The Japanese star Hanyu showed no ill effects from the right ankle injury that sidelined him for three months to surge into a four-point lead with a score of 111.68.
Six-time European champion Javier Fernandez of Spain heads the chasing pack going into Saturday's decisive free skate at the Gangneung Ice Arena on 107.58.
But Chen looks down and out after two major mistakes left him towards the back of the pack in 17th.
Hanyu's bid to become the first since American Dick Button in 1948/52 to claim back-to-back Olympic titles could not have got off to a more encouraging start.
Since Sochi he has been accorded cult status in Japan and his every move and every jump was greeted by deafening cheers -- and that was just in the warm-up.
From the moment the skating emperor catapulted his body into the air for an opening quad loop to his final combination spin, Hanyu looked every inch the man who will have gold hanging round his neck again in 24 hours.
His routine set to Chopin's Ballade No.1 earned him 10 points more than the one he led the short programme with in Russia four years ago.
With the music fading away, Winnie the Pooh bears came raining onto the ice, hurled down by his adoring army of fans that have become such a hallmark of any Hanyu appearance.
The hundred or so cuddly toys were picked up by a team of 50 or so girls, scurrying around the rink like ants on blades.
Next up came Chen, who for many was Hanyu's main challenger.
The 18-year-old American, the only man to beat Hanyu last year, took a tumble on his opening quad flip triple toeloop, and virtually performed a cartwheel to recover from a missed triple axel.
Hanyu's main threat to a historic double will now come from Fernandez, who is itching to close out his Olympic career with a first medal.
The 26-year-old Real Madrid supporter endeared himself to the crowd with a mischievously entertaining interpretation of the tramp from the Charlie Chaplin classic Modern Times.
Placed third, over seven points adrift of his compatriot, was another Japanese skater, Shoma Uno, with China's Jin Boyang lying fourth.