As you may want to invest into DeFi (Decentralized Finance) without paying the high gas fees of Ethereum (ETH) blockchain, you might be interested in EVM (Ethereum Virtual Machine) compatible chains like Binance Smart Chain (also called BSC, BNB chain or Binance chain), Avalanche (AVAX) chain, or Fantom (FTM) chain.
Binance and Fantom chains are particularly popular because they allow to invest into cryptos like Bitcoin (BTC) or altcoins easily. However, as you want to use DeFi instead of centralized exchanges to avoid the risks inherent to these exchanges, it is crucial to understand the risks of investing into tokens on these chains. Most of the tokens on Binance and Fantom chains are indeed "peg" tokens, i.e., they are not native to these chains.
How do Binance peg tokens work?
Binance peg tokens are tokens on the Binance Smart Chain (BSC) that are designed to be pegged to the value of other cryptocurrencies or fiat currencies. These tokens are called peg tokens because their value is pegged to the value of another asset.
For example, Binance USD (BUSD) is a peg token that is designed to be pegged to the value of the US dollar. The value of 1 BUSD is supposed to be equal to the value of 1 US dollar.
Binance peg tokens work by using a combination of smart contracts and reserves to maintain their pegged value. The smart contracts are programmed to maintain a specific ratio of the peg token to the asset it is pegged to. For example, if 1 BUSD is pegged to 1 USD, the smart contract would ensure that there is always enough BUSD available to be redeemed for 1 USD.
To maintain the peg, Binance also maintains reserves of the asset that the peg token is pegged to. These reserves are used to redeem the peg token for the asset it is pegged to. For example, if someone wants to redeem 100 BUSD for USD, Binance would use its USD reserves to fulfill that redemption.
Binance peg tokens can be used on the Binance Smart Chain just like any other token. They can be bought and sold on exchanges, used as a medium of exchange for goods and services, and even used to pay transaction fees on the Binance Smart Chain. Because they are pegged to other assets, they offer a stable and predictable value, making them useful for a variety of applications.
How do Fantom peg tokens work?
Fantom peg tokens are tokens on the Fantom blockchain that are pegged to the value of an asset on another blockchain, typically Ethereum. These tokens are used to allow users to transfer assets between different blockchains, without the need for a centralized exchange or a custodian.
Here's how Fantom peg tokens work on the Fantom chain:
- First, a user sends a transaction to a smart contract on the Fantom chain, which locks the original asset (e.g. ETH) on the Ethereum blockchain.
- The smart contract then mints a corresponding amount of peg tokens on the Fantom chain, which are pegged to the value of the locked asset.
- The user can then use these peg tokens on the Fantom chain for transactions and trades, just like any other token on the Fantom blockchain.
- When the user wants to unlock their original asset on the Ethereum blockchain, they simply send the peg tokens back to the smart contract on the Fantom chain, which then releases the locked asset on the Ethereum blockchain.
- The peg tokens are then burned, effectively reducing the supply of peg tokens on the Fantom blockchain.
Overall, Fantom peg tokens provide a seamless and trustless way for users to move assets between different blockchains, without the need for a centralized intermediary. This has many potential benefits, including faster transaction times, lower fees, and greater liquidity.
In summary
On Binance Smart Chain, you need to trust the proof-of-reserves published by Binance. On Fantom, the risks come from the smart contracts used to lock tokens on the original chain and mint them on the Fantom one. Therefore, in both cases, there are risks: Binance proof-of-reserves might be overrated, or Fantom smart contacts might be exploited.
Furthermore, these both blockchains are poorly decentralized. Only a few validators are needed to collude against these networks.
An alternative could be to use Ethereum sidechains or layer-2 chains like Polygon (MATIC), Optimism (OP) or Arbitrum... But it will be tackled in my next article.
Disclaimer: this article does not contain any financial advice. The information is provided for general informational and educational purposes only.
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