As challenges with on-chain blockchain scaling solutions have grown, the need to explore and design alternative off-chain solutions has also grown. Developers in the crypto space are determined to match the capacity of centralized services such as Visa, while offering a better experience for users, at lower costs.
State channels, sidechains and plasma are among the most talked about second-layer or off-chain blockchain scaling solutions in 2018. They are being widely implemented in various projects, including Bitcoin, Ethereum and Litecoin.
Taking a closer look at capacity issues experienced by major blockchains helps us appreciate the focus on these three solutions. Blockchain technology is disruptive, but its potency has been limited by the ability to handle a significant amount of activity.
The urgency for blockchain scaling becomes more pressing as the technology goes beyond value transfer and takes on the role of operating as back end for decentralized applications (dapps). Over time, it has become possible to host anything from a website to a video-streaming service on the blockchain.
In the early days, blockchain scaling efforts focused on increasing the size of the block—a collection or batch of transactions confirmed together. The sequence of blocks connected to one another forms the blockchain.
The Bitcoin block size has been maintained at 1 MB. This capacity allows it to process about seven transactions per second. The Ethereum blockchain can process about twelve. In comparison, Visa can handle a capacity of 50,000 transactions per second. Increasing the block size means that more transactions can be included and therefore confirmed.
Blockchain scaling attempts based on increasing the block size have included Bitcoin XT, which sought to increase the size to 8MB. Bitcoin Classic proposed a 4MB limit and Bitcoin Unlimited offered a flexible block size that depended on demand.
One such demand-based solution is Bitcoin Cash, which forked from Bitcoin in August 2017.
Other challenges in blockchain scaling
Increasing the block size has largely failed as a blockchain scaling solution because it requires wide community consensus on specific technical changes.
Bigger blocks also come with other challenges. They demand more capacity and resources from users and especially miners, who are directly involved with maintaining the ledger. Such resources come in the form of memory, which is needed for storing the shared ledger, and bandwidth for propagating it across the network. Both the Bitcoin and Ethereum ledgers have reached close to 150GB in size.
This means only a few players will have the financial capital necessary to set up systems for mining. This leads to increased centralization, which goes against the original spirit of blockchain.
Off-chain blockchain scaling alternatives include the Lightning Network, sidechains and plasma.
The Lightning Network
Developers Joseph Poon and Thaddeus Dryja originated the concept of the Lightning Network. They published a white paper in 2015 that provided details of how it could help blockchain scaling.
The Lightning Network provides the capacity to process more transactions through smart contract applications. Two or more users can create a transaction channel between them, known as a state channel, which allows them to send value back and forth without having to record each individual transaction on the blockchain.
When they close the state channel, only then does the net of all their transactions get recorded on the blockchain. The Lightning Network allows millions of channels to be created on the Bitcoin network, thus enabling millions of transactions per second, a capacity well beyond that of Visa.
The solution has already been implemented for several blockchains, including Bitcoin and Litecoin. Its use is not yet widespread and it may take time before there is enough infrastructure for its use to go mainstream.
Another option is the ability to create sidechains, or new blockchains that connect to existing ones. A team of Bitcoin Core developers from Blockstream introduced this concept in a white paper they published in October 2014.
Sidechains allow value to move between them. For example, a new blockchain can be created and linked to the Bitcoin blockchain. Users can move their bitcoins to the new chain and transact as they would on the original blockchain.
With many sidechains, the capacity to use a cryptocurrency increases significantly. Community consensus is not needed to add new sidechains.
To link two chains, a two-way pegging mechanism is used. A user sends coins to a special wallet on the main chain, where they are locked. Then, the same number of coins is created on the new chain and released to the user. When they want to move back to the old chain, the process is reversed.
The two-way pegging mechanism can be achieved through a centralized exchange, which stands as an entity between two chains, receives coins from one and releases an equivalent amount of coins on the other. This option is not desirable, however, since it introduces a single point of weakness and requires users to trust a third party, which also goes against the spirit of blockchain.
Two-way pegging can also be implemented through a federation, a group of miners that facilitate the movement of value between two chains through consensus. This option provides an improvement upon relying on a single player.
Simple Payment Verification (SPV)
The most ideal solution, however, is known as simple payment verification (SPV). Here users rely on a protocol to automatically lock their coins on one chain and generate a special ID. This ID proves to the new chain that they have sent their coins to a locked wallet and that their transaction is confirmed as genuine on a specific blockchain.
The new chain is then able to release an equivalent amount of coins to the user.
In sidechain architecture, blockchains that are linked are considered equal and there is no hierarchy. Moreover, when one blockchain has issues, the problems do not spread to the others. Problems are localized and confined.
While this solution is largely beneficial, it does provide a challenge. If one chain fails, the user is not able to move their funds back because there is no ultimate authority on which they can rely to execute the process.
In August 2017, Vitalik Buterin, the co-founder of Ethereum, and Joseph Poon, the designer of the Lightning Network, published a white paper. They described a new way to interlink blockchains through smart contracts. They named the architecture Plasma. The interlinked blockchains were to be placed in a hierarchy so that some were on top and therefore more authoritative than others.
Parent blockchains launch child blockchains. A child blockchain can also launch their own child blockchains.
Poon described the structure as similar to that of a court system. The lower level has many courts, while the higher levels have fewer. At the highest point is the supreme court.
Lower courts handle the bulk of the cases. The supreme court handles only what the lower courts cannot solve, or they give direction to the lower courts on how to solve cases.
The main parent blockchain is only consulted when disputes arise among child blockchains. This main blockchain is the ultimate truth source of the system and also facilitates the sharing of data and digital value in the system running on top of it.