chain, and then calling it a whole new thing because the branding is different.

The second approach is a bit more subtle but is usually more time and cost-efficient. Fork those dApps yourself and hire a dev team to pose as the founders and maintainers. If you can’t find any devs to act the part, play the role yourself but under a pseudonym so nobody is any the wiser.

The net result and goal are the same, emulating the Ethereum ecosystem but on your blockchain and with new dApp tokens that retail users can speculate upon. This allows for sentiment such as “If this new dApp token reaches just [x]% of the market capitalization of its counterpart on Ethereum…” You get the idea.

4. Get your dependencies in check and sell users a bridge

The nice advantage of forking geth is that your blockchain is running the EVM, meaning all of the tooling built around Ethereum and Solidity smart contracts work just the same. Importantly, this means Metamask (which your target audience already has downloaded) will work just as it does on Ethereum, just needing an additional RPC connection. The developer community can also use Hardhat, Truffle, and all the other dev tools they need to (hopefully) create new dApps on your chain.

However, it’s essential to make sure your other dependencies are in check as well. You’ll need a block explorer, so either fork an existing one or pay Etherscan to make a clone. You’ll need oracles for your forked DeFi apps, so get into contact with Chainlink. You’ll need liquidity and a fiat on-ramp for your coin, so work with exchanges to get listed. You want the experience to feel like Ethereum (but cheaper and faster).

Lastly, you need a way for people to onboard onto your new chain from existing ecosystems such as Ethereum. A siloed garden is no fun for anyone and significantly limits your growth potential. Therefore, you’ll need to create a cross-chain token bridge, which will take the form of a multi-sig managed by a small handful of trusted validators. Cross-chain bridges can be tricky to get right, as well over a billion dollars worth of crypto has been stolen from bridges in the past year alone.

Deploying a cross-chain bridge is simply a necessary risk to take to join the chain rotation cycle. Once deployed, make sure to let users know you have a bridge to sell them and that it’s the most seamless and secure bridge that they’ve ever seen before.

5. Spin up the money printer and start the growth cycle

By this point, you’ve created (forked) a new blockchain and you’ve managed to convince a number of community members into believing and/or echoing the narrative that your blockchain is faster and cheaper than Ethereum. But why should users switch over from the other “faster and cheaper than Ethereum” alt-L1 blockchains they’re already using? Your blockchain will likely have less liquidity, users, traction, and mindshare than existing solutions.

There is but one clear answer: to make money.

This next step is the key ingredient to making the L1 chain rotation thesis what it is. Deploy, endorse, and market a massive token subsidy program, where users can earn rewards by simply deploying their capital into your blockchain’s dApp ecosystem — commonly known as yield farming. These token subsidies can take the form of the chain’s native coin (of which you minted yourself a portion of the supply allocated for this purpose) and/or governance tokens deployed by the dApps themselves.

During a bull market where retail participants will speculate on anything that moves, the tokens used for subsidizing rewards will inevitably have a value above zero, even on day one, which is enough to kick-start the ensuing virtuous cycle. Make sure to give the subsidy program a catchy name and focus on how this program will enable growth and that your ecosystem is growing and that growth is good. Welcome to the world of printing money.

6. Enjoy the TVL growth as the “fundamentals” increase

When token subsidies are employed, the “yield” offered by dApps on your blockchain will look quite alluring. Lending rates on money markets will be higher, returns on provisioning liquidity in DEXs will be higher, and the ROI on depositing tokens into a contract that doesn’t do anything will be higher. As long as the money printer is still giving out tokens and people are willing to purchase these tokens, then the “yield” will continue to flow. However, most people don’t question where the yield actually comes from, and even for those who do, it doesn’t matter as the “yield” will still exist.

This increased “yield” from the token subsidy program will attract both retail users and mercenary capital to deploy their assets into your blockchain ecosystem via your cross-chain bridge. This capital deployment from yield-chasers will result in an increase in the Total Value Locked (TVL) of your blockchain and its dApps, a prime metric that signals to users and speculators that your blockchain is healthy and growing. The “fundamentals” of your blockchain are increasing and TVL is going to be used as proof of that.

7. Promote TVL growth as a success

Naturally, this increase in TVL will be very exciting, and now is the time to market your success. Multi-channel marketing campaigns, promoted tweets, and sponsored media articles are the fuel you need to accelerate this virtuous cycle. You won’t be alone either as your core dev team (who double as marketers), VC investors, token holders, dApp dev teams, and influencers will all be promoting how amazing the growth of this new chain is.

There’s no reason to stop at TVL either, as a whole host of metrics will be increasing as users chase subsidized yields. Active address count, daily transaction count, protocol revenue, market capitalization, and pretty much any metric that benefits from subsidized yields can be promoted as proof that your chain is the future.

The one metric you don’t want to highlight, however, is how much is being spent on token subsidies or the resulting inflation rate. The big number was impressive for the initial announcement, but after deployment, you want to focus on promoting yield, TVL, and growth. The goal is to incite FOMO and WAGMI energy. If you don’t have your capital deployed to this new chain and you’re not speculating on these hot new tokens, then sorry fren you’re missing out.

8. Watch the speculation accelerate

This is the stage where things really start to accelerate. The retail masses will see this marketing blitz on their social media timeline and feel they have to jump in, just think of the opportunity cost otherwise! The impressive growing TVL and other growth metrics will look too strong to ignore. As a result, retail will feel that these tokens are undervalued and begin to increasingly speculate and bid up their value. The token’s inflation rate, lack of value capture, or unsustainable economics is irrelevant, the TVL is going up and that is good!

People who speculate on tokens, tend to not only defend their investment but actively promote it as well, accelerating the cycle even further via word-of-mouth marketing. The amount of Koolaid being drunk at this point will be intoxicating, but with their portfolio value going up, they’ll feel validated in their thesis.

Anyone calling out the cycle for what it is, an unsustainable hype cycle, is just simply fudding because they missed out and didn’t make money like everyone else. The market has spoken and these valueless governance tokens are actually very valuable because the price is going up. Never mind the circular logic, look at the TVL growth!

9. Yields and TVL increase as the cycle accelerates

The L1 chain rotation thesis flywheel is now in full effect. When the price of a token used to subsidize yield increases in value, thanks to market speculation, then the rate of subsidized yield provided to users also increases. These increased yields attract even more capital to be deposited into your dApp ecosystem, improving the growth metrics such as TVL even further. These growth metrics can be repromoted on social media, leading to more speculation on those tokens, leading to increasing yield, leading to an increase in TVL, leading to… and the cycle accelerates.

Speculation on the fundamentals of your blockchain’s ecosystem has suddenly made the fundamentals even better. Can you see where this can start to go wrong?

10. Reality check

At a certain point, the underlying blockchain reaches its breaking point. Blocks begin to fill up, which causes transaction fees to increase and confirmation times to take longer. This was the very thing your chain was supposed to solve, no good! Thankfully, you can simply kick the can down the road by increasing the blocksize. Yes, this increases the hardware requirements of running a full node and yes this is unsustainable as eventually, disk IO will become so saturated that even the beefiest server-farm nodes cannot stay synced to the tip of the chain.

But don’t worry, these are just “growing pains” that every blockchain like yours runs into at some point. As it turns out, blockchain scalability is actually quite nuanced and a hard problem to solve. It always was, but now you need to convince your audience of this as well who are likely questioning if you really solved anything at all. It’s time for a pivot.

11. Continue the cycle via a narrative pivot

The cycle has been so profitable thus far, it would be a shame to just let it end like that. Thankfully, you don’t have to, because you are now an interoperability blockchain. Your blockchain isn’t a singular chain, no, it’s now an ecosystem of sidechains that interconnect via a central hub chain.

Except, you can’t call them sidechains because of the negative connotation around poor network security. The name doesn’t really matter, the point is that you’re now going to solve scalability by extending horizontally. These new chains won’t have the same level of security or decentralization as the first one, but when has that mattered in achieving success thus far?

What you’re attempting to scale is not necessarily transactions per second, but rather the flywheel effect. A new sidechain means a new token for people to speculate on, a new dApp to subsidize with tokens, and a new blockchain with empty blocks and state to be filled up. Eventually, these sidechains will become congested just like the first blockchain deployment did, but thankfully you already solved for that. Just launch another sidechain.

12. Onto to greener cheaper pastures (again)

The interoperability blockchain thesis is very nice, but by this point, the gig is usually up. When there becomes more sellers than buyers, which can happen for a number of reasons, the game of musical chairs has come to an end. The flywheel has begun to reverse itself. As the price of the token used to subsidize yield starts to decrease, the yields begin to decrease. Decreasing yields leads to people withdrawing their capital, either to generate more yield in another blockchain ecosystem or simply because the risk is no longer worth the dwindling return.

This causes the ever-important fundamental metrics like TVL to drop, which makes the subsidy token not look as attractive as an investment anymore. With the fundamentals “changed,” those speculating on the token become more bearish and begin to sell off. This causes yields to decrease further, which causes more capital to leave, which causes… and the cycle accelerates.

This doesn’t mean your blockchain and its ecosystem is dead, but rather much of the mercenary capital and retail is leaving for greener pastures. What is left are the users who found real utility from your blockchain ecosystem, feel the level of yield offered is still sufficient, or have simply become community members. Tokens never truly go to zero either, even during cases of extreme hyperinflation, so the subsidy will still always have some value to support the ecosystem.

But what exactly triggers the switch to more sellers than buyers in the first place? Most often, it’s a new shiny blockchain that has appeared offering better yield, lower transaction fees, faster transaction speeds, and/or a better narrative overall. This blockchain will probably run into all of the same issues as yours, but that doesn’t matter, the fact remains that they’re faster and cheaper than your blockchain and they’ll let users know.

And thus, the rotation cycle goes on.

Conclusion and Key Takeaways

Crypto in 2021 was largely defined by the jpeg NFT mania and the L1 chain rotation thesis. When money flows freely, projects have to compete on the basis of attention, and nothing attracts the attention of capital holders more than the opportunity to make money, either via speculative tokenized jpegs that can be resold at a higher price or by subsidized DeFi yields on a new blockchain fork.

While this blog post may seem like a pessimistic view on alt-L1 blockchains, the growth tactics I described above were simply the logical route to take given this approach was being actively rewarded by the market, in terms of both attention and capital allocation. It’s clear that not every blockchain other than Ethereum is a blatant unoriginal fork created as a cash grab, as many blockchains have real redeeming qualities and unique value propositions that push the industry forward as a whole. This blog isn’t meant to take shots at any specific blockchain ecosystems, but rather to highlight the capital rotation games that the crypto industry as a whole not only accepted but actively supported.

I’m interested in crypto because this technology presents a viable path towards improving society by re-establishing trust between mutually-distrusting entities by executing agreements on a credibly neutral settlement layer that is viewable to all and tamperable by none. I am not interested in crypto because of the various ways we can print money out of thin air to fake yield, create financial weapons of mass destruction that obliterate retail capital, or because of the highly reflexive and speculative properties. There was simply a systemic malformed incentive structure problem, something which not a single project or entity could solve, but is at the very least worth calling attention to and analyzing.

These days, given the current market conditions, the L1 chain rotation thesis strategy doesn’t work as well as it used to. Narratives of growth are now expected to be matched with sound economics and real defensive moats. I hope when the next bull cycle arrives, whenever that may be, that we have collectively learned our lesson about unsustainable capital rotation games. But to be frank, this is crypto and I have my expectations set accordingly.

For more content, follow me on Twitter @ChainLinkGod and listen to The CLG Podcast on Spotify and YouTube.

Originally published on Medium on July 9, 2022.

2019 was quite a monumental year for Chainlink, to say the least. Throughout the year there were countless integrations of the oracle framework from a wide array of different entities: crypto startups, large enterprises, blockchain/DLT projects, data providers, node operators, ecosystem builders and much more. I don’t blame you if you couldn’t keep up with the flurry of activity that's been taking place! Just one look at the chart below, and it becomes immediately clear that interest in the Chainlink protocol has been growing exponentially since 2017.

The Chainlink mainnet officially went live on May 30th (after three independent security audits) with just three security reviewed node operators (Chainlink, LinkPool, and Fiews). For most of 2019 there was just a single price feed reference contract that aggregated the ETH/USD market price every five minutes (update frequency later adjusted). While the chainlink network was technically live on the Ethereum mainnet, you could think of it more as an extended testing period as the Chainlink team carefully analyzed the reliability and security of their sole Aggregator smart contract (also audited) before they began expanding to include a wider array of different oracle networks.

Before you can run, you must first learn how to walk, especially when your value proposition is building new infrastructure that facilitates trust. Similar to raising a child, nurturing the early outgrowths of trust in the network is crucial to forming a foundation that can support long term success.

Over the course of the second half of 2019, the team successfully scaled the ETH/USD price feed from just three initial nodes (and three data sources) to their stated goal of 21 independent, security reviewed, and Sybil resistant nodes (and ten data sources) with zero issues or downtime. This proved that not only does Chainlink have scalable security but it can do so in an elegant manner wherein developers don’t have to redeploy the entire Aggregator contract each time they want to add more nodes (or remove nodes). This flexibility is important as developers can choose and pay for the exact level of decentralization/security required for their smart contract today, while simultaneously having the capability of easily scaling that security up as needed as the value of that contract rises.

Since launch, the Chainlink ecosystem has grown substantially from just three nodes to over 27 security reviewed nodes that are live today feeding off-chain data to the 29 various Chainlink Price Reference Data contracts currently being consumed by several Ethereum mainnet DeFi protocols such as Synthetix, Loopring, Ampleforth, and Aave. This means that Chainlink Oracle Networks are already securing over $150M worth of collateral locked in the above DeFi projects (now over $740M with the addition of Celsius). Oracle security is absolutely paramount for contracts that lock up and direct user funds. Without a secure oracle solution, DeFi protocols would be putting users’ collateral at risk of loss by malicious actors manipulating the oracle system that delivers the data that triggers and ultimately determines the action a smart contract takes. As the saying goes, “garbage in, garbage out.”

There are also 100+ independent community nodes listed on the open marketplace market.link. There are also 21+ Chainlink-connected data sources and 23 Chainlink-powered dApps on the API marketplace honeycomb.market. The pace of growth has been nothing short of mind-blowing and showcases a real demand by smart contracts to be connected to external sources of data (usually market prices) from outside the blockchain (off-chain) which is securely and reliably delivered to the smart contract by time-tested and security-hardened oracle networks.

LINK Token Usage

While these decentralized oracle networks are vastly more secure and even cheaper than trying to develop and run your own centralized oracle system, the current costs of Chainlink oracle networks is still quite real and primarily falls into two buckets. Firstly, there are the costs associated with paying oracle nodes in the ERC677 token LINK to access their off-chain data/APIs/compute. Secondly, there are the gas costs which are paid in the native currency of the Ethereum blockchain, ETH, each time an on-chain transaction is created. Specifically, ETH is needed when requesting data and when nodes deliver and aggregate such data.

As to why Chainlink needs its own token, I wrote about it in a thread here and The Crypto Oracle wrote about it here. In short,

• It enables TransferAndCall functionality (allows requesters to send LINK payments and request data from nodes in a single transaction)

• Isolates the security and economics of the overall network from unrelated external factors (incentives are aligned by having active nodes hold a share of the network and prevent security from being fragmented into many disparate networks)

• Forces nodes to have “skin-in-the-game” (LINK will be staked by nodes as collateral which can be slashed for malicious behavior or non-performance)

• Allows the Chainlink team to subsidize early oracle networks to make sure operating a node in the early days of the network is economically feasible (solving the chicken or egg problem of building a new network)

The amount of LINK paid to nodes for their off-chain data depends on the value of the contract being triggered, the use of free/paid APIs, what rates the nodes are willing to accept, and what the requester is willing to pay. Thus, before a network can be established, a price equilibrium needs to be found. The LINK payments need to be high enough to prevent bribery attacks, but low enough to be economically sustainable in the long term. This cost is unique for every integrating contract and oracle network and should be evaluated on a case by case basis.

For example, each node feeding data to the decentralized ETH/USD (21 nodes) and BTC/USD (20 nodes) price reference networks are paid quite handsomely at 0.333333333333333333 LINK per data feed, which has an update frequency of every twenty minutes (or a 0.5% deviation from last update). This amounts to ~7 LINK in total to update just one price feed network. This means a node that delivers data to just one of these price networks is currently paid ~8,760 LINK per year ($40k at current prices) and double that if the node is delivering data to both (ETH and BTC) price feed networks. This puts the total LINK cost of securing just one of these price networks at ~180,000 LINK per year (Over $800,000 at current prices) and double that for securing both networks. These numbers are calculated using worst case scenarios where feeds only update every twenty minutes and volatility is never above 0.5% within that time period (which is unlikely so nodes are actually paid more than this).

The parameters above have since been updated from when I initially wrote this article. As of April, the ETH/USD and BTC/USD feeds (now both 21 nodes each) update at every 1% deviation threshold since the last update and a heartbeat of every two hours. Node payments have also been bumped up to 2 LINK per node per update per data feed. This means node income is now more variable as these networks will trigger updates (and node payments) still incredibly often during times of high volatility, but much less often during times of low volatility.

It should also be noted that, down the line, the amount of tokens paid to each node operator can vary depending on a predetermined function (e.g. first nodes to respond get paid the most), and/or be pegged to a certain dollar amount of LINK tokens (e.g. $0.30 of LINK paid per node for each update) by leveraging a LINK/USD price feed network.

These LINK payment expenses to nodes are required to prevent bribery attacks (ETH and BTC price feeds are high value targets) as nodes who try to cheat would immediately get removed from that price feed (and likely all price feeds they currently feed data to, not just the one attacked). This would amount to losing out on all future revenue, which as demonstrated above, is quite a substantial amount. Such an attempted attack would also destroy a node’s reputation making any chance of them earning more money in the Chainlink ecosystem essentially impossible. Proof of the node’s malicious activity is immutable and forever viewable on-chain or on the Chainlink explorer by anyone. If they wanted to rejoin the network and make any revenue, they would have to create a brand new node and build their reputation all over again from scratch.

Potential attackers would have to convince not just one node to take on this monumental risk but at least 50% of the nodes in an oracle network (since the current Aggregator takes the median). This becomes more and more improbable (and expensive) too the more nodes that are added to a particular network (and the more each node is paid). These nodes would not want to lose out on such a lucrative revenue stream (i.e. payments in LINK and price appreciation of that LINK) for an insignificant bribe especially in the early days of the network. Many of these node operators are also public-facing businesses that offer other services to their customers (PoS validator pools, NaaS infrastructure, etc). Thus, their reputation determines not only their revenue in the Chainlink network, but for all other networks they currently serve. Additionally, node operators could be held legally responsible for their malicious actions as oracle manipulation is already illegal in traditional financial markets.

The LINK spent on these networks is a big reason why these Chainlink Price Reference Contracts are currently the most secure oracle networks on the market. The cryptoeconomic incentives heavily favor honest nodes as dishonest nodes will lose most, if not all, future revenue in the Chainlink economy. In order to raise the security of an oracle network, the creator/requester could take a combination of multiple paths: they could require each node to stake some amount of LINK as collateral which gets slashed if the node responds with outlier/faulty data or not at all (currently still in development), they could pay the nodes more LINK per request, and/or they could add more nodes to their oracle network to increase both the liveness and security guarantees. All of these methods increase the cost of bribery/collusion attacks, making the oracle network more dependable for the consuming smart contracts.

To sum it up, the LINK paid to nodes operators in each oracle network directly affects the level of security for such a network. While some of the payment is used by nodes to subsidize the ETH gas costs associated with creating on-chain transactions in response to data requests, most of it is pocketed by the nodes as profit. This profit incentive mechanism ensures nodes act honestly in delivering data and do not succumb to bribes. If you are looking to reduce costs of your oracle network, but keep security at the same level (or higher), reducing the amount of LINK paid to nodes is generally not the way to go.

Sharing the Costs

One way to mitigate these LINK payment costs is to have many projects contribute and support a common oracle network (like the ETH/USD reference feed). In this regard, the total payment to nodes remains the same, but the cost borne by each individual project goes down (while maintaining the same level of oracle security). Each project now only has to contribute a fraction of the overall funds required to run the network securely. These shared networks effectively become a public good available to any crypto project or smart contract developer, as no one project could support such a highly decentralized oracle network that’s sufficiently funded on their own.

If a project wanted to create a proprietary and isolated price feed, specifically to prevent freeloading of the oracle network they support, they could setup and fund their own oracle network using a whitelist-supported Aggregator contract (in development). In such a model, only pre-approved on-chain contracts can query the Aggregator for its latest/historical data. This is possible as Chainlink is a framework for building/connecting to any kind of oracle network. What works for one project, may not for another; this flexibility is key and is one of the killer features of Chainlink.

By designing oracle networks as public goods that are shared by many projects, the per-node LINK payment costs are reduced, as the costs are spread amongst each individual project without lowering the oracle network’s overall security. But this isn’t the only area where efficiencies can be made in regards to reducing the upkeep costs of an oracle network. We also need to examine the ETH used to pay for Ethereum transactions.

ETH Gas Payments

Every time you want to make a transaction on the Ethereum network, you need to pay for the costs associated with how much computational effort miners need to endure in order to process and verify that transaction (this is to protect against DDoS and spam attacks). The more complex a transaction is the more gas that’s required. A simple ETH transfer costs only 21,000 units of gas, while a more complex smart contract operation may cost up to 10,000,000 gas (current gas limit of a single Ethereum block). Every individual transaction has a gas limit, which the sender determines by setting a maximum limit on how much gas a transaction is able to consume.

The user initiating the transaction also chooses the gas price they are willing to pay, denominated in Gwei, for each unit of gas consumed (1 Gwei = 0.000000001 ETH). So while the gas used in a transaction is always fairly static, the gas price you need to pay for each unit of gas can change as the Ethereum network as a whole gets more or less congested (Remember the CryptoKitties craze in late 2017?). If you want your transaction to be processed and confirmed within a timely manner, you will have to pay a higher gas price as miners prioritize transactions with the highest gas price first. Miners can only fit so many transactions in a single block and ultimately want to maximize their profits. Essentially, Ethereum is a decentralized computer with limited bandwidth where users can pay more for better access to quicker bandwidth.

Currently, the Chainlink protocol is the third highest consumer of gas in the Ethereum network (can also be thought of as the third highest consumer of Ethereum blockspace). This is just behind dYdX (a margin trading DEX) and the stablecoin Tether USDT (used for value transfer/arbitrage across cryptocurrency exchanges). While Chainlink having this high level of gas consumption is considered bullish to many (as it shows real network usage), it is also one the major factors that contribute to the current costs of running and maintaining Chainlink oracle networks (these costs are borne by both requesters and responding node operators). The ultimate goal is to increase usage, while decreasing the amount of gas consumed.

Understanding the basics of Ethereum gas is needed to understand where most of the current costs of maintaining a Chainlink oracle network originates from. The gas required for requesting an update of an on-chain Aggregator contract (for say a price feed) from an oracle network increases linearly the more nodes that need to be pinged for their data. For example, back when the ETH/USD price feed featured only three nodes, an update request transaction cost 378,440 gas (~$2.04 at 20 Gwei gas price), while today with 21 nodes in the network it costs 2,374,048 gas (~$12.82 at 20 Gwei) to initiate an update. This is already 23% of the available bandwidth in a single Ethereum block!

Besides the gas costs associated with requesting an update from an oracle network, there are also the costs each responding node incurs when responding back on-chain with their data. Some nodes may also have to perform and pay for on-chain data aggregation (and update the trusted answer) if the minimum number of responses (a predetermined threshold) has been reached for that particular update round. For the ETH and BTC price feeds, the minimum threshold to start aggregating is after 14 responses (later lowered to 9). This currently costs anywhere from 42,204 gas per response (~$0.23 at 20 Gwei) if aggregation doesn’t need to be performed, all the way up to 144,776 gas per response (~$0.78 at 20 Gwei) if on-chain aggregation needs to be performed. These gas costs scale linearly with how many nodes were pinged for their data (more nodes = more response transactions).

500,000 is the default gas limit set per response transaction by Chainlink nodes. This prevents malicious data requesters from having nodes respond to a malicious contract that tries to drain as much of a node’s ETH funds as possible by performing needlessly complex operations, yet still leave enough gas to allow for the aggregation of many data points. This can also save on gas costs as miners are more picky on transactions that have a high gas limit since those take up a larger percentage of any given block. 500,000 is the optimal amount sitting right in that comfortable goldilocks zone.

Due to these gas costs (both request and response transactions), the current Aggregator contracts that lie at the heart of every currently live chainlink network can only support a maximum of 45 nodes before encountering gas consumption issues. While 45 nodes are still vastly more secure than a centralized oracle network with only a single node, if they want to eventually secure contracts that are valued in the billions, if not more, then they are going to need to bring these costs down multiple orders of magnitude to enable support for more nodes in a single network. Ethereum’s blockspace is not infinite and if we expect a plethora of heterogeneous oracle networks live at any single given point of time, then ultimately efficiencies need to be made. This is exactly what the Chainlink team has been working on mitigating for quite some time now.

Temporary Cost Saving Measures

A simple way of mitigating some of these LINK payment and ETH gas costs is to change the rate at which oracle networks update. This is a direct trade-off of latency vs cost, but could be customized for each oracle network depending on demand. The ETH/USD reference feed launched in May updated every five minutes (288 times a day), but was later reduced in November to every ten minutes (144 times a day). This cut costs in half (half as many LINK payments, half as much gas consumed), but also increased latency by twice as much. Around this time, the BTC/USD reference feed launched and was also set up to update every ten minutes. In February of this year, the BTC/USD and ETH/USD reference feeds were extended again to update every 20 minutes and at every 0.5% deviation from the last update (minimum 72 times a day but could be more depending on volatility).

In April of this year, these same reference feeds were adjusted to update every two hours and at every 1% deviation from the last update. Payments were also bumped up from 0.33333333333333333 to 2 LINK per node per update. As stated before, these oracle networks will update more often during times of high volatility and less often during low volatility.

While not the most optimal long-term way to scale, this was a quick and easy way to temporarily cut down on-chain costs and create more economically sustainable oracle networks that are being supported by the Chainlink team. This is just the first of many optimizations rolling out to reduce the overall expenses of oracle networks.

Chainlink Nodes and Gas Prices

Another obvious way to save money on Ethereum transactions is to lower the gas price used. By default Chainlink nodes set the gas price of their response transactions to 20 Gwei and if it doesn’t confirm within 12 blocks (~2.6 minutes as blocks are every ~13 seconds), then the transaction is bumped with a gas price 5 Gwei higher. It repeats this process 10 times or until the transaction confirms. If after 10 gas bumps the transaction has yet to be confirmed, then the node considers the job run a failure (ideally this would never happen). All of the above variables are 100% customizable by the node operator and can be set to any arbitrary value. While most of these variables have to be set before starting the node, the default gas price used for transactions can be updated in real-time as the node is running.

While transactions usually confirm quickly with no issue, this method causes nodes to often way overpay as the Ethereum network is *usually* not congested enough to justify paying such a high default gas price. This wastes the node operator’s ETH funds and ultimately digs into their profits. For example the gas price to confirm a transaction within one block may only be four Gwei, but the Chainlink node (by default) still sets the gas price to the value held in its database (initially set at 20 Gwei), this causes the node to overpay five times over what it actually needed to.

In order to mitigate this issue, Chainlink integration engineer Thomas Hodges created the Chainlink Gas Price Update Service that node operators can run locally on the same machine as their node. This module automatically fetches the latest gas price from multiple gas reporting APIs (default is EthGasStation, Anyblocks Analytics, and POA network but node operators can choose which APIs they want), and updates the Chainlink node with the max “fast” value of the endpoints every minute.

By leveraging this gas updater module, Chainlink nodes can always know what gas price they need to set to ensure their transaction goes through in a timely manner while not overspending their funds needlessly. The Chainlink team is working on building this feature natively into the Chainlink node itself, designed in such a way that there aren’t any dependencies on external gas estimator APIs. This makes the overall gas price estimation process of each node much more accurate and censorship-resistant. While it’s unlikely that all three default independent gas estimator APIs are DDoSed, hacked, or compromised at the same time, it’s not an impossibility, so having the Chainlink node calculate gas prices internally, using data from its connected Ethereum node, is much safer (multiple Ethereum nodes are connected behind a load-balancer for redundancy).

While this solution lowers some of the costs associated with paying gas for Ethereum transactions, this isn’t enough to scale Chainlink to the security level required by high value smart contracts (ones that would power entire industries: Insurance, Trade Finance, Derivatives, etc). But don’t worry, the Chainlink team isn’t asleep at the wheel, far from it, and in-fact right now there are a few major developments in the works that will largely solve these gas consumption problems.

Data Request Optimizations

A significant portion of the gas used in Chainlink networks can be eliminated entirely by never making any request transactions in the first place! This is possible with the new Prepaid Aggregator smart contract the Chainlink team has been developing silently since mainnet launch (note, still in development and no public audit yet). This is a much more flexible and upgraded version of the Aggregator v1 smart contract that is currently in use by all Chainlink networks today (Aggregator v1 is audited and time-tested).

How it works is largely in the name, instead of a requester having to make a specific on-chain transaction each and every time they want a data update, they can instead prepay ahead of time by loading the contract with enough LINK tokens (how much is up to the requester and depends on a multitude of factors). More LINK tokens can be added to the contract at anytime by anyone. The Chainlink nodes in the network then autonomously trigger new update rounds, push their data to the contract, and aggregate the data all on a predetermined basis with no further input needed from the requester.

These predetermined update parameters can be based on a time schedule (e.g. every 10 minutes), on a deviation threshold (e.g. every 0.5% price deviation since previous update), or a mixture of the two (e.g. every 1% price deviation or 2 hours since last update). This feature is enabled by what the team calls the “Flux Monitor.” Each node would run its own Flux Monitor module (integrated into the Chainlink node natively), this way a new round of updates can be initiated by any node in the network.

All nodes would run their Flux Monitor in the background which would, on a predetermined interval (e.g. every minute), check if a specific threshold/trigger has been met, and if it has, initiate a new round of updates and deliver their data on-chain. Nodes would also continuously monitor the on-chain contract to see if any other node in the network has already initiated a new round of updates, in which case it would fetch the desired off-chain data, feed it into the contract as usual, and perform aggregation if needed.

The Prepaid Aggregator contract and the Flux Monitor go very much hand in hand, each not being possible without the other. Additionally, this combination also greatly increases the censorship-resistant nature of Chainlink oracle networks as any node in the network can initiate a new round of updates, instead of just the single requester having that capability. DDoSing/censoring the requester would achieve nothing after they've already setup and loaded the contract with LINK. This makes Chainlink oracle networks much more autonomous and fault-tolerant overall.

Trying to perform the same DDoS attack on a distributed/decentralized network of Chainlink nodes becomes increasingly more difficult/impractical the higher the number of nodes in the network (if not being completely impossible due to how nodes are security hardened: e.g. inbound ports closed or IP-locked, denying unauthorized connections, only making external connections as needed). This creates an oracle network that is incredibly resilient to failure and capable of withstanding a much wider array of attacks.

The Prepaid Aggregator also contains many additional quality-of-life upgrades and new security features which greatly benefit both smart contract developers and node operators alike. This includes gas-optimised variable sizes and contract logic, improved readability (and thus auditability), isolated aggregation logic, increased transparency with additional getter methods, optional contract whitelisting for data access control, increased security for LINK withdraws through key hierarchy, and more.

The Prepaid Aggregator contract will likely end up becoming the de facto standard aggregator contract that will sit at the core of many Chainlink oracle networks, autonomously coordinating node activity and consensus. The contract will eventually become time-tested (and audited of-course) just like the current v1 Aggregator contract is today, and due to the flexible, compossible, and upgradable nature of the Chainlink framework, many more aggregation contracts/strategies can be created (by anyone) as a template or as a specialized contract that can meet any project/dApp’s exact aggregation, security, and off-chain data needs.

The Prepaid Aggregator contract will substantially lower gas costs for the requester (from consuming millions of gas per request to literally zero), but the added complexity in the aggregator contract logic will slightly increase the gas costs experienced by Chainlink nodes when they respond with their data on-chain. Due to this, the Prepaid Aggregator can only handle a maximum of 42 nodes (just slightly lower than the 45 nodes maximum of the Aggregator v1 contract in use today).

While 42 independent oracle nodes is still much more decentralized and secure than what a centralized oracle with only a single node can offer, gas costs still prevent Chainlink networks from scaling to the level required by high-value smart contracts which will want hundreds if not thousands of independent nodes in their oracle network feeding data to and triggering their contract logic. The Chainlink team have long recognized this issue (in the whitepaper), and have been working on a very key development that will largely alleviate this issue entirely.

Data Response Optimizations

In Chainlink oracle networks today, each time there is a data update request, every node in the network has to create their own on-chain transaction to contribute their data to the aggregator contract with aggregation being performed on-chain. As demonstrated in the sections above, this can be incredibly inefficient since the gas costs increase linearly with the number of nodes in a network. This method of on-chain aggregation will always have an upper bound on the maximum number of nodes that can be supported in a single oracle network.

To overcome this, Chainlink nodes can instead connect and coordinate off-chain (current plan is to use the libp2p networking stack) and achieve consensus among a majority of the nodes without needing to perform any expensive on-chain transactions to create the final aggregated data point. In order to prove that consensus was achieved off-chain, nodes sign the data and combine their signatures into a single Threshold Signature.

The result is that oracle networks now only have to create a single response transaction to update an on-chain contract with off-chain data. This transaction contains the final aggregated data point and a single threshold signature that proves the data was aggregated and signed by a majority threshold of nodes in the network. The threshold of nodes needed to create a complete threshold signature is determined beforehand and can any fraction of the network (e.g. 2/3, 4/5 of nodes). By having only a majority (not all) of the nodes in the network come to consensus, this avoids any issues related to stubborn/unresponsive nodes holding up progress.

Only a single node in the network needs to create the response transaction (usually the node that completed the threshold signature) leading to huge reduction in the amount of gas consumed in an oracle network overall. Nodes don’t need to stock up on nearly as much ETH as the probability of needing to make an on-chain transaction goes down the higher the number of nodes in a network. Additionally, the cost for verifying a threshold signature on-chain is extremely cheap at only 15,000 gas! This puts the total transaction cost at 36,000 gas (21,000 base gas cost + 15,000 gas for threshold signature logic). This low cost signature verification is achieved by taking advantage of the ECRECOVER trick discovered by Vitalik Buterin.

The most fundamental advantage gained through a threshold signature model is turning a linear cost into a static cost. This breaks the upper bound that was previously limiting how many nodes could operate in a single oracle network. With threshold signatures, any arbitrary amount of nodes can achieve off-chain consensus while only one node needs to push a single on-chain transaction (containing the data point) on the behalf of all nodes. The data point pushed on-chain will only be accepted if the threshold signature is verified to be valid (proves a certain threshold of nodes signed off on the data point) preventing any single point of failure. This means Chainlink networks will scale completely independently of Ethereum’s throughput (or the throughput of any blockchain as Chainlink is blockchain agnostic).

Decentralized oracle networks comprised of hundreds to thousands to virtually any arbitrary number are now not only possible from a technical perspective, but also from an economic perspective as well. As a requester, you can now pay nodes less LINK while those nodes still make the same exact profits (or more) as they no longer have to constantly make expensive on-chain transactions. This drastically decreases the marginal cost of adding new nodes to an oracle network, enabling a diverse and rich ecosystem of heterogeneous oracle networks, all at varying levels of decentralization.

An easy way of thinking about it is that the oracle network is essentially batching all the node’s response transactions together into just a single transaction, which is verified by a single threshold signature. This means the efficiency of Chainlink oracle networks goes from O(n), with n being the number of nodes, to O(1). An update of an oracle network with 21 nodes (ETH/USD price feed), would go from 21 on-chain response transactions (from each node), to only one single response transaction.

If it seems like I am repeating myself, I’m just trying to drive the point home, the advantage of threshold signatures cannot be understated. While 42 nodes are the maximum supported in the prepaid aggregator contract, off-chain aggregation using threshold signatures enables an unbounded number of nodes in a network! Not only can Chainlink oracle networks become massively more decentralized, but they become much cheaper at the same time. Leveraging Chainlink oracle networks will become economically feasible for projects at any stage of development/funding. If you want to understand the more nuanced points of threshold signatures or want to verify the math for yourself, Chainlink researcher Alex Coventry wrote a very informative article that crypto geeks will enjoy.

As of late March, Coventry posted an update regarding Threshold Signature’s development that the team was moving from Schnorr Signatures to BLS Signatures which will greatly reduce complexity and enable much larger signing groups. Off-chain communication efficiency has been lowered from the cube of the number of participants O(n³) to being linear O(n) (assuming the threshold number is roughly a constant proportion of the total participation group). On-chain gas costs for BLS signature verification will be slightly higher than Schnorr, but will still have a transaction efficiency of O(1) and actually lower costs for all participating nodes even further due to enabling much larger signing groups.

Total Costs Saved

With the above developments, supporting a Chainlink oracle network will become vastly cheaper and accessible to blockchain developers everywhere. Let’s see how much in gas is potentially saved by comparing the costs of running the ETH/USD reference feed today to how much it would cost when leveraging some of the above mentioned features. To keep things simple, I will assume each transaction is submitted with a 10 Gwei gas price (seems to be the current average).

Currently, it costs about 2,374,048 gas ($6.41) to request a price update from a network of 21 oracle nodes. With the Prepaid Aggregator contract, this would cost 0 gas ($0.00)! As stated before, this is because the new aggregator contract requires no request transactions to ever be made, effectively enabling infinite gas cost savings in this regard.

Currently, the cost from all 21 nodes responding with data back on-chain is 1,358,377 gas ($3.67), with an average cost of 64,684 gas per node ($0.17). With Threshold Signatures, the response from all nodes when batched together off-chain, leads to a static cost of only 36,000 gas ($0.09). With 21 nodes, this leads to an average per node cost of just 1,714 gas ($0.004)! This is a cost reduction of 37x.

Putting it all together, the total gas costs spent on a single update of the ETH/USD price reference feed from 21 nodes went from 3,732,425‬ gas ($10.07) to just 36,000 gas ($0.09)! This is a cost reduction of 103x.

If we scale things up to the maximum number of nodes allowed in the Aggregator v1 contract (45 due to gas consumption limitations), the total gas costs of a single update would go from ~10,000,000 gas ($27.00) to again just 36,000 gas ($0.09), leading to an average per node cost of just 800 gas ($0.002)! This is a cost reduction of ~277x.

Thanks to the Prepaid Aggregator and Threshold Signatures, an oracle network made up of 10,000+ nodes would still only cost 36,000 gas ($0.09) per update, which is an average per node cost of just <3.6 gas (<$0.000009)! The gas cost savings per node increases as the number of nodes in the oracle network increases.

It’s important to note however now that with Threshold Signatures being implemented with BLS signatures instead of Schnorr signatures, the gas consumption savings will be slightly lower, but will still offer a substantial cost savings now that signing groups can be made much larger with lower off-chain communication latency and bandwidth requirements. BLS based Threshold Signatures similarly offer a static transaction efficiency of O(1) no matter how many nodes are in the signing group.

Remember that these numbers are just what is spent on gas, but since the gas costs experienced by each node are now much much lower, nodes can be more competitive and accept a lower LINK payment per data request while at the same time the overall volume of the chainlink ecosystem will be increasing, so nodes will also be making up those costs on volumes if not profiting more than before. These cost savings trickle down the end-users of the consuming contracts/dApps.

Wrapping Up

So while today Chainlink oracle networks can be quite expensive to maintain, this will not be the case for forever. Using a public good model, adjusting the update frequency, using a gas price estimator, Prepaid Aggregator contract, Flux Monitor module, and Threshold Signatures are all strategies that the Chainlink team are deploying/developing that will massively alleviate these growing pains.

It should be noted that in this article, I limited the scope to only talking about Chainlink’s own network scalability and not about how Chainlink can scale other Smart Contracts through attested off-chain computation using Arbitrum, Trusted Execution Environments, Zero Knowledge Proofs, Mixicles, and more. I also didn’t mention many of the little improvements that have been made here and there to the Chainlink codebase over time, but instead focused this article on the major network-wide upgrades that will dramatically increase scalability, lower costs, and enable a much more sustainable cryptoeconomic model for both nodes and the data-requesting contracts. This would be a never ending article if I tried to cover everything!

Hope your brain didn’t melt too much from trying to soak it all in, but now you see why I believe 2020 will be the year Chainlink scales.

For more content, follow me on Twitter @ChainLinkGod and listen to The CLG Podcast on Spotify and YouTube.

Originally published on Medium on February 20, 2020.