Decentralized finance (DeFi) has exploded in popularity over the last few years, largely built on Ethereum. However, as Ethereum gas fees have risen, developers and users have looked to sidechains like Polygon to enable faster and cheaper transactions while still benefitting from Ethereum's security and decentralized features. This article will explore cross-chain DeFi strategies using Ethereum sidechains like Polygon.
Leveraging Polygon for Lower Fees
Polygon, previously called Matic Network, has emerged as one of the leading Ethereum sidechains for DeFi. Polygon uses a Proof-of-Stake chain running parallel to Ethereum, offering faster transactions and significantly lower gas fees. This makes Polygon highly appealing for DeFi activities like trading, lending, and providing liquidity.
Users can transfer assets between Ethereum and Polygon using Polygon's bridge. Once assets are on Polygon, gas fees for transactions can be a fraction of a penny, compared to upwards of $20-50 on Ethereum. This makes strategies like arbitrage trading and liquidity farming much more viable on Polygon.
Accessing Popular DeFi Protocols Through Polygon
Many of the most popular DeFi protocols like Aave, Curve, and Sushiswap are available on Polygon, allowing users to access fast and cheap DeFi services. These Polygon versions utilize the same smart contracts and liquidity pools while reducing fees 100x or more compared to Ethereum.
For example, lending on Aave Polygon has fees of ~0.1% versus 0.9-2.5% on Ethereum. Providing liquidity on Curve Polygon has fees of ~0.04% versus 0.3% on Ethereum. Trading on Sushiwap Polygon has fees of 0.3% versus 0.5-1% on Ethereum.
This makes strategies like lending, yield farming, and DEX trading substantially more profitable by slashing the overhead costs of gas fees.
Leveraging Faster Transactions for Arbitrage
The faster block times on Polygon open up arbitrage opportunities between Polygon and Ethereum that would not be feasible directly on Ethereum. For example, liquidity mining reward token prices often differ between the Polygon version and Ethereum version of protocols like Curve and Sushiswap.
Traders can spot these price discrepancies and capitalize on them by buying the token on the chain where it is cheaper and selling it on the chain where it is more expensive. The fast ~2 second block times on Polygon allow traders to rapidly execute this triangle arbitrage, while Ethereum's 15 second blocks would make this strategy unworkable.
Providing Liquidity on Polygon Versions of AMMs
Providing liquidity on the Polygon versions of popular Automated Market Makers (AMMs) like Uniswap, Sushiswap, and Curve can be extremely lucrative compared to Ethereum. The minimal fees mean almost all the trading fees go to liquidity providers.
Providing liquidity on Curve Polygon can yield 20-50% APY. Whereas on Ethereum, a significant portion of the yield from liquidity providing ends up going to gas fees. Polygon's low-fee environment leads to greater capital efficiency for liquidity providers.
Risks and Challenges
While Polygon offers faster and cheaper transactions for DeFi, there are some risks and challenges to consider:
- Dependence on Ethereum: Polygon relies on Ethereum for security. If Ethereum has issues, it could impact Polygon.
- Bridging assets: Bridging assets between Ethereum and Polygon has risks like delayed transactions and paying high Ethereum gas fees.
- Centralization concerns: Polygon has some centralization concerns compared to Ethereum around its PoS validators.
- Developer traction: Polygon needs to continue attracting DeFi developers for maximum usefulness.
Overall Polygon looks poised to enable lucrative new DeFi strategies, but users should understand the potential limitations. Polygon is an evolving platform and may overcome these challenges over time.
"Polygon has been a game changer for my DeFi strategies. I'm able to trade and earn yields that would have been eaten up by Ethereum gas fees. Yes, you need to bridge assets carefully, and it's not as decentralized as Ethereum. But Polygon is scaling Ethereum now instead of years from now."
Key Benefits of Using Polygon for Cross-Chain DeFi
There are a few key benefits Polygon specifically brings for cross-chain DeFi strategies with Ethereum:
- Drastically reduced transaction fees compared to Ethereum
- Faster block times enabling advanced arbitrage strategies
- Easy bridging between Ethereum and Polygon
- High Ethereum security since Polygon commits checkpoints to Ethereum mainnet
- Rapidly growing ecosystem of DeFi dApps and liquidity on Polygon
Potential Risks When Using Sidechains Like Polygon
While sidechains like Polygon provide many benefits, users should be aware of some potential risks including:
- Delayed or failed transactions when bridging assets between chains
- Assets on sidechains can be susceptible to security issues or bugs
- Early sidechains may be more centralized than desired
- Liquidity on sidechains may still be low for some asset pairs
- Difficulties withdraw funds if sidechain has issues or loses validation
Proceeding with caution and using established sidechains like Polygon can help mitigate these risks when using cross-chain DeFi strategies.
How Can Polygon's Low Fees Unlock New DeFi Opportunities?
Polygon's ultra-low fees open up many DeFi opportunities that were previously too expensive on Ethereum. A few examples include:
- Algorithmic trading - High frequency trading bots can run profitably paying just a fraction of a penny per transaction.
- Flash loans - Traders can take out flash loans for arbitrage paying minimal fees.
- Undercollateralized loans - Borrowers can take uncollateralized loans and pay them back quickly while avoiding expensive Ethereum fees.
- Micro-tipping - Users can send micropayments for content or services without high gas costs.
- Micropools - Liquidity providers can contribute to AMM pools in small amounts without being eaten away by fees.
- NFT fractionalization - NFTs can be fractionalized and traded in tiny pieces opening up new markets.
Essentially any DeFi activities that require many on-chain transactions become viable on Polygon where Ethereum fees would eat up most profits or make them unworkable. Exciting new DeFi use cases are unlocked when fees are no longer a barrier.
How Can Ethereum Sidechains Help Scale DeFi?
Ethereum sidechains provide a shortcut to scaling decentralized finance by offering faster and cheaper transactions while benefitting from Ethereum's security. Here are some of the ways sidechains can help scale DeFi:
- Attracting new users - Near zero fees and faster transactions provides onboarding for crypto newcomers.
- Supporting micro-transactions - Micropayments can unlock new DeFi transaction models.
- Reducing costs for institutions - Major players can enter DeFi but need lower fees.
- Enabling new products - New DeFi products that require speed and low costs.
- Alleviating Ethereum congestion - Transaction volume can be absorbed by sidechains.
- Leveraging Ethereum's network effect - Benefit from Ethereum's first mover advantage.
- Experimenting with innovations - Sidechains are a testing ground for new DeFi innovations.
- Decentralization bridge - Allows gradual transition to fully decentralized Ethereum 2.0.
Sidechains are a pivotal bridging technology to make DeFi accessible to the mainstream and support the next wave of adoption. This scaling solution is already enabling new and exciting DeFi use cases.