Cross-Chain Bridges: What Are These and How Do They Work?

The existence of cryptocurrencies relies completely on blockchain technology. Between Bitcoin's inception in 2009 and present day, more than 1,500 cryptocurrencies are thriving in the ecosystem. While the idea of blockchain is a singular data transfer type, research firm Alchemy claims that there are over 125 Layer 1 and Layer 2 blockchains. Cross-chain bridges were introduced to bridge the gap between these different blockchains and the wide array of cryptocurrencies that are used for facilitating unique trade-offs, security gurantees, and scalability. Essentially, cross-chain bridges raise the interoperability quotient in the crypto sector and allow users to send cryptocurrency from one chain to another.

Before cross-chain bridges came into being, people were unable to use Bitcoin on the Ethereum blockchain or vice versa. This restricted cryptocurrency users from working on different blockchains like how credit cards work for various providers.

A cross-chain bridge reportedly connects independent blockchains and enables the transfer of assets and information between them. This, in turn, allows users to access other protocols easily.

Previously, if an ETH holder wanted to convert these assets into Polygon, the person would have had to use a centralised exchange like Coinbase or Binance to do so.

Cross-chain bridges, on the other hand, work by "wrapping" tokens in a smart contract and issuing native assets that can be used on another blockchain.

“For instance, wrapped BTC (wBTC) is an ERC-20 token that uses BTC as collateral. Users must deposit BTC on the Bitcoin blockchain before receiving wBTC tokens on the Ethereum network,” the Alchemy study explained.

Binance Bridge, Celer cBridge, Multichain, and Wormhole are among popular cross-chain bridges.

In recent times, however, these cross-chain bridges have caught the attention of hackers and money launders swarming towards the crypto sector.

In the last two years, over $540 million (roughly Rs. 4,290 crore) have reportedly been laundered by RenBridge. The platform is a decentralised application (dApp) that allows the minting of real BTC, ZEC, and BCH on Ethereum as an ERC20 token (renBTC, renZEC, renBCH), a report by Elliptic stated in a recent study.

Back in June, Layer-1 blockchain Harmony's Horizon Bridge was hacked for the sum of roughly $100 million (roughly Rs. 780 crore). Harmony's blockchain bridge enables users to transfer digital assets between different blockchains, the most notable of which are the Binance Smart Chain, Ethereum, Bitcoin, and Harmony networks.

Qubit Finance's bridge was hacked for $80 million (roughly Rs. 630 crore) back in January, thieves stole $320 million (roughly Rs. 2,510 crore) from the Wormhole bridge a month later, and hackers drained $625 million (roughly Rs. 4,730 crore) in Ether and USDC from Axie Infinity's Ronin bridge in March.

As per the Elliptic report, decentralised cross-chain bridges such as RenBridge provide an unregulated alternative to exchanges for transferring value between blockchains and hence pose a challenge. Transactions on these cross-chain bridges are processed by a network of thousands of pseudonymous validators known as “Darknodes”.

Malicious actors exploit these bridges by depositing their tokens from one chain to the bridge and then receiving the equivalent of a parallel token in another chain.

Earlier in July, the Financial Action Task Force (FATF) had published a special report saying that illicit activities involving cross-chain bridges will become an area of increasing regulatory focus as 2022 steps into its second-half.

The FATF is the global standard setter for anti-money laundering and countering the financing of terrorism (AML/CFT) measures.