Wormhole: The Largest Crypto Financing in 2023
On November 29, 2023, Wormhole raised $225 million in a recent funding round. As the year draws to a close, this milestone is already being touted as the largest crypto fundraising in 2023.
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We've previously covered this achievement, so now it's time to get a closer look at the project.
Wormhole is a decentralized protocol that facilitates messaging between various blockchains. It supports 25 different networks, including major EVM-compatible solutions, and networks like Solana, Algorand, Near Protocol, and others.
However, the protocol's utility extends beyond just cryptocurrency transfers between networks. Wormhole also enables the movement of NFTs across blockchains and allows users to participate in governance and voting within DAOs using tokens from different chains.
Wormhole is pushing the boundaries of DeFi by enhancing interactions with a variety of protocols. A notable development was the launch of Wormhole Gateway in the summer of 2023 – an appchain developed within the Cosmos ecosystem, tailored for specific applications.
How Does Wormhole Work?
In cross-chain transactions, users rely on an intermediary, and in the case of Wormhole, smart contracts play this crucial role. While these contracts guarantee transaction term fulfillment, it's essential to be aware of potential security risks they may pose.
For transferring a token from blockchain A to blockchain B, a user initially transfers the asset to a smart contract in the source network. Subsequently, a smart contract in blockchain B creates an equivalent asset value in a 1:1 ratio, a process known as “wrapping.”
Wrapped tokens mirror the value of the original assets. For example, if 1 BTC on the Bitcoin network is valued at $38,000, then 1 WBTC (Wrapped Bitcoin) on Ethereum would hold the same value. When a user chooses to convert wrapped tokens back to the original asset, the WBTC on Ethereum is burned, unlocking the equivalent BTC on the Bitcoin network for the user.
Wormhole operates on this mechanism. Going beyond smart contracts, Wormhole features a dedicated pool of validators known as ‘Guardians.' Let's explore their role, along with other critical aspects of Wormhole's architecture.
Wormhole Architecture
The Wormhole Architecture. Source: wormhole.com
The operation of Wormhole starts with interaction with the emitter, a contract for posting messages on the core contract. Next, the core contract relays the message into transaction logs, indicating details about the sender and a sequential number for naming the operation.
Messages, once logged, are signed by the Guardians. Collectively, they form the Guardian Network, comprising 19 members, with notable ones like 01node, Everstake, and ChainodeTech.
The Guardian Network is a crucial element of Wormhole's protocol. These guardians oversee and validate messages transmitted by the Main contract in each supported blockchain. The computational demands for guardians are substantial since they need to run a full node for every blockchain within the ecosystem.
A transaction is locked by a smart contract and produces a VAA (Verifiable Action Approval) only after ⅔ of the guardians have signed it. The VAA, a message approved by the guardians, contains information about the sender and the signed transaction.
Relayers are employed to transfer the VAA to the final blockchain and to create wrapped tokens. They are categorized into three types:
- Client-Side Relaying: Here, users perform all actions, including transaction signing and fee payment, independently.
- Specialized Relayers: These relays perform particular parts of the process, facilitating task delegation. Calculation levels and fee payments can be transferred to Layer 2 (L2) solutions.
- Standard Relayers: This is Wormhole's decentralized network of relays that transfer the VAA to the final blockchain.
Token creation is conducted in the target blockchain, hence the fee is paid in that network. For example, to transfer SOL from the Solana network to Ethereum, you need to hold a certain amount of ETH.
Standard relayers address this issue. They utilize a required portion of the tokens locked in the original network, and they assume the responsibility for fee payment in the destination blockchain.
Wormhole Ecosystem Overview
Wormhole Ecosystem Categories in 2023. Source: twitter.com
Wormhole, while popularly recognized for facilitating cross-chain cryptocurrency transactions, also serves a variety of other functions. The solutions currently available in the Wormhole ecosystem include:
- Wormhole Messaging: This is a web3 messaging protocol that assists in transferring data and asset value between blockchains. Being open-source, it allows developers to incorporate it into the development of decentralized applications.
- Wormhole Connect: A widget designed for seamless integration of the cross-chain exchange protocol directly into decentralized applications (dApps).
- Wormhole Gateway: This is an application-specific blockchain powered by the Cosmos Software Development Kit (SDK), aimed at enhancing liquidity within the Cosmos ecosystem.
An example of a notable project using the Wormhole protocol is Portal. Its current Total Value Locked stands at $656.45 million, with a maximum TVL of $4.6 billion. This decline occurred against the backdrop of the UST crash in May 2022.
For more information on other projects based on Wormhole, visit their website.
Advantages of Wormhole
Non-EVM Network Support. Wormhole is one of the few protocols enabling asset transfers between non-EVM and EVM-compatible blockchains. For example, it allows transferring APT from Aptos to Ethereum.
Rigorous Validator Requirements. Wormhole uses a Proof-of-Authority network for validating transactions, involving 19 validators. Each validator must operate a node in all the supported blockchains.
Operational Efficiency. Thanks to relayers, Wormhole-based applications facilitate improved cross-chain exchange interactions. Users often experience reduced fees as a result of shifting computation to L2 solutions.
Potential Risks in Using Wormhole
Smart Contract Vulnerabilities. Being a decentralized protocol, Wormhole's fund security depends on the robustness of its smart contracts. A notable hacking incident in February 2022, resulting in a $320 million asset theft, underscores potential vulnerabilities. Although $225 million was recovered, it still points to possible weaknesses in the smart contract architecture.
Risk of Centralization. Despite the necessity of having 19 guardians for decentralization, their collective functioning could inadvertently lead to protocol centralization.
Regulatory Concerns. Wormhole's presence in the DeFi sector attracts regulatory scrutiny. Increased regulatory interventions could potentially affect the protocol's operations.
The Future of Wormhole
Securing $225 million in funding is a strong indicator of the project's potential, particularly in a bear market. However, the future success of Wormhole is also contingent upon factors beyond this financial milestone. Key aspects include user interest and trust, overall market sentiment, and the level of competition within the cross-chain solutions sector.
For example, LayerZero has gained attention as an alternative method for asset transfers between blockchains. Predicting who will emerge as the leader in this space, or if this will be a significant competition at all, is challenging. Always remember to DYOR!
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