Investment Thesis: Interoperability

The digital assets industry encompasses diverse sectors, each presenting unique strengths and investment potential. The strategic allocation of capital across these sectors can define the difference between a well-diversified portfolio generating positive returns and a concentrated one overly reliant on specific sectors. In this series, we aim to highlight interesting sectors within the industry and delve into why the Hodl Funds chose to invest in them. Among these sectors lies interoperability, a sector that will become even more important as the industry matures.

What is Interoperability?

Interoperability refers to the capability of various blockchain platforms to effectively communicate and collaborate. This concept enables the exchange of information, value, and transactions across different blockchain systems, each characterized by protocols and governance models. Similar to the internet's role in connecting diverse computer networks, interoperability in blockchain technology creates a cohesive ecosystem. Distinct blockchains can interact and support one another, thereby improving the overall efficiency and utility of the blockchain space.

Why is Interoperability Important?

The issue of interoperability in blockchain technology originated due to the development of blockchain networks over the years. Initially, most blockchains were created as standalone systems with their own unique protocols and governance models. This approach led to a fragmented blockchain landscape where networks operated independently, needing more ability to interact with each other. This isolation not only limited the scope and utility of individual blockchains but also hindered the overall growth of the blockchain ecosystem. The lack of interoperability emerged as a challenge, prompting the need for solutions that could bridge these isolated systems and enable seamless communication and transactions across various networks.

As the industry continues to mature and the number of individuals and institutions entering space increases, the industry needs to be interconnected. Currently, it can be unappealing for a business to operate on blockchain as they may be bound to continue within this ecosystem, even though other businesses operate on a different blockchain. If the industry is interconnected, the ecosystem becomes a more user-friendly and inclusive environment. Other advantages include decreased network congestion and therefore less costly transactions and increased liquidity.

Why should Interoperability be a part of a portfolio?

A well-diversified portfolio is crucial for sustained returns, and within digital assets, interoperability remains one of the biggest problems that need to be solved and therefore offers a unique investment opportunity. As aforementioned, the industry continues to mature, and more institutions and users will enter the digital ecosystem. These institutions need to effectively interact with the different blockchain networks and can’t afford to be siloed out if other institutions choose a different blockchain.

Currently, the interoperability sector has grown to a market capitalization of $32B, coming down over 60% from its peak in 2021. As it remains a vital problem for the industry, expectations are that the sector will recover this lost ground and will continue to grow in value. However, it's difficult to state which project will become the industry standard as new technologies are introduced at an incredible pace. Currently, the biggest project in terms of market capitalization is Chainlink with over $10B. Nevertheless, there are various interesting projects worth researching as they still have a chance to succeed.

Interesting Lending & Borrowing Projects

Due to the crucial role of the sector, there are hundreds of projects aiming to become the industry standard for interoperability. One of these exciting projects is Quant Network, which aims to provide interoperability through its product called Overledger. The Overledger is a blockchain operating system that provides a bridge for connecting different blockchains. This bridge allows the transfer and sharing of data and value across various blockchains, making it a significant tool in achieving interoperability. For a comprehensive understanding of Quant Network's impact on blockchain interoperability, we recommend reading our detailed Quant report.

Read more about Quant

Another exciting and emerging project is Axelar which provides a decentralized network that connects various blockchains, allowing users to interact with decentralized applications across 50+ blockchains. Launched in 2022, Axelar provides a Proof-of-Stake blockchain that acts as a programmable interoperability layer, within this environment programmers can create interoperable smart contracts, allowing users to interact with a vast ecosystem of blockchains with a single click. For a more in-depth analysis of the Axelar Network and its contributions to interoperability, we recommend the detailed analysis available in the Axelar Coin Report.

Read more about Axelar

Hodl's Takeaways

As the industry grew and more blockchain networks were introduced, the problem of interoperability emerged. Although the industry has experienced significant progress in developing interoperability solutions such as bridges, atomic swaps, and multi-token wallets, true interoperability remains unseen. With the adoption of digital assets and blockchain continuing at a rapid pace, the industry must develop an interconnected network to increase the user experience of new users and businesses. Due to its significant importance for the industry, the upward growth potential of interoperability solutions is vast. However, we do believe that only a few solutions will survive and become the industry standard, mostly due to the network effect.

So interoperability is an important sector in the industry and will play a crucial role in the upcoming years. Currently, there are tens of protocols in the race to become the standard and many new projects will enter the race as well. Investing in all these projects is a risky endeavor and relying on one specific sector forms additional risks. We believe to safely navigate the industry and leverage its overall growth, investors should invest in a well-diversified portfolio. However, creating a well-diversified portfolio requires research and deep knowledge of the industry.

At Hodl, we believe that every modern investor should have an allocation to digital assets, and through regulated investment funds, we aim to aid professional investors in achieving this. Curious about what digital assets can bring to your portfolio? Book an appointment to discuss the possibilities

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