Understanding Cross-Chain Token Transfers

Definition
DEFINITION

Cross-chain token transfers are when tokens on one blockchain network are transferred to another chain, such as ETH being sent from Ethereum to Optimism.

Cross-chain token transfers unlock the multi-chain, multi-trillion-dollar future of Web3. The design choices that blockchains make can give them unique advantages, such as high levels of decentralization for secure settlement, fast finality for high performance, or low-cost transactions for scalability. For Web3 to take advantage of all of these capabilities, it requires cross-chain token transfers.

Whether it’s cross-chain token transfers between private bank chains and public blockchains or layer 1s and layer 2s, secure and seamless interoperability is critical for unlocking the full potential of tokenized assets and the onchain economy. Now that the world’s largest financial institutions are actively seeking to adopt blockchain technology, tens of trillions of dollars worth of tokenized assets are set to flow onchain if they can access a secure interoperability standard.

In this post, we explore the different types of cross-chain token transfers and the burgeoning universal standard for blockchain interoperability.

<div class="educational-divider sections-divider"></div>

What Are Cross-Chain Token Transfers?

A cross-chain token transfer is when an asset on one blockchain network is sent to another chain, such as ETH being sent from Ethereum to Avalanche. This makes a token accessible across the onchain financial ecosystem, where it can be used as DeFi collateral, for payments, and more.

<div class="educational-divider sections-divider"></div>

Types of Cross-Chain Token Handling Mechanisms

Burn and Mint

Overview of how the burn and mint mechanism for cross-chain token transfers functions.
Tokens are burned on the source chain and minted on the destination chain.

A burn and mint token transfer simultaneously burns the token on the source chain and mints the same token on the destination chain, effectively transferring it from one blockchain to another. Tokens can be transferred back and forth between either chain using the same method.

Burn and mint is the most capital-efficient mechanism because it doesn’t require any collateral to be locked (unlike “lock and mint” or “mint and lock” types). Eliminating the need for a token pool holding assets also mitigates the risk of a valuable pool of capital potentially being exploited by malicious actors.

Another key advantage is that burn and mint tokens are native assets on every supported blockchain. Consider the ease of using native USDC across all chains rather than various wrapped versions like USDC.e, USDC.bC, and axlUSDC. This avoids various UX friction points and can help mitigate some of the security vulnerabilities around wrapped tokens.

In order for a burn and mint token transfer to take place, the token’s contract must be natively deployed on both the source and destination chains and needs to support burn/mint functionality. Additionally, the cross-chain solution requires burn and mint privileges to enable cross-chain transfers. Maintaining the security standards of the underlying blockchain the tokens are issued on requires a cross-chain solution with comparable levels of security, reliability, and decentralization.

Lock and Mint

A lock and mint token transfer involves having native tokens locked on the source chain (e.g., BTC), while a wrapped version of the token (e.g., WBTC) is minted on the destination chain. This transfer in reverse, from a wrapped token to the native token, is known as burn and unlock. The wrapped tokens (WBTC) are burned and the native tokens (BTC) are unlocked.

Because any token can be wrapped without additional functionality required in the token contract, the lock and mint mechanism is backward compatible with any token. This has helped the lock and mint transfer approach become very common.

While using Chainlink CCIP mitigates the following risks, the lock and mint mechanism can have various trade-offs:

  • DeFi exposed—Wrapped tokens can expose DeFi protocols accepting them to underlying bridge risks that can lead to wrapped tokens becoming unbacked. In 2022, bridge exploits led to over $2B in funds lost.
  • Fragmented liquidity—Each bridge mints a different wrapped token, which results in multiple non-fungible versions of the same underlying asset. This splits liquidity across the DeFi ecosystem and makes it challenging for protocols to accept certain assets.  
  • Reduced transparency—Locking native tokens inside the lock and mint contract makes it harder for token issuers to track their assets across the multi-chain ecosystem.

In order to help mitigate these downsides, token issuers or a token’s community can appoint canonical wrapped tokens that approved bridges can mint.

Lock and Unlock

Overview of a lock and unlock cross-chain token transfer.
Tokens are locked on the source chain and unlocked on the destination chain.

The lock and unlock model is another common approach to bridging assets. It works by creating liquidity pools on both the source and destination blockchains. To transfer tokens cross-chain, assets are locked in the liquidity pool on the source chain and unlocked from the liquidity pool on the destination chain.

Oftentimes, liquidity providers are incentivized with rewards such as fee sharing to lock tokens on both sides of the bridge, making this method less capital-efficient than other cross-chain transfer types. To help access liquidity, cross-chain solutions can leverage existing native tokens in these pools rather than minting new versions.

While both the lock and unlock and lock and mint mechanisms are inherently more complex and less secure than the burn and mint method, all three handling mechanisms can be highly reliable and secure when powered by Chainlink CCIP.

<div class="educational-divider sections-divider"></div>

Secure Cross-Chain Token Transfers With Chainlink CCIP

Chainlink Cross-Chain Interoperability Protocol (CCIP) unlocks a new era of secure blockchain interoperability. Underpinned by burn and mint or lock and mint transfer mechanisms, CCIP features Simplified Token Transfers. It’s the most secure, reliable, and easy-to-use solution for building cross-chain applications and services.

CCIP is being adopted as the industry standard for cross-chain token transfers for the following reasons:

  • Defense-in-depth security—CCIP’s consensus and transport layer is powered by Chainlink decentralized oracle networks, which have enabled over $8.5T in onchain transaction value. Additional layers of protection include CCIP’s Risk Management Network, transfer rate limits, and the Smart Execution of transactions.
  • Effortless integration and scalability—Through a single interface on a single blockchain, developers can integrate CCIP and access all supported blockchains. Tokens transferred via CCIP are also highly composable, enabling advanced functionality to be built with them.
  • Future-proof—CCIP is architected to support continuous updates, including the integration of new blockchains, advanced functionalities, and new security features.

Moreover, CCIP supports arbitrary messaging and programmable token transfers that power advanced use cases such as cross-chain NFTs, cross-chain gaming, and cross-chain data storage.

<div class="educational-divider sections-divider"></div>

Chainlink CCIP for Leading Financial Institutions and DeFi Protocols

Swift, Chainlink, and more than a dozen of the largest financial institutions and market infrastructure providers, including BNY Mellon, Citi, DTCC, and Euroclear, successfully demonstrated a secure and scalable way to transfer tokenized assets cross-chain using CCIP. In a separate project, Australian bank ANZ used CCIP to explore cross-chain settlement of real-world assets.

Quote about Aave’s CCIP integration from BGD Labs Founder Ernesto Boado.
Aave integrated Chainlink CCIP for secure, reliable, and cross-chain communication.

CCIP is also rapidly being adopted as the premier cross-chain solution in DeFi markets. Already, Aave is using CCIP for cross-chain governance and Synthetix has integrated CCIP to power its Synth Teleporters and unlock cross-chain liquidity.

CCIP doesn’t only enable interoperability within capital markets and DeFi, it connects them. Bringing the global financial system and Web3 together via a secure interoperability standard lays the path for tens of trillions of dollars worth of tokenized real-world assets to flow onchain and grow the blockchain industry by an order of magnitude.

<div class="educational-divider sections-divider"></div>

Conclusion

In the increasingly multi-chain world of Web3, cross-chain token transfers will be fundamental to the liquidity, utility, and accessibility of tokenized assets. While it’s important for developers to understand the transfer types, abstracting the complexities away with CCIP Simplified Token Transfers enables them to easily build highly secure and scalable cross-chain applications right away. As the $2B+ of bridge exploits demonstrates, security is paramount for any cross-chain solution, and this is why CCIP’s unparalleled levels of security position make it the industry-standard blockchain interoperability solution across both capital markets and Web3.

Learn more about blockchain technology

Get the latest Chainlink content straight to your inbox.