An application chain is an independent blockchain built specifically for a particular application or function. It features its own consensus mechanism, governance model, and resource allocation, and typically maintains interoperability with other blockchains. The goal of an application chain is to optimize the needs of specific applications, such as improving processing speed, reducing transaction costs, and enhancing security, to address resource competition and congestion issues often encountered on public blockchains. However, application chains have certain drawbacks, including high technical requirements and poor composability and interaction compared to protocols.

Development of Application Chains

The concept of application chains first appeared in 2018 after the launch of the Cosmos SDK. Following this, many blockchain protocols, such as Terra and Osmosis, began to develop in the direction of application chains.

Between 2022 and 2023, Layer 2 solutions such as Optimism and Arbitrum introduced L2 stacks like OP Stack and Arbitrum Orbit, which allowed protocols to build application chains on Layer 2 easily. This significantly increased the appeal of application chains.

By 2024, the number of application chains grew exponentially. One reason was the bull market, which attracted more capital and talent. As a result, many successful protocols began with the goal of establishing application chains. On the other hand, some established protocols reached a bottleneck, and transitioning to application chains created new opportunities and injected fresh energy into their native tokens.

Advantages of Application Chains

Reduced Operational Costs

One of the main advantages of application chains over protocols within ecosystems is the reduction in operational costs. When a protocol exists within an ecosystem, it must pay various fees to maintain operations. However, when the protocol itself is an application chain, these costs are significantly reduced.

Protocols that execute smart contracts, transfers, or other operations on the blockchain, like users, are required to pay transaction fees (gas fees). For complex DeFi protocols, these costs increase with the complexity of operations.

Additionally, some blockchain protocols need to store data on the chain, such as user balances and smart contract states. Public blockchains often charge fees for on-chain data storage, as storing data consumes network resources. For example, on Ethereum, writing new data incurs a fee. Some blockchains, like NEAR Protocol, may charge for storing data over time to ensure the cost of long-term storage.

No Longer Bound by Network Constraints in the Ecosystem

Different chains have varying network activity levels, speed, and gas fees. For instance, on Solana, which has a high volume of meme coin transactions, network downtime often occurs due to increased meme activity. In such cases, regular DeFi users may face network congestion and rising fees because of interactions unrelated to their interests. Over time, traders who are not interested in meme coins might migrate to other protocols, hindering the development of DeFi on Solana.

With the establishment of an application chain, all interactions on the chain are based on the functionality of the protocol itself. Users do not need to bear the costs of network congestion caused by other protocols. As a result, the cost and speed experience are typically better compared to protocols within a larger ecosystem.

Increased Autonomy

For some specific DeFi protocols, expanding functionality can be challenging due to the limitations imposed by the ecosystem they operate in. By having their own custom application chain, building out functionality becomes much easier.

For example, dYdX Chain, built on Cosmos, benefits from complete customizability in terms of blockchain functionality and validator tasks. It is an independent blockchain that can be fine-tuned for specific purposes. This allows developers to freely customize every aspect, from the underlying protocol to the user interface.

Each dYdX Chain validator runs an in-memory order book that never reaches consensus (i.e., it is off-chain). Order placements and cancellations are propagated across the network like regular blockchain transactions, and the order books stored by each validator eventually sync. The network matches orders in real time, and the resulting trades are submitted to the chain for every block. This allows dYdX Chain to maintain decentralization while achieving extremely high order throughput.

Token Empowerment

Increased token empowerment is one of the main reasons for developing an application chain. Protocol tokens are often used as gas fees (e.g., dYdXChain uses USDC or DYDX for transaction fees) or staking tokens for nodes.

For instance, Unichain’s whitepaper mentions that node operators must stake UNI tokens on the Ethereum mainnet. The staking status is tracked within Unichain’s smart contracts, and notifications about staking and withdrawal operations are relayed via a native bridge. Unichain blocks are divided into fixed-length Epochs, and at the start of each Epoch, the current staking balance is snapshot, after which fuel fees for Unichain are collected and rewarded to the node stakers. Similarly, dYdX token holders can share in all the revenue on dYdXChain after staking their tokens.

Additionally, participants can stake and vote for validators, increasing a validator’s staking weight. The validators with the highest staking weight in each Epoch are considered active validators and are eligible to issue proofs and receive designated rewards for that Epoch.

Ideally, $UNI tokens will gain additional utility beyond voting and enter a deflationary state in this economic model.

Disadvantages of Application Chains

High Development and Maintenance Costs

Creating and maintaining an independent application chain requires building and maintaining infrastructure, including nodes, network security, and consensus mechanisms. This is far more expensive than developing a protocol on an existing blockchain. Additionally, the development of an application chain typically requires deeper technical expertise and more resource support, increasing both time and financial demands.

However, this disadvantage has been significantly mitigated with the introduction of modular development tools. Notable tools like Cosmos SDK, OP Stack, and Arbitrum Orbit allow for the rapid and secure deployment of Layer 1 (L1) or Layer 2 (L2) solutions.

For example, dYdX’s application chain, dYdXChain, uses the Cosmos SDK, while the recently popular Unichain is built using the OP Stack. These tools have greatly reduced the complexity of development.

Cross-chain Compatibility Challenges and Limited Composability

While cross-chain protocols have been gradually maturing, cross-chain interoperability still faces significant technical and security challenges. Application chains may encounter compatibility issues when connecting with different blockchains, especially when interacting with chains that have limited cross-chain support. Furthermore, vulnerabilities or security risks in cross-chain bridges could jeopardize the safety of assets on application chains.

Although the use of modular development tools has solved many issues related to cross-chain interactions within the same modular environment, it has also led to an increasing number of public blockchains. This proliferation makes composability more difficult when using various chains together.

For example, consider a trader who exchanges tokens on Unichain with the intention of borrowing on AAVE. After the token exchange, the trader would still need to cross-chain the tokens back to the mainnet. This adds complexity compared to the current process of directly exchanging tokens on Uniswap and depositing them into AAVE, making the workflow much more cumbersome.

Differences Between Application Chains and Sidechains

• With the increasing emergence of application chains, discussions around the differences between application chains and sidechains have become more common. Both application chains and sidechains exist to meet specific needs, but there are several key differences between the two:
• Different Purposes

Sidechains typically exist for a specific purpose, such as trading or lending, and they support deploying multiple protocols. In essence, a sidechain is a simplified version of the main chain. On the other hand, the purpose of an application chain is more focused and specific. It is created to meet the development needs of a particular protocol.

• Different Development Focus
  The teams behind sidechains are often derived from the main chain team. In contrast, the teams behind application chains usually originate from the protocol layer. This means that in the later stages of development, sidechains tend to focus on expanding the ecosystem of the main chain. In contrast, application chains are more inclined to focus on user and developer needs.

• Adaptability
  Based on the two factors mentioned above, sidechains are generally more adaptable to various protocols, whereas application chains are highly specialized and optimized to serve the needs of a specific protocol.

Case Study

dYdX Chain

dYdX, one of the largest decentralized derivatives exchanges, specializes in perpetual contracts, margin and spot trading, as well as lending. Traditionally, dYdX relied on an off-chain order book and operated primarily on the Ethereum mainnet. However, with the launch of version V4, the dYdX Chain was officially deployed, built using the Cosmos SDK. This shift marked a significant transition, allowing dYdX to move away from Ethereum’s high transaction fees and its development limitations.

With the launch of the dYdX Chain, the DYDX token gained additional utility. While previously, dYdX’s protocol revenues were allocated to the project team, post-launch, the revenue from transactions on the dYdX Chain will now be distributed to DYDX token holders. Moreover, transaction fees on the dYdX Chain can also be paid using DYDX tokens, further enhancing the token’s utility and value.

This transition to an application chain has significantly improved the operational efficiency and user experience on the dYdX platform, while also increasing the financial incentives for DYDX token holders, as they can now directly benefit from the protocol’s success on the new chain.

Unichain

Uniswap, the largest decentralized exchange (DEX) in the blockchain space, announced in Q2 of 2024 that it would launch Unichain, a blockchain built using the OP Stack. While it introduces new technologies like Flashblocks, the core advantage of transitioning to an application chain is that Unichain will no longer face the network congestion issues caused by other protocols. This shift is expected to result in improvements in both transaction fees and efficiency.

On the token level, users can stake UNI tokens on the mainnet to become node operators for Unichain and share in the verification rewards.

Conclusion

Currently, the DeFi market lacks new innovations, so the shift towards application chains can be seen as one of the few directions for change among DeFi protocols. DeFi protocols such as Uniswap, dYdX, and Injective have all transitioned towards the application chain model. The emergence of application chains not only enhances the user experience but also serves the key purpose of increasing platform popularity and token utility, creating a win-win situation for both users and the protocols themselves.

However, the rapid growth of application chains contradicts concepts like interoperability and chain abstraction. While user experience improvements are noticeable in specific interactions, the blockchain landscape becomes more complex. Imagine a scenario where your planned journey involves Lending -> Swap -> NFT Purchase, and each of these steps needs to be executed on a different application chain. This significantly increases the interaction path. So, is the application chain truly beneficial or harmful to you?