Layer Zero and the OFT Standard

LayerZero launched the OFT standard last year to improve the interoperability of major blockchains. Historically, transferring tokens between chains has used a variety of bridges, and while these may seem to allow the transfer of tokens from one chain to another, what they’re actually doing is locking them on the native chain and producing a wrapped version on the new chain. Not only is this costly and dangerous, but the lack of composability means that token liquidity winds up fragmented between chains.

Enter Omnichain Fungible Tokens, a new type of token that is composable on all of LayerZero’s integrated blockchains (1). Using the contract-to-contract communication the protocol has already established, OFTs can be transferred directly between any integrated chain and used in any of their dApps. Through its communication network, the protocol facilitates transfers by simply burning an OFT token on one chain, presenting the receipt to the second chain, and minting the equivalent number there - maintaining a static supply regardless of where the tokens happen to live. It’s like the ERC-20 standard, only instead of allowing composability on different apps, it allows composability on 14 blockchains!

The ultimate goal here is to create a DeFi experience where you don’t need to worry about the chain you’re using - where all tokens, applications, and protocols just interact seamlessly. If you’ve used DeFi in any capacity, you already know how this could be a major efficiency booster for all users! Overall, I believe OFTs have the potential to be one of the next breakthrough technologies in the world of blockchain, and another necessary step towards mass adoption. I think they can serve as a solution to three obstacles currently preventing DeFi from being truly multi-chain: depeg risk, bad UX, and fragmented liquidity. Let’s examine how they address each of these issues, then we’ll look at the state of OFT adoption today.

The primary utility of the OFT standard is allowing tokens to be used across any LayerZero compatible blockchain, just as tokens that use the ERC-20 standard are compatible with EVMs. One huge benefit that comes from the OFT standard is that it eliminates depeg risk from assets that are on more than one chain. For example, ETH on Ethereum and ETH on Avalanche are two different assets - whenever ETH is on Avalanche, it’s actually wrapped ETH. Since ETH is so liquid, you probably won’t see a major depeg, but here’s a chart that shows the price of the ETH/USDC pair on Uniswap (Ethereum) divided by the ETH/USDC pair on Trader Joe (Avalanche):

See how much the prices deviate from each other? The horizontal green lines represent a 1% move from parity in either direction. So clearly, even Ethereum isn’t immune to fluctuating by several percent at times between different chains. You can imagine how a less liquid token would fare!

For a good example of that, look no further than Sushiswap’s native token SUSHI. It’s a relatively illiquid altcoin, but even on its own exchange, the price fluctuates wildly between even the most popular of blockchains. Here’s the price of SUSHI on Ethereum vs on Polygon – both taken from the Sushiswap exchange:

The green lines this time represent 10% above and 10% below parity. This is a daily chart, too, so it’s pretty normal to see a 20% swing in the “same” asset’s price between different chains. Again, OFTs fix this. If SUSHI used the OFT standard, that chart would be a straight horizontal line.

There are a lot of theories on how mass adoption will truly happen in crypto/web3. Based on the current UX, it seems to me like achieving mass adoption is still basically a pipe dream. The only people who use the services web3 has to offer are people who like the tech and are interested in learning some relatively complex stuff in order to understand it (or dream of catching 100x moves on the shitcoin du jour). But that’s a very small subset of people!

One major factor that I think is acting as a roadblock right now is the amount of blockchains, rollups, etc. in the system, as they’re still clumsy to navigate. Explaining to someone with little knowledge of crypto that they can transact for lower fees on a “layer 2” chain, even though it’s for their benefit, makes for a very tedious process. Assuming they’ve only used CEXs, which is the case for most people who buy crypto, they would have to:

1. Make a web3 wallet account like Metamask
2. Add Arbitrum to Metamask
3. Send their coins from a CEX to Metamask
4. Then bridge their coins from Ethereum to Arbitrum
5. Then connect their wallet to an app on Arbitrum

Meanwhile, they probably have no idea what any of this means or how to get their money back to their bank account if they need to.

Don’t get me wrong, I think that a mature web3 needs to have many blockchains integrated and ideally tailored to specific needs. I also think that immense progress has been made in scalability so far, but it’s still nowhere close to something that people can use as effortlessly as they use to connect their phone or TV to an app – not even close!

For one thing, you shouldn’t have to decide, or even know, which chain you’re using at any given time. For example, when someone trades stocks, they probably don’t know which exchange they’re trading on; they only know the broker they’re using to execute the trade. Or for a non-financial example, when you use your phone, it would be much more cumbersome to have to understand the data routing infrastructure that makes your apps work in order to function within those apps.

This is where OFTs come in. OFTs make the entire web3 experience easier and more intuitive because everything having to do with connecting to or transferring between blockchains is completely omitted from what the user sees. Going back to the example above, it solves for every one of those steps except for needing a web3 wallet account (although who knows – OFTs may eventually solve this issue, too!).

This way, if you hold an OFT, you’ll have access to every app on any chain that’s compatible with LayerZero. Everything you currently have to worry about with bridging, connecting your Metamask to different chains, remembering which apps are on which chains, will be solved. It’ll be like one giant combined system. Which brings us to the third problem that OFTs can improve: the liquidity problem.

One of the major issues with web3 is fragmentation – liquidity is all over the place on different blockchains, rollups, and apps within each chain. If there was a way to combine all that liquidity, it’d open the door for a much more efficient and comprehensive financial system.

Specifically, the fragmentation of liquidity in DeFi has three major consequences:

First, it means that if a certain app, rollup, or chain doesn’t start out with a ton of funding and liquidity, it has almost no shot of ever gaining traction. The liquidity will always flow to places that already have liquidity. The adoption of OFTs would also be a great opportunity for the LayerZero-integrated chains that are relatively illiquid, as they’d benefit from the shared pooling.

Second, it makes for a really bad onboarding experience for new users. Bridging, connecting to different chains, knowing which coins are compatible/available on which chains are all very unappealing things to understand, much less execute, for casual users.

Third, as institutions move into the space, there will be the need to move huge amounts of money, potentially billions of dollars, in one transaction. In the current system, institutions would have to use third-party bridges to move these large sums of money around. However, that would be extremely expensive and would also create a huge target for hackers. And let’s face it, who would blame them for not wanting to use bridges after what happened in 2022?

OFTs fix all of this. Liquidity can easily flow between chains and will go wherever it can be used most efficiently. As we already went over, new users won’t have to worry about dealing with the infrastructure side of things to manage their money. And as for the institutions, they’d be able to pool their money in OFTs and have access to over a dozen blockchains’ worth of services, rather than rely on bridges to keep their funds safe.

Stargate

LayerZero’s OFT debut came all the way back in March 2022, when it was announced that Stargate Finance (a bridge built on top of LayerZero) would be launching their $STG token as an omnichain fungible token. As you can imagine, this raised a lot of hype around the topic, which sort of died down after $STG’s token crashed soon after the launch (thanks Alameda!)

Tapioca

More recently, however, there’s been a resurgence in the OFT hype. Back in November, there were two major developments in the OFT space by TapiocaDAO and Avalanche.

First, Tapioca announced that their TAP and usd0 tokens would use LayerZero’s OFT standard, which means you’d be able to transfer them between all LayerZero chains as if you were sending them to a different address (which is still an extra step but way easier than using a bridge!). These tokens aren’t live yet, but the rumor from the team is March 23rd is the magic day.

BTC.b

Less than two weeks later, Avalanche announced the introduction of BTC.B, which is an OFT version of BTC. Basically, this allows BTC holders to send their native BTC to the Avalanche blockchain using the Core wallet, and receive BTC.B in their account, which can then be used on any LayerZero-compatible chain.

The most recent addition has also come from an Avalanche-native project: Trader Joe, which is converting its native token, $JOE, to be an OFT. From what I’ve seen, this would mean that Trader Joe is set to become the first DEX leveraging this standard, and it’ll be interesting to see how this affects their usage as well as other DEX’s decisions to go the OFT route moving forward.

Allgate

Finally, there’s a project built on LayerZero called Allgate which really caught my eye. The goal of Allgate is to provide an easy solution for any project to turn their token into an OFT. In addition to the previously mentioned price consistency, here are some examples of actions that will be possible using the OFT standard, straight from Allgate’s blog:

Their goal is to make OFTs the norm in web3 by onboarding existing protocols and tokens onto the OFT standard. Using Allgate, any project will be able to change their existing token into an OFT in order to create a much more streamlined experience for their users. Not only would this benefit users with a simpler experience (fewer txs, no bridging, etc.), but it also makes life easier for devs.

Recently, Allgate has been making some waves in the cross-chain community. On February 28th, they launched v1 of their platform, which allows anyone to create a new OFT token. The response has been pretty amazing; in less than a week, 253 OFTs were created and deployed using Allgate:

As the saying goes, the best tech in crypto is built during the bear. There’s been no shortage of new ideas this bear market, but to me this could be the beginning of true interchain integration, which would be a massive step forward for the space. As we move into the next bull market, whenever that may be, OFTs may well be the missing link that gives us an interoperable system and hastens the onboarding of a new generation of users.

(1) Blockchains currently integrated with LayerZero include Ethereum, Polygon, BNB Chain, Avalanche, Optimism, Arbitrum, Moonbeam, Fantom, Harmony, Celo, Klaytyn, Gnosis, Fuse, and Aptos. That LayerZero has managed to produce composability between Aptos - a non-EVM chain - and all these EVMs is a huge milestone in itself.