The importance of Sidechains

Ciao from Venice!

Let’s discuss one of the most important topics for the future of blockchains: sidechains and scaling solutions.

As you’re probably aware: A blockchain classically consists of a chain of blocks. This chain is usually called the mainchain. It links the individual blocks so that a blockchain is created. In addition, there are the so-called sidechains, which run next to the mainchain. They are, so to speak, branches of the mainchain. This means that they can exist relatively autonomously next to the mainchain.

For this, it is necessary that tokens are “transferred” from the mainchain to the sidechain. After all, it should not be possible to output these tokens twice. Instead, the tokens are “marked” so that they are (temporarily) no longer processed on the mainchain. The sidechain represents a black box. This means that many independent transactions can take place in this black box without the entire network being aware of it. Because this only reads the mainchain and does not see what happens in the background on the sidechain.

A bank example

To explain the principle, let us start with an example from the banking world that we are all familiar with. A bank offers cash and virtual money in its accounts. If the money moves in the form of a bank transfer, then this transfer is recorded by the bank. It is therefore visible.

However, it is also possible for us to make a payment of 100 dollars. When we use it to buy products, we pass this cash on to other people who in turn use it for their own purchases. This process happens quite often, so many transactions take place in our imaginary cash system. At the end of our experiment, all participants return their cash to the bank.

This is an interesting phenomenon: The amount of cash has not changed, only the distribution. And although many networked transactions have taken place, the bank ultimately only sees the closing balances of our individual persons.

So let’s get back to the blockchain: the situation is quite similar with a sidechain, since the tokens are transferred to a sidechain and are therefore in a black box.

What are the advantages of sidechains?

A sidechain can define its own rules. For example, a sidechain can use a different consensus algorithm (e.g. proof-of-work) than the mainchain. This allows flexibility within the network and at the same time the possibility to relieve the mainchain. On the sidechain, transactions within the sidechain can be executed largely independently of the mainchain — so not all users are aware of it.

If a normal Bitcoin transaction is sent, it is processed by all participants in the network and is therefore visible to them. This leads to capacity problems with large transaction volumes. If, on the other hand, a sidechain is used, the Bitcoin network would be relieved in this case.

What types of Bitcoin sidechains are there?

Custodian — The Monitor

The so-called custodian is a central party that reserves the tokens. You send the bitcoin to this custodian, who in turn holds it in his possession and ensures that it cannot be output on the mainchain. The disadvantage of this approach is that the custodian is trusted to monitor the frozen coins.

Federation — The Sidechain Panel

Instead of placing trust in only one hand — as with the custodian — a federation can alternatively be formed. For this purpose, access to the frozen tokens is granted via a multi wallet. This means, for example, that there are three keys. At least two of them are needed to open the treasure chest with the tokens. If the keys are given to (e.g.) three persons, two of three persons have to agree to release the tokens.

SPV Sidechain — The automated check

The sidechain variant that Blockstream describes in the official sidechain white paper is a so-called SPV sidechain. This requires so-called SPV proofs (simplified payment verification proofs). The technical term means that based on cryptography with only a few required data it can be checked whether a transaction is contained in a block. If this condition is met, the tokens are transferred.

Drivechain

In a drive chain, the miners are involved in the decision process for transferring the tokens. Actually, they are the custodians (see above) about the transferred tokens — so they can release them again on the mainchain. The Drivechain is based on the idea that the monitoring of funds by Miner is less dangerous than using a centralized custodian.

Hybrid Models

Of course, the individual variants can also be combined — the hybrid model of a sidechain is no different. RSK Labs, for example, has investigated a concept that combines the drivechain idea with a federation. Put simply, both the miners and the individual members of the federation can use their keys to decide on the transfer of the tokens.

Lisk — a sidechain network by nature

Lisk is a project that was developed with a special focus on sidechains and wants to use the advantages of capacity relief and the possibility to develop dApps off the mainchain.

Are sidechains Layer 2 scaling solutions like Lighting Network and Plasma?

Sidechains are second-layer solutions. Essentially, the phrase “second-layer solution” is a euphemism for security-reduced transaction scaling tech.

Lightning Network is a way of caching bitcoin payments through multisig HTLCs. It promises to dramatically boost transaction capacity of Bitcoin-like systems.

Sidechains are alternative blockchains pegged to a mainnet blockchain. The peg promises to expand the capabilities of an underlying cryptocurrency like BTC, e.g. Rootstock is bringing Ethereum tech to the BTC currency unit.

Both Lightning Network and sidechains make major security tradeoffs compared to normal mainnet transactions. For example, you can lose all the money you have on LN if your counterparty defrauds you and you’re unable to take the required on-chain countermeasures in time to avert financial loss.

Meanwhile, you can lose all the money you have in “cold storage” on a sidechain if the peg breaks down; this peg will break in RSK should trusted third parties in charge of the peg abscond with the money (exit scam), and will break under future SPV security models in the event of a 51% attack.

So, there’s obvious pros and cons of sidechains that should not be ignored. As they become the catalyst for how blockchains grow and scale, it will be increasingly important for us to understand their direction and developing impact.