CoolWallet users have the best of both at their disposal, thanks to the Web3 hardware wallet’s range of integrated CEX trading options like Changelly and ChangeHero, as well as top DEX protocols like 1Inch and our newest bridge integration with XY Finance.
In a previous article, we covered in detail our new XY Finance bridge swap collaboration and the benefits of cross-chain asset trading it brings to our users. We also created this step-by-step guide on how to use it from within our feature-rich CoolWallet App.
But just what are crypto bridges and crypto swaps, how do they differ what are important considerations to take into into account before deciding on which option to take?
Let’s dive in!
What are Crypto Bridges?
Crypto asset bridges are cross-chain tools that allow the transfer of assets from one blockchain to another and therefore connect different networks, addressing a key challenge in the crypto sector – the lack of interoperability.
Since blockchain assets are often not compatible with one another, bridges create synthetic derivatives or wrapped tokens that represent an asset from another blockchain. Some bridges, known as unidirectional or one-way bridges, allow you to port assets only to the target blockchain and not the other way around.
Bridges can be either custodial (centralized) or noncustodial/self-custodial (decentralized), which determines who controls the tokens used to create the bridged assets.
What are Crypto Swaps?
Crypto swaps, on the other hand, refer to the exchange of one coin or token for another usually within the same blockchain. This process is seamless and allows users to instantly acquire the coin they want. Because token swap processes and related transactions are stored on the chain, users also benefit from data integrity. Swapping helps investors save money while trading crypto by eliminating a layer of transaction fees.
Cross-chain swaps, also known as atomic swaps, are a mechanism that allows users to exchange cryptocurrencies directly between separate blockchain networks without intermediaries such as centralized exchanges. This process only executes if both parties each deposit a predetermined amount of tokens to the exchange contract, reducing counterparty risks.
However, cross-chain swaps have certain limitations. For instance, each blockchain must use the same hashing algorithm for atomic swaps to work. Also, cross-chain swaps can be complex and time-consuming, especially for beginners, and they may raise privacy concerns as they take multiple blocks to be completed, potentially alerting malicious actors.
How Do Crypto Bridges Work?
Crypto bridges are highly technical in nature and can therefore be difficult to grasp, but here are some core tenets to understand.
- Cross-Chain Communication: A crypto bridge facilitates the transfer of data and value between blockchains, allowing assets from one chain (like Ethereum) to be used or represented on another (like BNB Chain).
- Lock and Mint Mechanism: Typically, this process involves ‘locking’ an asset on its native blockchain and then ‘minting’ a corresponding asset on the target blockchain. For example, if you send Bitcoin to an Ethereum bridge, the Bitcoin is locked, and an equivalent amount of a wrapped version of Bitcoin (like wBTC) is minted on Ethereum.
- Smart Contracts: These bridges often rely on smart contracts, which are self-executing contracts with the terms of the agreement directly written into code. They manage the lock-and-mint process and ensure that the original asset is either locked or released based on certain conditions being met.
- Relayers and Validators: Some bridges use a network of relayers and validators to oversee and validate transactions across blockchains, ensuring security and consensus.
Crypto Bridges vs Swaps: Key Differences
The key difference between crypto swaps and bridges lies in their operation across blockchains. Swaps occur within the same blockchain, while bridges facilitate the transfer of assets across different blockchains. Bridges can also be used to exchange data, including decentralized identifiers, smart contract calls, off-chain information from oracles, etc.
- Functionality: Crypto swaps involve exchanging one type of cryptocurrency for another within the same blockchain or across different blockchains. They are primarily used for trading purposes.
- Mechanism: Swaps can occur on both centralized and decentralized platforms and usually involve direct exchange rates without the need for wrapping or minting new assets.
- Liquidity Pools: In decentralized exchanges, swaps often rely on liquidity pools where users supply assets to facilitate trading and earn fees in return.
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- Purpose: Bridges are designed for interoperability, allowing assets and information to move between different blockchain networks.
- Lock and Mint Process: Unlike swaps, bridges often involve the locking of an original asset and the creation of a wrapped version on another chain.
- Cross-Chain Functionality: Bridges extend the utility of an asset beyond its native blockchain, enabling participation in different ecosystems.
How Centralized vs. Decentralized Exchanges Use Bridges
In centralized exchanges like Changelly or ChangeHero, bridges operate under the control of a central authority. These exchanges manage user accounts and control private keys, and users rely on the exchange’s security protocols to safeguard their assets. Centralized bridges, also known as trusted bridges, rely on a centralized authority or intermediary to facilitate the transfer of assets between different blockchains. In a trusted bridge, users must trust the intermediary to hold and manage their assets appropriately.
On the other hand, in decentralized exchanges like 1Inch and XY Finance, bridges work in a more decentralized manner. Users interact directly with smart contracts, retaining ownership of their private keys throughout the trading process. These trustless or decentralized bridges use smart contracts to lock the deposited asset and issue equivalent tokens on the destination blockchain. The code is usually open source, so anyone can peek under the hood to see what’s really going on.
However, it’s important to note that both centralized and decentralized bridges come with their own set of risks, which is something that Ethereum co-founder Vitalik Buterin has warned against in the past.
Centralized bridges may be susceptible to large-scale hacks or insider attacks, while decentralized bridges are subject to exploits and are often relatively untested. Therefore, users should carefully consider these factors when choosing between different types of bridges and exchanges.
Here are other differences in the way that CEXs and DEXs execute bridges.
Centralized Exchanges: E.g. Changelly and ChangeHero
- Controlled Environment: These platforms offer a more managed environment where the exchange itself facilitates the bridging process.
- Custodial Services: Users must trust the platform with their assets, as these services are custodial and the exchange holds the private keys during the transaction.
- Security and Compliance: CEXs must adhere to regulatory standards such as KYC and provide a certain level of security and customer support.
Decentralized Exchanges: Eg. 1Inch and XY Finance
- User Autonomy: In DEX bridges, users retain control over their private keys and assets throughout the process.
- Smart Contract-Based: The bridging process is handled by smart contracts, reducing the need for intermediaries.
- Flexibility and Innovation: DEX bridges often support a wider range of assets and innovative features, catering to a more technical audience.
- Security Risks: While offering autonomy, DEX bridges can be more susceptible to smart contract vulnerabilities and require users to be more vigilant.
Crypto asset bridges play a crucial role in enhancing the interoperability and functionality of various blockchain networks. Understanding their mechanisms, especially in the context of centralized and decentralized exchanges, is vital for participants in the crypto ecosystem. While they share some similarities with crypto swaps, bridges have distinct functionalities and purposes, primarily focused on cross-chain interactions and asset portability.
As the crypto landscape continues to evolve, bridges will likely become even more integral to the seamless operation and growth of the blockchain world, paving the way for a more interconnected and efficient digital asset environment.