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

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A version of this article with my illustration appeared on Gadgets360

Cryptocurrencies exist solely because of blockchain technology. More than 1,500 cryptocurrencies have thrived in the Bitcoin ecosystem since its launch in 2009. While the concept of blockchain is a single sort of data transfer, Alchemy asserts that there are over 125 Layer 1 and Layer 2 blockchains. Cross-chain bridges were developed to bridge the gap between these various blockchains and the diverse range of cryptocurrencies that are employed to facilitate unique trade-offs, security guarantees, and scalability. Cross-chain bridges, in essence, increase the interoperability quotient in the crypto industry by allowing users to transmit cryptocurrency from one chain to another.

Before cross-chain bridges, it was impossible to use Bitcoin on the Ethereum blockchain or vice versa. This prevented cryptocurrency users from functioning on multiple blockchains, similar to how credit cards work for different suppliers.

A cross-chain bridge, according to reports, joins independent blockchains and allows assets and information to be transferred between them. As a result, users can simply access various protocols.

Previously, an ETH holder would have required to use a centralized exchange like Coinbase or Binance to convert these assets into Polygon.

Cross-chain bridges, on the other hand, function by “wrapping” tokens in a smart contract and issuing native assets usable on another blockchain.

“Wrapped BTC (wBTC), for example, is an ERC-20 token that uses BTC as collateral.” “Before getting wBTC tokens on the Ethereum network, users must deposit BTC on the Bitcoin blockchain,” according to the Alchemy study.

However, in recent years, these cross-chain bridges have piqued the interest of hackers and money launderers flocking to the crypto sector.

RenBridge is said to have laundered approximately $540 million in the last two years. According to a recent study, the platform is a decentralized application (dApp) that allows the minting of actual BTC, ZEC, and BCH on Ethereum as an ERC20 token (renBTC, renZEC, renBCH).

Layer-1 blockchain Harmony’s Horizon Bridge was hacked in June for around $100 million. The blockchain bridge provided by Harmony allows users to move digital assets between blockchains, the most noteworthy of which being the Binance Smart Chain, Ethereum, Bitcoin, and Harmony networks.

Hackers stole $80 million (approximately Rs. 630 crore) from Qubit Finance’s bridge in January, $320 million from the Wormhole bridge a month later, and $625 million in Ether and USDC from Axie Infinity’s Ronin bridge in March.

According to the Elliptic research, decentralized cross-chain bridges such as RenBridge represent a difficulty since they give an unregulated alternative to exchanges for transferring wealth between blockchains. Transactions on these cross-chain bridges are handled by a network of thousands of pseudonymous validators known as “Darknodes.”

Malicious actors take advantage of these bridges by depositing tokens from one chain to the bridge and obtaining the equivalent of a parallel token in another chain.

Earlier this month, the Financial Action Task Force (FATF) issued a special report stating that illicit operations employing cross-chain bridges will be a growing regulatory focus as 2022 enters its second half.

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

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