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Research

Thanefield’s Interoperability Thesis

By Karim HMay 10, 2024No Comments

Introduction

There are more chains now than there were a year ago, and it’s a near-certainty that this time next year, there will be more than there are now. What’s more, with Ethereum’s rollup-centric roadmap and the proliferation of appchains and L3s, this trend is more likely to accelerate than it is to ease.

The main beneficiaries of this proliferation are projects in the interoperability space, a vertical we’ll broadly define as the universe of projects focused on moving assets and information across chains. The winners in this vertical could stand to inherit a massive addressable market by helping mend the liquidity fragmentation and operational hurdles that will inevitably develop in a multichain world.

With this in mind, we dug into many different projects in the space with the goal of finding the most asymmetric way to express a bullish view on the vertical. In this article, we’ll begin by discussing the various protocols that we’ve explored and highlight the differences in their design choices and the market structures for their tokens.

We believe there has been a genuine innovation in the interoperability space, and substantial progress has been done by various teams. In particular, we’ve seen positive developments in RFQ-based designs and modular architectures, and we believe these approaches are going to gain traction going forward due to security and efficiency improvements they offer.

While there are several attractive bets to make in private markets, we’ve found Synapse (SYN) to be the most compelling investment in public markets and have accordingly established a large position. Tailwinds for the project include an intents-based RFQ bridge, which has recently entered production and surpasses the current state of the art in bridging; the launch of Synapse Interchain Network, a communication layer whose token should command significantly more value than a bridge token; and the LayerZero (ZRO) token launch, which should cause the token to rerate.

Interoperability Landscape

Synapse

Product Overview and Roadmap

Synapse’s current product offering consists of a suite of bridging and interchain communication solutions. While ultimately subjective, next to other bridges, we believe that Synapse stands out in terms of usability and comprehensiveness of its offering. Recent developments and upcoming items on the roadmap are very positive and will likely be reflected more aggressively in the token’s price.

On the bridging side, Synapse has several workflows: a standard bridge, which can transfer native and wrapped assets; a native integration with Circle’s CCTP, which allows for direct USDC transfers; Synapse X for cross-stablecoin transfers using external pools; and an intents-based RFQ bridge, in which market makers competes to offer quotes on bridging rates.

Of these offerings, we believe Synapse’s RFQ bridge offers the most opportunity on a forward basis. The RFQ bridge first went live in January for small orders and has since increased transfer limits to $100k, with plans to continue to increase caps. Similarly to how RFQ-based trading platforms can quote more effectively and competitively than a single market maker, RFQ bridging has the potential to improve pricing significantly for end users, especially those transferring along a less liquid path.

Due to the ARB incentives from Arbitrum’s STIP program that were passed to users as fee rebates, the overall volume bridged through Synapse increased by an order of magnitude at the start of the year. It’s has since returned to a baseline level, which has been elevated by an overall increase in activity in the crypto market and increasing traction on Ethereum L2s. While Synapse Bridge is still the dominant route, with the recent governance proposal of seeding a Synapse Labs-run RFQ relayer with a $5m loan from the DAO, we expect RFQ volume to make up a larger share of the overall volume going forward. An additional catalyst for RFQ routing is its integration into aggregation platforms such as Socket, the messaging layer for the Bungee bridge aggregator.

Synapse’s token, SYN, was launched in 2021 and currently has a market cap and FDV of about $210 million.

Synapse Interchain Network & Synapse Chain

The most significant item on the core team’s roadmap is the Synapse Interchain Network (SIN), a generalized message-passing layer with a 1-of-N honesty assumption. This network facilitates trust-minimized cross-chain communication and settlement, and is differentiated by its security properties from most competitors’ architectures, which largely employ multisig-like M-of-N security assumptions.

SIN’s architecture is predicated on modular security, allowing applications to select security assumptions and trade-offs that best align with their operational requirements. With the understanding that a large DeFi protocol leveraging SIN for cross-chain governance might prioritize the balance between speed and security differently from an online game utilizing SIN for the transfer of in-game assets, SIN provides customized solutions tailored to the specific needs of each application. Critically, it’s also a plug-and-play solution, with users of the network natively benefitting from SIN’s security and liquidity.

The network comprises three principal roles: Notaries, Guards, and Executors. Notaries and Executors are required to stake SYN tokens to participate in the network, thereby contributing to its security and functionality while earning fees for facilitating cross-chain transactions. This mechanism not only adds utility to the SYN token but also enhances the network’s economic model.

At the core of SIN sits Synapse Chain, an optimistic rollup based on a modified version of the OP stack, which serves dual functions as both the data availability layer for the Synapse Interchain Network and a sovereign execution layer. This architecture enables the Synapse Chain to maintain the state of all chains connected through SIN through state root commitments, settle transactions processed through SIN, and make the these transactions’ proofs readily available.

Source: Synapse docs

SIN should also be constructive in terms of tokenomics through its staking mechanics, which will remove some of the token supply from active circulation, creating a token sink. SIN also facilitates value accrual to the SYN token by increasing the size of the addressable market, exceeding the scope of bridging as it is generally understood—this platform could potentially enable use cases including cross-chain decentralized identity, credit and undercollateralized lending, and margining for perpetual DEXes.

Hyperlane

Hyperlane is a permissionless interoperability layer that allows smart contract developers to send arbitrary data between blockchains. The current version of the protocol, v3, which is focused on modular interoperability and customizable security, was released in in November 2023. Hyperlane sets itself apart through two distinctive features: its modular architecture and its permissionless design. Mirroring the structure of many interoperability solutions, Hyperlane utilizes an external set of validators in its model, although it’s important to note the validator set is fully permissionless.

In Hyperlane’s architecture, there are three main agents: Validators, Relayers, and Watchtowers. Validators confirm the root has achieved finality and post their signature for Relayers to collect it and transport across chains. Watchtowers are still under development, with their planned role being to have an additional check on validators.

The modular framework enables developers to selectively utilize components of the interoperability stack necessary for their applications. This selection is made possible through the use of Interchain Security Modules (ISM), provided out-of-the-box by Hyperlane. Depending on the specific requirements of their application, developers can choose ISMs that best align with the security trade-offs they are willing to accept. Importantly, by decoupling security modules from the messaging interface, Hyperlane allows developers to dynamically change security depending on parameters such as the content of the message or recepient, instead of accepting universal security guarantees. With an addition of hooks, which enable integration of external message passing systems, the architecture offers an elegant alternative approach to monolithic designs.

Furthermore, Hyperlane’s fully permissionless design allows for the deployment of its contracts on any layer-one blockchain or rollup. This unique characteristic ensures that any chain can be interconnected with all other chains linked to Hyperlane, enhancing the blockchain ecosystem’s connectivity and flexibility.

Hyperlane most recently raised a $18.5M seed round, and has not yet launched a token.

Wormhole

Wormhole is a generalized message-passing system characterized by an external verification architecture, which depends on the scrutiny of a specific group of validators, referred to as Guardians. This network of Guardians is a permissioned collective comprising up to 19 validators, where a consensus for any action requires the agreement of two-thirds of its members. Conversely, if 2/3 of validators collude, the whole system can be compromised, and with the collusion of 7 validators, messages can be censored. In 2022, a security breach caused by a signature verification vulnerability led to a loss of 120k of Wormhole Wrapped ETH on Solana.

Distinct from some competing externally verified cross-chain messaging protocols, Wormhole lacks a slashing mechanism, opting instead to bank on the reputations of its Guardians. At time of writing, the majority of these Guardians are professional PoS validator companies.

Source: Wormhole docs

Wormhole presently facilitates connections across 29 chains, including EVM chains, Cosmos chains, Sui, Aptos, and Solana. The ecosystem surrounding Wormhole is very active, featuring both in-house and third-party-developed products. Among the in-house offerings are Portal; a bridge service; Connect, a developer widget for integrating the bridge into various products; and Queries, a recent addition that enables applications to swiftly retrieve any on-chain data on demand.

In its pre-token private funding round, Wormhole secured $225 million at a valuation of $2.5 billion. The W token, launched in April, now trades at a market cap of $1.1 billion and a FDV of $6.1 billion.

LayerZero

LayerZero is a smart contract suite for cross-chain message passing. The protocol was initially launched in 2022 and is in the process of migrating to its second version.

The primary point of contact for LayerZero V2 is a smart contract known as an Endpoint contract. LayerZero’s Endpoints are deployed across every supported blockchain, and are immutable and non-upgradeable, ensuring the system’s operational continuity.

In all, sending a cross-chain message with LayerZero consists of the following steps:

  1. A user calls the _lzSend function on the source chain, specifying the destination chain and message.
  2. The application’s Decentralized Validator Network (DVN) listens for events emitted by this function and okays the transfer if it is valid, based on an M-of-N security model.
  3. An executor for the application calls the lzReceive function on the destination chain, and the message is received.

LayerZero’s modular approach allows applications leveraging LayerZero to configure their own verifier networks and authorized executors, and several out-of-the-box DVNs are also available. The executor role is optional, and enables the automation of message reception, offering developers further customization in how their applications interact with LayerZero.

The ecosystem of projects using LayerZero is large, with the most prominent project being Stargate, an asset bridge developed by the LayerZero team that supports several EVM chains. Stargate currently handles about $63M in daily volume, and its token, STG, currently trades at a market cap of about $115M and an FDV of about $560M.

The LayerZero (ZRO) token launch is highly anticipated, and Stargate’s bridge volumes are likely substantially bolstered by farming activity in anticipation of an airdrop. As the project most closely affiliated with LayerZero, STG may trade as a proxy for attention on ZRO ahead of the latter token’s launch.

Across

Across is an intents-based bridging protocol. As in Synapse’s RFQ bridge, market makers referred to as relayers compete to fill a user’s bridging specification. Relayers are then batch-repaid by the settlement layer after a 90 minute challenge period, with the challenge protocol being based on the UMA Optimistic Oracle.

At the moment, this relayer fills are accepted on a first-come-first-serve basis: the first market maker whose quote meets the user’s requirements and is confirmed on the destination chain wins the right to fill the bridging transaction, and fees are fixed. The design of Across’ settlement layer can accommodate other competition types in the future.

The Across bridge currently supports Ethereum mainnet and several L2s, and is responsible for roughly $24M in daily bridging volume. The network’s token, ACX, currently has a market cap of about $76M and an FDV of $225M.

Axelar

Axelar is a cross-chain message-passing solution, structured as a proof-of-stake blockchain and developed using the Cosmos SDK. As a permissionless and externally verified system, Axelar boasts a network secured by 75 validators who validate all cross-chain messages going through it. For a message to be successfully transmitted, it requires the signature of two-thirds of the validators. Axelar’s approach to progressive decentralization has involved expanding its validator count, and this process is set to continue going forward.

Positioned within the Cosmos ecosystem, Axelar benefits from the native interoperability standard, the Inter-Blockchain Communication (IBC) protocol, facilitating seamless cross-chain communication with other networks within the Cosmos. For integration with EVM chains, Axelar utilizes Gateways—smart contracts that initiate events. These events are conveyed to the Axelar network by relayers for processing.

Source: Axelar docs

Axelar employs a comprehensive suite of security measures including rate limits, periodic rotation of validators, the capability to freeze transfers, and the strategic use of the AXL token to enhance economic security. It has also adopted quadratic voting within its validator set to promote greater decentralization.

The Axelar token, AXL, was launched in September 2022 and currently has a market cap of $1 billion and an FDV of $1.45 billion.

Market Context

There’s been significant dispersion across the interoperability space over the last year. While AXL and ACX have significantly outperformed ETH and BTC, SYN and STG have both significantly underperformed.

While this is somewhat expected in the case of STG, the less-anticipated token in the LayerZero ecosystem, we believe that SYN is oversold and see a long SYN position as the most effective way to express a bullish view on the interoperability space broadly.

The recent launch of W and upcoming launch of ZRO should cause smaller assets, including SYN, to reprice upwards, similarly to how appreciation in alt-L1 valuations rippled down the liquidity curve. Pricing SYN against Wormhole’s current FDV of $6.1B and adjusting for daily volume, where Wormhole most recently processed $29.9M and Synapse processed $20.5M, would imply a fair value SYN FDV of $4.2B. This clearly optimistic figure would imply a 20x return on investment at the current SYN FDV of $210M. While this figure is subject to a number of caveats, including addenda on vesting schedules and newcoin/oldcoin dynamics, we believe the gist of the thesis holds: with the launch of W at a multi-billion dollar FDV and the upcoming launch of ZRO, which will likely trade similarly, SYN should continue to reprice significantly as one of the few Binance-listed competitors with a liquid token and comparable transaction volumes.

Conclusion

Against the backdrop of a multichain market, which inherently implies a certain degree of liquidity fragmentation, we expect the interoperability sector to outperform. Given the complexity of the problem, projects must make a large number of design decisions, many of which imply substantial tradeoffs. While many of these details are too intricate to describe in depth in an overview like this one, we hope this piece helps clarify the choices made by these projects and their ramifications.

We’ll seek to express this express this sector-wide view in both public and private markets. In private markets, there are several attractive opportunities, and we believe developments in RFQ-based designs and modular architectures are worth keeping an eye on.

For both structural and fundamental reasons, we believe that the best vector for public markets is a long SYN position. Structurally, we think that compared to other, newer bridge tokens, SYN appears underpriced—and while the market prices it as just a bridge token, the upcoming Synapse Interchain Network promises to extend its utility well beyond that. Fundamentally, we believe that a bet on one of the best products on the market at a cheap valuation, where the team is actively engaged and is capably executing on an ambitious roadmap, is a compelling bet to make.

 

Edit: a previous version of this post excluded SUI volumes from the daily volume on Wormhole. The post has been amended to reflect this.