Let’s begin by clarifying what a layer one solution is, and what a sidechain is. After having done that, we will cover the interesting parts.
Like a lasagna, or even a tree. The trunk is in this case the layer one, and as you go up, you start seeing big branches, then smaller ones, and finally very little ones.
In this example, the biggest branches are the sidechains and other scaling solutions. These are also known as layer two solutions, the Lightning Network is a famous example of such a system. The smaller branches are the dApps, protocols and other systems based on the L2 solutions, and sometimes, directly based on the layer one.
Sidechains allow you to move assets from the main chain, the layer one, to another blockchain, a sidechain. In other words, they allow two blockchains to communicate with each other.
Essentially, a sidechain is an extension of a blockchain, like a branch of a tree.
When speaking about sidechains, the words source and destination are often used. Here is what they mean.
- The source is the blockchain about which the events are.
- The destination is the blockchain to which the events are communicated.
This is really important, because it defines how sidechains can be used.
Bitcoin can’t be a destination blockchain for example, because a destination can only be a blockchain which has smart contracts enabled. Though, Bitcoin can be a source. In other words: Bitcoin can communicate events to Cardano, but Cardano can’t communicate events to Bitcoin.
This system can be used in Atomic Swaps for example. A Cardano smart contract can « know » that a Bitcoin transaction took place. Thanks to that, you can create a mechanism where ADA is sent, only if Bitcoin was transferred in the first place.
This enables the creation of decentralized exchanges where users can exchange their BTC for ADA, with the advantage that it’s impossible for the counterparty to play unfairly by backing out of the trade.
The advantage being that it’s fully decentralized, it’s automatic, meaning that the company can just relax during the ICO, and for the investors, it allows to have a much better user experience, which ultimately results in raising more funds.
This mechanism is called the one-way peg.
But there is also the two-way peg, which enables cross-chain assets. Yes. You heard it well. Cross-chain, meaning you can send ADA on Ethereum, and use Ethereum-based dApps with ADA, and then send it back to Cardano.
This may seem like nothing, but it’s huge, because it opens the door to massive amounts of liquidity. In our current society, you can’t use the EURO in the United States. You have to use the USD. But here, it’s like if you were able to spend EURO, not only in the US, but everywhere: in China, in Mongolia, in South Africa,…
How it works? It’s pretty simple.
Let’s imagine Denicio has 50 ADA. He wants to use Sebastien’s sidechain, an incredibly scalable sidechain, made specifically for games.
- Denicio sends 50 ADA to an output address. Once the funds arrive in the output adress, they are locked, he will not be able to access them, at least currently.
- A few minutes pass, the same amount Denicio sent to the output address, 50 ADA, is released on Sebastien’s sidechain. Now, Denicio can use his 50 ADA to play games on a chain, which is completely different from Cardano.
- If Denicio wants to move back his funds, because he played the whole afternoon and he is a bit bored of Minecraft, it’s simply the same process. He sends the 50 ADA to an output address, waits a few minutes, and receives his ADA back on the Cardano mainnet.
But how can you just seamlessly move an asset from one chain to another? Good question. Well sidechains rely on something called federations. A federation is basically a group of servers which is going to act as a bridge between the main chain, and the sidechain. There is one problem: it adds another layer, which makes the user experience not horrible, but definitely not great when moving an asset to a sidechain.
There are some interesting things in regards with sidechains. One of them is that sidechains take care of their own security. If there is a problem with a sidechain, like a hack for example, it will not affect the main chain. This also works the other way around.
It’s a really interesting concept, because sidechains allow developers to access an enormous amount of potential users (on the layer one), while not being dependent of the main chain in terms of security. In other words, you get the benefits without the downsides.
Though, as a developer, you have to take care of the security of the sidechain, which means either finding people who are wanting to act as miners on your chain, or having some kind of proof of stake mechanism, but which also requires entities and a real community. Another way of doing things, is to use a concept called merged mining.
With merged mining, miners of the main chain mine your cryptocurrency to. The problem in regards with that, is that it makes the network very centralized, because if the main chain collapses, all these sidechains using merged mining will also collapse.
In short: you either have to be willing to create a whole community around your project to make sure your network is secure enough, or you have to take risks and rely on the main chain.
Cover the practice? Really? Well, here is how sidechains can be used in Cardano. The technology behind sidechains is actually literally part of the system behind Cardano, which exists of two different blockchains.
- Cardano SL, which is the Settlement Layer. This is where all the payments are done, and, in contrast with the Computation Layer, the SL is « dumb », there aren’t a lot of features, and it has very small codebase. Your funds are kept here for safety.
- Cardano CL, which is the Computation Layer. This is where all the smart contracts are being executed, and where Cardano differentiates itself from something like Bitcoin for example. User funds are kept here temporarily to use smart contracts.
Again, these are two different blockchains, constantly communicating with each other. The advantage is that, if the CL fails for some reason, because of a hack for example, your funds are still safe, because they are on the SL.
There are two very important things to know about the Computation Layer:
- Cardano CL has kind of its own cryptocurrency, because it uses a currency called ADA-20, but which is the equivalent of ADA.
- The Computation Layer is a sidechain for the Settlement Layer, it’s not a standalone blockchain.
On Cardano, developers will be able to create sidechains which replicate current “traditional systems”, meaning having a permissioned blockchain for example. This will allow governments, and other entities to participate in the Cardano ecosystem, while not giving away their regulatory power.
Developers have been creating a lot of sidechains recently, and this should continue to increase in the future, even exponentially. Bitcoin for example, has Rootstock and Liquid, Ethereum has POA Network, without even speaking of Tron, which has its famous “Sun Network”. In the case of Bitcoin for example, Rootstock allows developers to create smart contracts and have a higher scalability for their dApps, while still being part of the Bitcoin ecosystem. Here is a little overview of the following three major sidechains: Rootstock, Liquid and POA.
- Rootstock, also called RSK, is an open source smart contract platform with a two-way peg to Bitcoin. It uses merged mining, allowing Bitcoin miners to be part of the RSK ecosystem, while still mining Bitcoin. The idea behind Rootstock is to expand the use cases of Bitcoin, by having smart contracts, and offering a higher scalability. By having a cryptocurrency pegged to Bitcoin, called RSK Smart Bitcoin (RBTC), Rootstock does not compete with Bitcoin.
- Liquid, a sidechain made by Blockstream, is a payment system for traders and exchanges, which enables faster, and more confidential Bitcoin transactions. Besides, Liquid also allows the issuance of digital assets.
- POA is an Ethereum-based sidechain using a consensus called proof of authority. The idea behind it is to provide a cheap, fast and secure platform for smart contracts. POA has an impressive block time of five seconds, and creating these blocks doesn’t require mining.
To conclude, it’s fair to say that sidechains have a bright future. They offer greater scalability, and sometimes also security, than most traditional blockchains.
Source: Crypto New Media