Polygon Product Updates

Welcome back, everybody. It’s been another exciting week in crypto and we’re pleased to bring you the next edition of The Blockchain Review. There were a few different exploits that impacted various elements of different ecosystems this week. So it’s worth pointing out the differences between native and derivative tokens. Particularly those derivatives that live on other networks, and how these compare with Layer 2’s.

Native coins like ETH and BTC only ever live on their original chains. When you see wrapped versions then it’s only as strong as the protocol or entity which is holding the original. For example wBTC is issued by Bitgo and provided they don’t lose the BTC it will be redeemable 1:1. 

In the case of centrally issued stablecoin tokens like USDC then the issuer, Circle, must create their own version on other chains and give a promise they’ll be redeemable 1:1 with USD. However, Circle hasn’t issued any stablecoin on Evmos or Moonbeam, two of the newer EVM chains which were proportionally most affected by the Nomad hack. To date Circle has only issued native USDC tokens on Ethereum, Solana, Avalanche, Tron, Algorand, Stellar, Flow and Hedera. 

So when earlier this week the Nomad cross-chain bridge suffered an exploit that drained an estimated $190M from the protocol. Anybody who held their ‘mad’ derivative tokens has suffered, even if they weren’t locked in for liquidity or undergoing a bridge via the Nomad protocol. This is because Nomad issued ‘mad’ derivatives of USDC, USDT, ETH and BTC  for use across a number of chains. 

These derivatives can help to fuel the growth of the newer ecosystems when users want to transfer in the original native tokens but there isn’t any liquidity available. For example, users of Nomad who wanted to bridge in USDC to Evmos had to have a derivative called madUSDC issued. This wasn’t wasn’t a promise by Circle to pay back USDC one-to-one with USD, but rather a derivative of USDC. In effect a promise by the Nomad smart contract to pay back USDC one-to-one with madUSDC from somewhere in it’s cross chain activity.

But when the exploit took place on Nomad these tokens were quickly drained. There was a rush to bridge back to Ethereum and original native assets, which quickly caused large disparity in the value of derivatives compared to the originals. Effectively there was a depeg between mad and natives with the key point being that anybody holding ‘mad’ derivatives across any chain, even if they weren’t using Nomad during the hack, were affected.

This is one of the inherent weaknesses of a cross chain world and leaves people vulnerable to hacks or exploits of bridges even long after they’ve used or interacted with them so it’s a point that Vitalik has raised on many occasions. In comparison Layer 2’s share security with Layer 1 so you have the option not to use one of the cross chain bridges, and fail safes are built in to withdraw back to the original Layer 1 Ethereum.

From a UX perspective there may not be much apparent difference to a user when bridging assets from Ethereum to other networks but it’s good to be aware of the differences. Metamask or any of the wallets may eventually consider differentiating between chains. E.g. Labeling Layer 2 networks as different to other EVM networks.

When bootstrapping an ecosystem derivatives can play an important part in the growth of the chain, but users should pay attention and be aware of the actual tokens which they receive. If derivative tokens lose it’s peg to the native then there’ll be nothing to redeem it back, or in the case of centrally-issued stablecoins no promise to redeem it back to USD. 

We’ll always provide you with our research to help with your education. We’ll keep close track of the main developments and evolution of the niches in blockchain so that you get the best of the new knowledge. When you’ve finished reading your report then please remember to fill out the feedback form, your research is valued and we’re always open to suggestions.

With Great Respect,
Ivan Liljeqvist