Wednesday, September 7, 2022

What Exactly Are Cross-Chain Bridges, and How Do They Work?

A version of this article with my photo appeared on Gadgets360.

Blockchain technology is the fundamental underpinning of cryptocurrencies and their very existence. Since the launch of Bitcoin in 2009 until the present day, there have been over 1,500 new cryptocurrencies that have successfully entered the market. Research company Alchemy claims that there are over 125 Layer 1 and Layer 2 blockchains in existence, despite the fact that the concept of blockchain refers to a single data transfer type. Cross-chain bridges were developed in order to close the gap that existed between the various blockchains and the vast number of cryptocurrencies that are utilized for the purpose of facilitating one-of-a-kind trade-offs, security guarantees, and scalability. These blockchains and cryptocurrencies are used for the purpose of facilitating unique trade-offs. Cross-chain bridges, in their most fundamental form, are what allow users to send cryptocurrency from one chain to another and also raise the interoperability quotient in the cryptocurrency industry.

In the past, users were unable to transact using Bitcoin on the Ethereum blockchain or vice versa because there were no cross-chain bridges available. This prevented users of cryptocurrencies from operating on different blockchains, similar to how credit cards prevent users from operating on different networks.

It has been reported that independent blockchains can be connected via a cross-chain bridge, which then makes it possible to transfer assets and information between the chains. In turn, this makes it easier for users to access protocols used by other services.

In the past, an ETH holder who desired to convert their assets into Polygon was required to do so through the use of a centralized exchange such as Coinbase or Binance. This was the only option available.

On the other hand, cross-chain bridges function by "wrapping" tokens in a smart contract and issuing native assets that can be used on another blockchain. This allows the tokens to be used on the second blockchain.

Wrapped Bitcoin, or wBTC, is an example of an ERC-20 token that serves as collateral and uses Bitcoin. According to the findings of the Alchemy study, users are required to make a BTC deposit on the Bitcoin blockchain before they can receive wBTC tokens on the Ethereum network.

Hackers and money launderers are swarming towards the cryptocurrency sector. Recently, however, these cross-chain bridges have caught the attention of hackers and money launderers.

According to the reports, RenBridge has been responsible for the laundering of more than $540 million over the past two years. According to a report that was published by Elliptic in a recent study, the platform is a decentralized application (dApp) that enables the minting of real BTC, ZEC, and BCH on Ethereum in the form of an ERC20 token (renBTC, renZEC, and renBCH).

Back in June, the Horizon Bridge of the Layer-1 blockchain Harmony was subjected to a cyberattack that resulted in the loss of approximately $100 million. Users are able to transfer digital assets between various blockchains, the most notable of which are the Binance Smart Chain, the Ethereum network, the Bitcoin network, and the Harmony network, thanks to the blockchain bridge that Harmony provides.

In January, thieves stole $80 million (approximately Rs. 630 crore) from the bridge belonging to Qubit Finance. A month later, they stole $320 million from the bridge belonging to Wormhole. Finally, in March, hackers stole $625 million in Ether and USDC from the Ronin bridge belonging to Axie Infinity.

According to the Elliptic report, decentralized cross-chain bridges like RenBridge present a problem because they offer an unregulated alternative to exchanges for the purpose of transferring value between blockchains. A network of thousands of pseudonymous validators known as "Darknodes" is responsible for processing the transactions that take place on these cross-chain bridges.

In order to take advantage of these bridges, malicious actors deposit their tokens from one chain onto the bridge, at which point they are rewarded with the equivalent of a parallel token in another chain.

The Financial Action Task Force (FATF) had published a special report earlier in the month of July, in which it was stated that illegal activities involving cross-chain bridges will become a subject of increasing regulatory focus as 2022 moves into the second half of the year.

The Financial Action Task Force (FATF) is the global body that establishes standards for anti-money laundering and countering the financing of terrorism (also known as AML/CFT).