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The first article about blockchain engineering jargon has already covered some crypto concepts you should know as a blockchain engineer. In this second article, we’ll dive a bit deeper into blockchain jargon to help you with your upcoming blockchain job interview or provide you with more knowledge about the blockchain ecosystem.
In this blog post, we’ll take a look at the following concepts:
Let’s take a look at the first subject of blockchain bridges.
In its essence, a bridge helps two blockchain ecosystems to connect to each other. A bridge allows the transfer of value from one chain to another. For instance, values such as tokens, assets, or even smart contract instructions. Most often, you’ll find a bidirectional bridge that allows information to flow in both directions. However, this is not a requirement. It’s also possible to create a more basic unidirectional bridge to allow value from one blockchain ecosystem to enter the other.
By design, blockchains are siloed, and for a good reason: Security. Any outside influence poses a security threat for a blockchain ecosystem because it can influence the blockchain’s rules.
But why are blockchain bridges so important? Blockchain bridges enable interoperability between two different networks. For instance, you can connect the Bitcoin network with the Ethereum network. This connection allows users who own Bitcoin to access DApps on the Ethereum blockchain without buying Ethereum tokens. As you can see, this opens up many new use cases, especially for DeFi. Blockchain bridges allow developers to build complex DApps that execute across multiple platforms.
When discussing bridges, there are two main types of bridges you should know:
A custodial bridge relies on a trusted centralized custodial provider that acts as a middleman. Such custodial bridge issues wrapped tokens users get when depositing to the custodial provider.
For example, a user wants to access the Ethereum ecosystem with its Bitcoin. This user can deposit 1 Bitcoin to the custodial provider. Now, the custodial provider will store this Bitcoin securely and issue wrapped tokens on the Ethereum blockchain. The provider will mint an equal amount of wrapped Bitcoin tokens (wBTC) on the Ethereum blockchain. The only difference is that this wBTC is an ERC20 token. This ERC20 token can now be used in Ethereum-based DeFi protocols, such as Aave, Compound, or Uniswap. Of course, the user can always deposit their wBTC tokens to the custodial provider and unlock its 1 Bitcoin again.
A decentralized bridge freezes assets on one blockchain in a smart contract and issues the equivalent amount in the native token of the other blockchain. To give an example, you freeze 1 Bitcoin in a smart contract, and the decentralized bridge will unlock 10 Ether on the Ethereum blockchain. As you can see, a decentralized bridge issues real tokens instead of wrapped tokens.
Scalability has been a big issue that has plagued the industry for years. Many blockchain platforms try to develop the fastest blockchain. However, it’s important to understand there’s a big difference between Layer-1 and Layer-2 solutions.
A Layer-1 solution refers to the basic blockchain, like Bitcoin, Ethereum, or Algorand. A Layer-2 solution refers to a third-party integration that improves the scalability of the underlying blockchain. In other words, Layer-2 scaling solutions augment the base layer of the blockchain protocol itself to improve scalability.
To give you a better understanding, let’s take a look at the protocol level. A Layer-1 blockchain has control over the protocol because this is the base blockchain. A Layer-2 blockchain builds on top of the Layer-1 solution or communicates data with the Layer-1 solution but can’t change the base protocol.
A Layer-2 blockchain solution can often handle transaction processing and report back to the Layer-1 blockchain about the updated state. Often, a Layer-2 blockchain is good at data processing using a different consensus algorithm to improve scalability. This concept is called a sidechain, which is just another blockchain optimized for transaction processing.
Well-known Layer-2 solutions include the Bitcoin Lightning Network and Ethereum Plasma. For instance, the Bitcoin Lightning Network uses state channels that perform blockchain operations and report them back to the main chain.
A Decentralized Autonomous Organization (DAO) is a smart contract running on a blockchain that offers built-in mechanisms to collectively manage a project and/or its code.
First, let’s take a look at traditional companies to better understand how DAOs work. A company is often managed by the CEO, executives, committees, and the board. These people make decisions on behalf of the entire company.
A DAO works oppositely. A DAO gives anyone who has a stake in the company voting power to decide on important topics. In other words, everyone in the company, from employee to CEO, can collectively manage the company. However, it’s essential to include a staking element to avoid proposal spamming. Only people who have a stake in the DAO get voting rights and can create new governance proposals.
Most projects use DAOs to give power to token holders to decide upon proposals and updates. People who own a bigger stake of the tokens often get a bigger proportion of the voting power. In the end, they commit more money and have a more significant skin in the game than others. So it’s fair to give them more voting power. However, this can lead to problems of power centralization, especially if multiple wealthy token holders decide to work together.
On the other hand, DAOs also provide benefits to the governance of a project, as Cointelegraph describes.
“Trusting that code is easier to do as it’s publicly available and can be extensively tested before launch. Every action a DAO takes after being launched has to be approved by the community and is completely transparent and verifiable. Such an organization has no hierarchical structure. The lack of a hierarchy means any stakeholder can put forward an innovative idea that the entire group will consider and improve upon. Internal disputes are often easily solved through the voting system, in line with the pre-written rules in the smart contract.”
To give you an example of a DAO, let’s take a look at the Decentraland DAO. Decentraland is the first-ever virtual world owned by its users. Users can buy pieces of land, build stuff, offer services, and trade anything with other users in the game. To enrich the gaming experience, Decentraland wants to put control over the game in the hands of its players. Therefore, the Decentraland DAO gives players voting power to determine how the world should behave and allocate money to improve the project further.
In short, DAOs mimic companies, but they give anyone who’s involved in the company decision power.
If you want to better understand the above concepts, I recommend looking up relevant projects that use the above technologies. For instance, look up actual bridges and try to learn from their approach. Wormhole is a bridge that creates a connection between Ethereum and Solana.
Lastly, the Aragon project has been one of the leading innovators for DAO technology. They also power countless DAOs for different projects and have many ready-to-use templates.
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