Table of contents:
Introduction
Three challenges of scaling Blockchain
What are off-chain scaling solutions?
Introduction to sidechains
What is a sidechain?
How does a sidechain work?
Why are sidechains used?
Introduction to payment channels
What are payment channels?
How do payment channels work?
Payment routing
Conclusion
Introduction
Scalability is the ability of a system to grow to meet the increasing demand for transactions. With computers, you can enhance performance by upgrading hardware to execute some tasks faster. When it comes to scalability in blockchains, we are talking about increasing the capacity to process many transactions simultaneously.
Protocols like Bitcoin have many strengths, but scalability is not one of them. If Bitcoin were a centrally managed database, it would be easy to increase the speed and throughput of the network. But Bitcoin's value propositions (censorship resistance) require many participants to synchronize a copy of the blockchain.
Three challenges of scaling Blockchain
Running a Bitcoin node is relatively cheap, and even simple devices can do it. But because thousands of nodes need to update each other, there are certain limitations to their capacity.
The chain has a limited capacity to process transaction volumes so as not to allow the database to grow to an unwieldy size. If transactions are too large and too fast, nodes will not be able to keep up. Moreover, if the blocks are too large, they cannot be quickly forwarded through the network.
As a result, we find ourselves facing some kind of bottleneck. A blockchain can be seen as a train service departing at scheduled times. Each carriage has a limited number of seats, and to get a ticket, passengers must bid to secure a seat. If everyone tries to board the train at the same time, ticket prices will be high. Similarly, a congested network with pending transactions will require users to pay higher fees for their transactions to be processed.
One solution is to make the carriages larger. This means more seats, higher throughput, and lower ticket prices. But there is no guarantee that the seats won’t fill up as before. Carriages cannot be permanently expanded, just as blocks or block gas limits cannot expand indefinitely. The second issue is that maintaining the sole nodes on the network will be more expensive, as they will require more expensive hardware to remain synchronized.
The creator of Ethereum, Vitalik Buterin, has outlined 3 Scalability Trilemma issues to describe the challenges that blockchains face. He hypothesized that protocols must always trade off between scalability, security, and decentralization. These always conflict with each other – focusing too much on two of the properties will diminish the third property.
For this reason, many consider scalability to be something to achieve off-chain, while security and decentralization should be maximized on the blockchain itself.
What are off-chain scaling solutions?
Off-chain scaling describes approaches that allow transactions to be made without bloating the blockchain. Protocols that connect to the chain allow users to send and receive funds without transactions appearing on the main chain. We explore the two most notable solutions on this front: sidechains and payment channels.
Introduction to sidechains
What is a sidechain?
Each sidechain is a separate blockchain. However, it is not an independent platform, as it is linked to the main chain in some way. The main chain and sidechain can interact with each other, meaning that content can flow freely from one blockchain to another.
There are several ways to ensure that funds can be transferred back and forth. In some cases, assets are moved off the main chain by being sent to a special address. They are not actually sent away – instead, they are locked into this address, and a corresponding amount is released on the sidechain. A simpler (though centralized) option is to send funds to a custodian, who will exchange the escrowed funds for money on the sidechain.
How does a sidechain work?
Suppose Alice has five bitcoins. She wants to exchange them for five equivalent units on a Bitcoin sidechain – let’s call them sidecoins. The mentioned sidechain uses a two-way peg, meaning users can transfer their assets from the main chain to the sidechain and vice versa.
Remember that a sidechain is a separate blockchain. Therefore, it will also have blocks, nodes, and validation mechanisms. To get her sidecoins, Alice will send her five bitcoins to another address. The recipient will then add these 5 sidecoins to her address after receiving the bitcoins. Additionally, it might have some setup to increase reliability - software automatically adding sidecoins after detecting the payment transaction.
Alice has now converted her funds into sidecoins, but she can always reverse the process to get her bitcoins back. Now that she has joined the sidechain, she can freely trade on this separate blockchain. She can send or receive sidecoins from others, just as she does on the main chain.
For example, she could pay Bob one sidecoin for a Binance jacket. When she wants to get her Bitcoin back, she can send her remaining four sidecoins to a special address. After the transaction is confirmed, four bitcoins will be unlocked and transferred to the address she controls on the main chain.
Why are sidechains used?
You might wonder what the purpose of this is. Why doesn’t Alice just use the Bitcoin blockchain for convenience?
The answer is that sidechains can have features that the Bitcoin blockchain cannot provide. The blockchain is a carefully designed exchange system. Although Bitcoin is the most decentralized and secure cryptocurrency, it isn’t the best blockchain in terms of throughput. While Bitcoin transactions are faster than traditional methods, they are still relatively slow compared to other blockchain systems. Blocks are mined every ten minutes, and fees can rise significantly when the network is congested.
It must be acknowledged that small daily payments may not require this level of security. If Alice needs to pay for a cup of coffee, she cannot wait for this transaction to be confirmed. She will have to stand in line, and her drink will be cold by the time it is delivered.
Sidechains are not bound by the same rules. In fact, they don’t even need to use a Proof of Work consensus mechanism to operate. You can use any consensus mechanism, trust a single validator, or any number of validators. You can add upgrades that do not exist on the main chain, create larger blocks, and ensure that execution is done quickly.
Interestingly, even if a sidechain has serious bugs, they do not affect the underlying chain. This allows them to be used as a platform for testing and deploying features that do not require consensus from the majority of the network.
As long as users are satisfied with the trade-offs, sidechains are an efficient way to scale blockchain. Nodes of the main chain do not have to store every transaction from the sidechain. Alice can join the sidechain with a Bitcoin transaction, conduct hundreds of sidecoin transactions, and then exit the sidechain. In that process, for the Bitcoin blockchain, Alice only needs to perform two transactions – one to enter and one to exit.
Ethereum's Plasma operates similarly, but there are some significant differences. Learn more: What is Ethereum Plasma?
Introduction to payment channels
What are payment channels?
Payment channels serve as a secondary channel to help blockchains scale – similar to sidechains, but fundamentally they are quite different. Like sidechains, payment channels push transactions off the main chain to prevent blockchain bloat. However, unlike sidechains, they do not require a separate blockchain to operate.
A payment channel uses smart contracts to allow users to transact without publishing their transactions to the blockchain. It does this by using an agreement enforced by software between two participants.
How do payment channels work?
In popular models like the Lightning Network, two parties will first send funds to an address they jointly own. This is a multi-signature address that requires two signatures to spend the funds. So, if Alice and Bob create such an address, the funds can only be moved out with the consent of both.
Suppose each person sends 10 BTC to an address, and that address now has 20 BTC. It will be easy for them to keep a ledger that states that Alice and Bob each have 10 BTC. If Alice wants to give Bob one coin, they can update it to reflect that Alice has 9 BTC, Bob has 11 BTC. They do not have to publish to the blockchain even as they continue to update these balances.
However, at a suitable point, suppose Alice has 5 BTC and Bob has 15 BTC. They can create a transaction sending these balances to addresses owned by the parties, sign it, and write it to the blockchain.
Previously, Alice and Bob may have recorded ten, a hundred, or a thousand transactions on their ledger. But for the blockchain, they only perform two operations on-chain: one for the initial deposit transaction and one to allocate the balance when all transactions are complete. Aside from these two transactions, all other transactions are free and occur almost instantly as they are executed off-chain. There are no fees to be paid to miners, and no block confirmations need to be performed.
Of course, the example discussed above requires both parties to cooperate, which is not an ideal situation if they are strangers. However, special mechanisms can be used to penalize any fraudulent attempts, allowing the parties to interact securely without the need for trust.
Payment routing
Clearly, payment channels are a convenient tool when two parties have high transaction volumes. Additionally, they have other advantages. A network of these channels can be divided into multiple parts, meaning Alice can pay a party with whom she has no direct connections. If Bob has an open channel with Carol, Alice can pay her provided there are sufficient funds. She will push funds towards Bob's channel, and Bob will in turn push them to Carol. If Carol is connected to another participant, Dan, the same can be done.
Such a network evolves into a decentralized linked structure where individuals connect with multiple peers. There will often be multiple routes to a destination, and users will choose the most efficient route.
Conclusion
We have discussed two approaches that help increase the scalability of blockchain, allowing transactions to be executed without burdening the main blockchain. Both sidechain technology and payment channels are not yet fully mature, but they are increasingly being adopted by users looking to address the shortcomings of layer-one transactions.
In the future, as more users join the network, it will be important to maintain decentralization. This can only be achieved by creating limits on the growth of the blockchain, so that new nodes can easily join. Proponents of off-chain scaling solutions believe that over time, the main chain will only be used to settle high-value transactions or to peg in/out of sidechains and open/close payment channels.
