While perusing the internet for the pros and cons of cryptocurrencies, one of the primary concerns that isn’t related to a lack of regulation, fraud, high volatility, and an inherent lack of value related to computer code, is its scalability.
Scalability in economics implies that a company can increase sales given increased resources. In programming, it’s mostly the same but is a little different. Scalability, in regards to cryptos, is that the system handles more work by adding more resources. This is important as a network’s ability to handle more transactions per second (TPS), with lower fees, is key to its adoption.
For example, Ethereum networks can only handle about 30 TPS because of the current Proof of Work model, which is significantly lower than the thousands of TPS that credit card companies can handle. Proof of Work pits miners against each other in a race to solve a complex mathematical equation where the first to solve it gets to verify a transaction and earn a reward. This clogs up transactions and results in high fees. For ETH, this can result in more than $20 in fees just to bump your place to the front of the line to be able to immediately send your friend $1 in ETH.
This is a massive flaw to Proof of Work blockchain projects as dApps and other projects that exist on the Ethereum, Bitcoin, or another blockchain inherits and contributes to this issue.
A great example of this is how the popular NFT project CryptoKitties jammed up the Ethereum blockchain as people rushed to buy the cartoon cats.
Thankfully for the alleged future of finance, there are a lot of projects being created that are helping to boost transactions per second capability while lowering gas fees and maintaining blockchain-worthy security. These solutions – which are referred to as layer-two scaling solutions – can be application-specific or they can have a wide reach. But before we can get into the scaling solutions, we should understand the trilemma which burdens blockchain developers.
The Blockchain Trilemma and Scaling Solutions
The “Blockchain Trilemma”, which was coined by Vitalik Buterin, recognizes that there are often trade-offs made in the pursuit of creating a blockchain that is decentralized, scalable, and secure.
This isn’t a set-in-stone law, where a move to increase security takes from scalability or decentralization, but it is a conundrum that has raised several red flags for widespread blockchain adoption.
Security and decentralization are the primary marketing points of most blockchain projects, so the original host chains like Ethereum are keen on getting those parts right.
With opportunity and demand for scaling, third-party blockchains have started finding creative scaling solutions that utilize the host blockchain’s audience and security. This often comes with a little more centralization, but we will get to that later.
Currently, the most well-known scaling methods are sidechains, rollups, and channels.
Sidechains are blockchains that exist on a host blockchain. A great example of this is Polygon (MATIC) which is a side chain and scaling solution on the Ethereum blockchain.
Sidechains are connected to the host blockchain via a two-way peg where necessary information is communicated with the host chain. Sidechains sacrifice some security for faster transaction speeds by being more centralized. Sidechains must offer their own security, and can actually run on Proof of Stake and Proof of Work consensus models.
Sidechains lock up currency on the main chain and release it onto the sidechain. This allows transactions to occur on the sidechain without the reproduction of coins. This also makes it so that the sidechain’s validators or miners can approve transactions on the sidechain.
Here is where the centralization comes in: the so-called federation is tasked with monitoring and ensuring that the assets locked up on the main chain are always exactly equal to the assets released in the sidechain. This can be computerized, but it is often managed by the sidechain’s organization.
The transactions on the sidechain get validated by the stakers or miners and updated on the sidechain. This allows the sidechain to complete transactions related to the main chain, but without contributing to the main chain’s backlog. The sidechain can occasionally communicate with the main chain through other scaling methods to ensure the main chain has a complete copy of its ledger.
In sum, Sidechains are basically blockchains within a blockchain that are made to boost scalability and decrease fees. For those looking to explore and invest in sidechains, Rootstock and Polygon are two of the most popular sidechains out there. Rootstock brings smart contracts and other Ethereum-like applications to the Bitcoin blockchain, while Polygon lowers transaction costs and boosts TPS on the Ethereum blockchain.
In addition to sidechains there exist rollups, particularly Zkrollups and Optimistic rollups. On a technical level, these are very complicated. But at a high level, rollups combine a bunch of transactions into one single transaction.
Now, there is a ton of demand for this kind of solution as existing blockchains try to handle increased demand. This demand, Polygon and others believe, will be monetized and has led the project to have dreams of being an open-source aggregator of scaling solutions, similar to AWS.
This led to Polygon acquiring the popular rollup solution Hermez for $250 million, which was the first token merger in crypto history. Similar to a company acquiring another through an all stock transaction, all “HEZ” tokens were acquired by Polygon.
Channels can be thought of similarly to how the exchange of money currently works.
When you Venmo a friend $20 for dinner, the twenty doesn’t get thrown in an envelope, mailed to your friend’s bank, and then appear in their statement. Rather, the money doesn’t really move from coffer to coffer, it just gets recorded as if it did.
Channels allow you to lock your crypto up and then using code, the channel makes sure that you can only send what you have via virtual Bitcoin, or some other crypto. You can send the virtual Bitcoin back and forth with your friends on the Lightning Network – or any other channel – until you decide to liquidate from the channel. A block is not created on the Bitcoin blockchain until you liquidate, which will result in one block being made, instead of there being one per transaction.