As the blockchain industry continues its rapid evolution and growth, blockchain networks are no longer standing alone or separate from one another. Due to the fact that users, developers and institutions are now routinely transferring assets across a number of different layer 1 (L1) blockchains such as BTC, ETH, SOL, AVAX and POLY, the multi-chain environment has not only created new opportunities for innovation, scalability and interoperability; it has also put a spotlight on an important gap in compliance and security systems; namely Chain-Hopping.
Chain Hopping refers to an increasing concern regarding the movement of funds that have a blurred source or history by transferring them between incompatible L1 blockchains, thereby changing their origin and/or transactional history. And, while there are certainly technical ramifications to chain-hopping, there is also a much more profound structural issue that will continue to impact blockchain analytics, as well as regulatory oversight and enforcement, as well as the larger global challenge of effectively combating financial crime.
From the perspective of modern anti-money laundering tools, it has become increasingly challenging to trace crypto transactions across fractured blockchain ecosystems. As fraudsters continue to develop and utilize ever-more sophisticated methods to move crypto-created assets in untraceable ways, the intended use of traditional monitoring techniques to look at these methods will be more difficult to accomplish and comply with.
This article will discuss why chain-hopping is such a major issue, how chain hopping works in the multi-chain ecosystem, how chain-hopping impacts AML tools and systems, and what to expect in the future in terms of overall transparency of cross-chain transactions.
The Importance of Chain-Hopping in Crypto Ecosystem
Chain-hopping can be defined as the transfer of digital assets (also known as cryptocurrencies) between two or more different blockchains (e.g., transferring a cryptocurrency from Ethereum to Polygon). This is typically done through the use of bridges, swaps, or decentralized exchanges. There are many legitimate reasons for performing a chain-hop: to gain access to a decentralized finance (DeFi) protocol on another blockchain; to reduce transaction fees; etc. However, chain-hopping can also be exploited by individuals to hide the details of their transactions on one blockchain when they move to another blockchain.
In other words, chain-hopping disrupts the continuity of the transaction data for a digital asset. A blockchain has its own public ledger, consensus model, and data structure. When a digital asset moves from one blockchain to another, the transactional context of the digital asset gets lost or obscured.
Why Layer-1 Incompatibility Matters
Layer-1 (L1) blockchains are different from one another in terms of how they operate and are built. For instance:
Bitcoin is built upon a user transaction (UTXO) model;
Ethereum is built upon an account (or, balance) model;
Solana focuses on providing a high-throughput solution using several different consensus (validation) methods to maintain high speeds.
Avalanche is able to support a number of interoperable blockchains.
These differences can present challenges for a product that analyses blockchain transaction data and/or provides anti-money laundering (AML) solutions to better see transaction activity across disparate blockchain systems.
Why Chain-Hopping Is a Major Challenge for AML Tools
AML tools have become heavily dependent on blockchain analytics to analyze the flow of transactions and detect anomalies. Chain-hopping creates several hurdles for AML tools.
Key Challenges
Data Fragmentation: There is fragmented data of transactions on multiple blockchains with no standardization.
Bridge Complexity: The reporting system of cross-chain bridges is not transparent or standardized.
Anonymity Layers: Users can use mixers, privacy coins, and decentralized exchanges along with chain-hopping.
Speed and Volume: High-speed cross-chain transactions make it difficult to monitor in real-time.
Lack of Interoperability: AML tools need to handle data from multiple blockchain protocols with different formats.
This makes it exponentially more difficult to track the flow of illicit money when it is moved between chains rather than being restricted to a single chain.
Chain-Hopping and Money Laundering in Crypto
Chain-hopping has had a major impact on the way financial crimes are perpetrated in the crypto space. Currently, rather than using mixers or privacy coins, criminals have resorted to using cross-chain transactions to launder their money.
A general money laundering process in the crypto space may include:
Transfer of money from Bitcoin to Ethereum using a bridge.
Asset swapping using decentralized exchanges.
Transfer of tokens to a fast L1 network such as Solana.
Conversion of assets to stablecoins or NFTs.
Finally, cashing out using centralized exchanges.
Each of these processes adds a new level of complexity to the AML system, making it difficult to track the entire transaction history.
How Chain-Hopping Works: A Step-by-Step Explanation
A general explanation of the chain-hopping process is provided below:
Steps in a Chain-Hopping Process:
Initial transfer of funds to the original blockchain (for example, Bitcoin).
Transfer to the cross-chain bridge or wrapped token protocol.
Conversion to a token on another blockchain (for example, wBTC on Ethereum).
Swap using decentralized exchanges or DeFi protocols.
Transfer to other L1 networks.
Final consolidation or off-ramping.
This process makes it difficult for the AML system to track the entire transaction history.