Great thanks to Dominator008 for his support to this Insight！

Binance Smart Chain (BSC) launched last September, opening a new era of exchange-blockchains and attracting attention of numerous projects. In a couple of months, BSC ecosystem saw an overall growth — AMMs, lending & borrowing, stable coins, NFTs and other ecosystem projects began building on BSC. Then in December 2020, Huobi announced the launch of their own Huobi ECO Chain (Heco) followed by the announcement of OKExChain which launched with live trading, mining and EVM Module for smart contract development functions.

Exchange chains are currently a hot topic in the industry and the trend will continue to be for a long time. BSC is currently one of the leading exchange chains and since its launch, has quickly attracted many users, projects, and seen significant growth of its on-chain data. Its transaction volume reached $1.2 billion in just one month since launch. The goal of BSC is to offer quicker and more convenient asset transfers across multiple Layer 1 blockchains and/or dApps. We also look forward to the implementation of Ethereum Layer 2 scaling technology to “compete” with BSC in the near future. Alternatively, we see a possibility where the two can work together to create a better user experience.

This year, BSC aims to build cross-chain financial infrastructure, unlock the Internet value, provide more solutions for various blockchain composibility, and enable different DApps to interact and transfer assets via BSC bridge service. At present, BSC is spending more effort on subsections such as algorithms, aggregation solutions, cross-chain and multi-chain, gamification, community, and social tokens, synthetic assets, institutional DeFi, infrastructure, and tools, etc., which provide a massive design space and infrastructure support for more and more projects who choose to migrate to BSC.

With an increasing number of projects migrating to BSC, we believe BSC is to Ethereum what Kusama is to Polkadot. New projects can be tested in a real environment already while leveraging Binance’s 100M user base and at a lower cost. Presently, the development of the layer 2 network (sidechains excluded) is not as fast nor developed as exchange chains and we see this as an opportunity for BSC to attract projects who will choose to migrate to avoid the high gas fees of Ethereum Mainnet.

The exchange chains have taken over a lot of traffic from Ethereum and have become the essential public chains that cannot be underestimated in the ecosystem. A prime example of power of BSC has been Pancake Swap. In our opinion, BSC itself will become more decentralized, and encourage communities to run nodes and BNB holders to pledge to nodes for revenue. In the long run, BSC will become an important part of the future multi-chain ecosystem.

As a reply to the rapid development of the Ethereum DeFi ecosystem, exchange chains have their own pros and cons. IOSG reckons that exchange-leading chains like BSC will continue to trend in the short term. The reasons are as follows:

• Large user base. The exchange has a bigger user base compared with Ethereum. In fact, many of the BSC (and other chains like Heco) users have not even used Ethereum or installed MetaMask, nor have they accessed DeFi. Exchanges provide robust customer service (KOLs and even founders themselves take matters into their own hands), decent allowance, and discounts to enlarge the user base. The low transaction fee, quick confirmation process, and considerable wealth effect have strengthened users’ engagement.
• More capital: In terms of access to a diverse set of assets, exchanges easily outperform Ethereum or any public chain. Exchanges build low-cost cross-chain technology and bring a smooth user experience. Besides, they allow previous players who hold “mainstream tokens (XRP, EOS, BCH)” to have the chance to join DeFi. It’s actually true when BSC put forward “All chains are connected in one” after it first came online.
• Rapid technological iteration. By now, BSC and Heco nodes are based on Ethereum codes, which reduces the barrier to entry for further development and help maintain the base layer. Providing with a user-friendly cross-chain function and a remarkable structure that realizes the IBC-like (Inter Blockchain Communication) function between BSC and Cosmos SDK-based BC (Binance Chain). Compared with the decentralized development methods such as the Ethereum Foundation, the exchange chains are undoubtedly more efficient in the short term.

Although exchange chains possess obvious advantages, they are far from perfect. The problems mainly include:

• Highly centralized. Technically, current exchange chains can’t be viewed as public chains and are similar to consortium blockchains or private chains. The number of nodes are not enough to offer qualities of decentralisation (for example BSC has only 21). Although it is open to the community to operate nodes, BNB’s high staking threshold results in a low user engagement. Inevitably, the exchange chain will be criticized with centralization by the fundamentalist Ethereum community. With the progress of layer 2, we will see a corresponding rise in user’s demand for decentralization. We believe BSC and Ethereum both will have plans to improve decentralization.
• Overloaded node capacity: By using EVM code and PoA (Proof of Authority) consensus, increasing the block size, and shortening block generation time, BSC is able to deliver 10 times more transactions than Ethereum. However, such a simple scaling method, when met with sudden and rapid user growth, will bring about a more serious “state explosion” problem. Similar to EOS’s supernode, exchange chain nodes also have higher requirements on the device and operator’s maintenance, and it will increase as time goes by. State explosion will make the decentralization of the exchange chain and its upper limit of performance reach bottlenecks. We believe that it is an urgent issue to be solved.