What is a sidechain in crypto?

The idea of a sidechain first emerged in 2014. In a research paper, HashCash inventor and Blockstream CEO Adam Beck, along with fellow co-founder Mark Frindebach and Bitcoin engineers Matt Corallo and Luke Dashr, described ways to improve Bitcoin’s blockchain platform; they understood that it could still be improved so that Bitcoin could serve a global audience.

Researchers noted that Bitcoin’s infrastructure constantly had to compromise scalability and decentralization. And there were also concerns about possible censorship and leakage. A tool was needed to engage more users to accept bitcoin (BTC).

What is a sidechain?

A sidechain is a mechanism for securely leveraging various digital assets from one blockchain into another blockchain. Sidechain significantly extends the functionality of already existing blockchain platforms. In addition, sidechains help improve the efficiency of Layer 1 blockchains. For example, Bitcoin and Ethereum networks are unable to process a large number of transactions at a low cost. Sidechain is a type of Layer 2 protocol and takes some of the load off of overloaded Layer 1 blockchains. This includes Bitcoin and Ethereum.

Layer 1 is the underlying blockchain network and its underlying infrastructure. Layer 1 blockchain can confirm and terminate transactions without using another network.

Layer 2 is a secondary structure or protocol on top of Layer 1 of the blockchain. These protocols are needed to increase the speed of transactions, improve scaling, and so on.

How do sidechains work?

There are two of the most common kinds of sidechains: those with two independent blockchains and those where one is dependent on the other. In the first case, both are equal, but sometimes both blockchains have their native token. The first is treated as the primary and the second as a branch. Usually, the child chain does not create its assets and receives them through transfers from the parent chain.

Sidechains can interact in different ways. But they almost always support the function of exchanging assets between chains. Two-way binding is used for this purpose. For example, if BTC is to be exchanged for ETH, the exchange occurs through a BTC-ETH pair. With a traditional centralized exchange, a central trusted party takes care of this. And it results in a mediation fee and risk to the third party.

In the case of a decentralized two-way bind works by “lockboxes” on both blockchains. For example, if you need to transfer 1 BTC from the Bitcoin network to a sidechain. First, you need to move 1 BTC to a lockbox address in the Bitcoin blockchain. Then, any BTC in the box is effectively removed from the total Bitcoin supply at the current moment. At the time, information about the sidechain address to which 1 BTC will be sent is specified. Once the transaction is received by the Bitcoin network and added to the blockchain, the sidechain blockchain releases 1 BTC. It sends it to the address specified in the Bitcoin network transaction. All of the above moves are made in reverse order to send the BTC in reverse order.

The cryptocurrency world’s system of moving assets from one chain to another and back again through two-way pegging (or shortly peg) is commonly referred to as a bridge. Assets can also be exchanged — for example, BTC to ETH. The architecture of bridges can be different.

Smart contracts

To make a digital asset transfer between a sidechain and its main network (mainnet), an off-chain process is needed to transfer data between the two blockchains. In this process, assets are blocked and released at either end of the two blockchains after the confirmation of the transaction using a smart contract. Smart contracts help remove the risks of foul play and confirm inter-chain transactions. Once a transaction has occurred, the smart contract notifies the mainnet. Smart contracts help remove the dangers of foul play and ensure inter-chain transactions. Once a transaction has occurred, the smart contract notifies the mainnet.

Transaction information is then passed to the smart contract on the sidechain off-chain, verifying the transaction. The funds can then go to the sidechain. So users can transfer digital assets over both blockchains. This can go from mainnet to sidechain or the other way around.

Pros and cons of sidechains

Advantages

• Sidechain technology is well developed, with continuous research and improvements.
• Sidechains are needed to support shared computing and compatibility with Ethereum Virtual Machine (EVM) because Ethereum-native dApps can run on them).
• Different consensus model sidechains allow for efficient transaction processing and lower user fees.   
• EVM-compatible sidechains enable the expansion of the dApps ecosystem.

Disadvantages

• The convenience of a sidechain comes at the cost of reduced decentralization in exchange for better scalability.
• Sidechains have their consensus mechanism and are not subject to Ethereum’s security guarantees.
• Sidechain needs better trust prerequisites (e.g., a quorum of sidechain validators can commit fraud).

Federations

It is essentially a group that acts as a link between the main chain and one of its sidechains. The task of federations is to determine when assets used by a user will be blocked and unblocked. The sidechain makers can choose the federation members. But the problem is that federations are another +1 level between the main chain and the sidechain.

Sidechain security

Sidingchains handle their security. If there is a shortage of mining power, the sidechain can be hacked. But such an attack would only damage it, not the main chain. And if the main chain is hacked, the sidechain will continue to function, though the peg will lose most of its worth.

They need test sidechains for their miners. They are attracted by the possibility of “pooled mining,” where two different ones can be mined simultaneously, provided they are based on the same algorithm.

Current sidechain platforms: top-5

1. Rootstock (RSK) has created an open-source test network for its sidechains. It is called Ginger and is bilaterally linked to the Bitcoin blockchain, offering rewards to miners for pooled mining. RSK aims to achieve the Bitcoin blockchain’s ability to work with smart contracts and make payments faster.

2. Ardor’s business service platform uses the Proof-of-Stake consensus mechanism. The company’s developers call the sidechains “child chains” and are integrated into the main chain. Ardor’s main blockchain stores all transactions and provides the necessary safety protocols.
3. Liquid is the inter-exchange settlement network of cryptocurrency exchanges and institutions worldwide. It makes Bitcoin transactions and digital asset issuance faster. Blockchain Liquid is designed for market makers, exchanges, and brokers. Users can tokenize fiat currencies, securities, and even other cryptocurrencies. A federation of functionaries manages Liquid’s bindings and consensus. The Liquid sidechain has a native token, LBTC.
4. Plasma enables the enforcement of highly scalable smart contracts with state updates per second (potentially billions), allowing the blockchain to serve a large number of decentralized financial applications around the world. These smart contracts are incentivized to continue to operate autonomously through transaction fees on the network (this depends on the underlying blockchain) to provide transactional state transitions. Plasma is also suitable for providing economic stimulus for globally persistent data services (a potential alternative to centralized server farms). Plasma also allows for the exiting of broken chains and creates mechanisms to stimulate and oblige further valid execution of the data.
5. Alpha functions as a sidechain to the Bitcoin testnet, although the binding mechanism works through a centralized protocol adapter. Its operation is based on a verifiable federation to manage testnet coins transmitted to the sidechain through the “Deterministic Pegs” element and to produce blocks through the “Signed Blocks” element. This way, you can quickly explore the possibilities of the new chain.