Blockchain Scalability - Sidechains and Payment Channels

Introduction

Broadly speaking, scalability refers to a system's ability to handle growing demands. In the computer field, you can enhance computational performance and speed up task processing through hardware upgrades. When discussing the scalability of blockchain, it typically means improving system performance to process more transactions.

Protocols like Bitcoin have many advantages, but they fall short in terms of scalability. If Bitcoin operated on a centralized database, administrators could easily increase processing speed and throughput. However, Bitcoin's value proposition—such as its censorship resistance—requires multiple participants to collaborate in maintaining copies of the blockchain.

The Scalability Issue of Blockchain

The operational costs of running a Bitcoin node are relatively low, allowing even low-spec devices to participate. However, thousands of nodes need to remain up to date, which limits the system's capacity.

Blocks are typically capped to control the number of transactions processed on-chain, preventing uncontrolled data growth. If the volume of data increases too quickly, nodes may struggle to keep up. Additionally, excessively large blocks can make rapid propagation across the network difficult.

At this point, the network may encounter bottlenecks. One can liken blockchain to a train service with fixed intervals between departures. Each train car has limited seating, and passengers must bid for tickets. If everyone wants to board, ticket prices naturally rise. Similarly, a network clogged with unconfirmed transactions forces users to pay higher fees to prioritize their transactions.

One solution is to increase the capacity of the train cars. As the number of seats increases, passenger flow will also rise, leading to lower ticket prices. However, the capacity of the cars remains limited, just as the maximum size of blocks and transaction fees cannot increase indefinitely. This raises the costs for nodes within the network, as they can only stay in sync through hardware upgrades.

Vitalik Buterin, the founder of Ethereum, introduced the "scalability trilemma," highlighting the challenges faced by blockchain. He argues that protocols must balance scalability, security, and decentralization. The three aspects are mutually exclusive; if any two are overly emphasized, the third will inevitably suffer.

Thus, many believe that scalability may be achieved off-chain, while security and decentralization should be maximally optimized on the blockchain itself.

What Are Off-Chain Scaling Solutions?

Off-chain scaling refers to methods that support transaction execution without increasing the burden on the blockchain. On-chain protocols allow users to send and receive funds, but transactions do not immediately appear on the main chain. In this regard, we will explore two notable advancements: sidechains and payment channels.

Introduction to Sidechains

What is a Sidechain?

A sidechain is an independent blockchain that is not entirely separate from the main chain, existing in a connected manner to some extent. The main chain and sidechain can interoperate, allowing assets to flow freely between them.

There are several ways to transfer funds. In some cases, funds can be deposited into a specific address, transferring assets from the main chain to the sidechain. In this instance, the funds are not genuinely moved but are locked in the address, with the sidechain receiving the corresponding amount. A more direct method—potentially more centralized—involves sending funds to a custodian, which then facilitates the exchange of funds for the sidechain.

How Sidechains Work

Suppose Alice has five bitcoins and wishes to exchange them for an equivalent amount of currency on the Bitcoin sidechain (referred to as "sidechain coins"). The sidechain we are discussing is bi-directionally pegged, allowing users to transfer assets from the main chain to the sidechain and vice versa.

A sidechain is a distinct blockchain with different blocks, nodes, and validation mechanisms. To obtain sidechain coins, Alice must send her five bitcoins to another address. This address may belong to another user. Once the bitcoins are received, the address owner will credit Alice's sidechain address with five sidechain coins. Furthermore, this address may utilize a trustless setup, where software automatically credits the sidechain coins upon detecting the payment.

Sidechain Expansion

Once Alice converts her bitcoins into sidechain coins, she can also reverse the process and convert the sidechain coins back into bitcoins. After owning assets on the sidechain, she can freely trade on this independent blockchain. Similar to the main chain, she can send or receive sidechain coins from others.

For example, she might pay Bob one sidechain coin to purchase a hoodie from Binance. When she wishes to convert back to bitcoins, she can send the remaining four sidechain coins to a specific address. After the transaction is confirmed, four bitcoins will be unlocked and transferred to her address controlled on the main chain.

Why Use Sidechains?

You might wonder why sidechains are necessary. Can't Alice rely solely on the Bitcoin blockchain?

The answer is that sidechains may offer more functionalities than Bitcoin alone. Sidechains are carefully designed off-chain transaction systems. While Bitcoin is the most secure decentralized cryptocurrency, it is not the leader in throughput. Although Bitcoin transactions are faster than traditional methods, they are somewhat slower compared to other blockchain systems. A new block is mined every ten minutes, and during network congestion, transaction fees can significantly rise.

However, everyday small payments do not necessarily require such a high level of security. If Alice goes to buy coffee, she certainly does not want to wait for transaction confirmation. If the transaction is queued for confirmation, her coffee might already be cold.

Sidechains are not bound by these rules. They can even operate without using proof of work. Users can freely choose their consensus mechanisms, trust a single validator, or adjust various parameters. Sidechains can implement upgrades that the main chain does not support, generate larger blocks, and achieve faster settlements.

Interestingly, even if a serious error occurs on the sidechain, it will not affect the underlying chain. This allows sidechains to serve as experimental platforms to test features that should occupy a majority consensus within the network.

If users are satisfied with off-chain transactions, sidechains could represent a significant step toward effective scaling. Main chain nodes do not need to store all transactions from the sidechain. Alice can enter the sidechain with a single Bitcoin transaction, conduct hundreds of sidechain coin transactions, and then exit. To the Bitcoin blockchain, she has only executed two operations: one in and one out.

Introduction to Payment Channels

What Are Payment Channels?

Payment channels serve a similar function to sidechains regarding scalability, but they are fundamentally different. Like sidechains, payment channels separate transactions from the main chain to prevent unlimited expansion of the blockchain. However, payment channels do not rely on an independent blockchain.

Through smart contracts, payment channels enable users to transact without directly publishing these transactions on the blockchain. Participants can complete transactions using software protocols.

How Payment Channels Work

In the popular Lightning Network model, both parties first deposit tokens into a shared address. This is a multi-signature address, which requires the agreement of both parties to access the funds. Therefore, if Alice and Bob create such an address, the funds can only be moved with their mutual consent.

Suppose both of them deposit 10 bitcoins into this address; the balance would then be 20 bitcoins. They can easily confirm the initial balance, with Alice and Bob each holding 10 bitcoins. If Alice needs to transfer one token to Bob, she can update the ledger: Alice's balance becomes 9 bitcoins, while Bob's balance increases to 11. They can update their respective balances without having to publish the transaction on the blockchain.

After completing all transactions, suppose Alice holds 5 bitcoins and Bob holds 15. They can create a transaction to send these balances to their respective addresses, sign it, and broadcast it on-chain.

Alice and Bob can record dozens, hundreds, or even thousands of transactions in the ledger, but on the blockchain, they only need to execute two operations: one for the initial funding transaction and another for redistributing the balances after transactions are completed. Except for these two operations, all other transactions occur off-chain, incurring almost no fees and being completed nearly instantaneously. Both parties do not need to pay miner fees or wait for block confirmations.

Of course, the above example assumes that the transacting parties know each other and are closely cooperating, which may not be suitable for strangers. However, special mechanisms can be employed to prevent fraud, allowing even unfamiliar parties to transact securely.

Payment Paths

For users who transact frequently, payment channels are clearly more efficient and convenient. This method is continually being refined. The network of these channels can expand, enabling Alice to make payments to recipients with whom she has no direct connection. If a payment channel exists between Bob and Carol, as long as there is sufficient capacity, Alice can pay Carol through Bob’s channel. After Bob transfers funds into Carol’s channel, Carol can similarly transact with other participants.

This network structure will ultimately evolve into a distributed topology, where everyone can connect with multiple peer nodes. Users can freely choose the most effective path among numerous payment channels.

Conclusion

In this article, we discussed two scalability solutions, both of which facilitate transactions without increasing the burden on the underlying blockchain. Although sidechains and payment channels are not yet fully mature, an increasing number of users looking to avoid the drawbacks of base-layer transactions are beginning to adopt these technologies.

Over time, more users will join the network, making it crucial to maintain decentralization. To achieve this, the growth of blockchain capacity can be restricted, allowing new nodes to join at any time. Proponents of off-chain scalability solutions believe that as technology advances, the main chain may only handle high-value transactions in the future or serve solely for connecting/disconnecting sidechains and opening/closing payment channels.

Risk Warning

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