The 2023 Guide to Sidechains in Crypto Trading

Blockchain technology in the mainstream can be traced back to the legendary Satoshi Nakamoto’s creation of Bitcoin as a peer-to-peer electronic currency that anyone can use.

It has since become so much more, and some of the most crucial developments on a technological level have targeted blockchain scaling, with solutions ranging from rollups to sidechains.

Many early blockchains, including Bitcoin’s many forked derivatives, were intended to function primarily as currencies. On the other hand, modern blockchains function more as ecosystems or development platforms.

What both sorts have in common is the need to be able to process a significant number of transactions.

Transactions per second (TPS) is the performance characteristic that blockchains tend to be held up to when judging their suitability to disrupt traditional centralized systems. In terms of payments, Visa and Mastercard are the gold standards. For programmable blockchains like Ethereum, the bar is even higher.

So, how do sidechains help solve the problem of blockchain scale? Read on to find answers to this question and more!

What is a Sidechain?

A sidechain is a blockchain in and of itself that runs independently from other blockchains. However, it is connected to the blockchain it wants to help scale in some way, usually via a two-way bridge.

Sidechains can have very different logic from the blockchains they attempt to help scale, known as a “parent blockchain” or “mainnet.” In fact, most sidechains tend to feature more efficient, faster consensus algorithms to take over much of the processing workload.

This approach has tradeoffs, generally when it comes to decentralization or security. The blockchains that actually need help scaling, Bitcoin and Ethereum, refuse to compromise on either. This is called the “blockchain trilemma,” since speed/scalability are hard to assure when refusing to trade away security or decentralization.

Both Ethereum and Bitcoin are built with security and decentralization at the forefront, so scalability has to give way. That’s why so many scaling solutions exist, from the sidechain solution featuring a separate chain to solutions layered atop the parent chain itself.

How Does a Sidechain Work?

The main function of a sidechain is to transfer assets between themselves and the mainnet in a frictionless, efficient, and secure manner. This allows the entire crypto ecosystem to expand and allows developers to build decentralized applications without worrying about end users suffering in terms of speed and cost.

In the case of Bitcoin, transactions sent to various addresses require confirmation before they are broadcast to the entire network. Following a security check, the funds sent via these transactions can be moved onto the sidechain. This frees users up to move their assets around on the sidechain quickly and at a low cost.

One of the main innovations that makes this possible is the two-way peg or bridge. This is a mechanism by which coins are transferred between chains using a virtual transfer mechanism. What this means is that coins don’t actually move on the mainnet—they’re frozen in place on the mainnet but are unlocked and can be transferred on the sidechain.

This process is facilitated by smart contracts. These are pieces of code that execute certain actions when specific conditions are met, and they are the reason why blockchains are so powerful as technology platforms.

Smart contracts are used to build the processes that allow sidechains to work in the manner they do, locking tokens on parent chains, unlocking them on side chains, and vice versa. As long as they’re coded properly and well-audited, the only way to compromise this system is to take over network validators with an attack on either blockchain.

The Potential of Sidechains

Sidechains are extremely efficient solutions for adding scalability to a mainnet that is seeing increasing adoption and use but may not be able to handle the required demands. However, there’s more than one way to skin a cat.

As mentioned, sidechains are independent blockchains that connect to a parent chain via a two-way bridge. There are other solutions, called layer 2s, which are blockchains that extend the mainnet but are not completely independent. These networks form additional layers atop the parent chain and use the mainnet’s consensus, hence their name.

Currently, the preferred layer 2 for scaling tends to be the “rollup method.” Rollups bundle hundreds of transactions into a single mainnet transaction by executing them off-chain. This increases speed and reduces cost since the gas for the single mainnet transaction is shared across all transactions on the rollup.

Rollups themselves are divided into optimistic rollups and zero-knowledge rollups. Optimistic rollups are optimistic because transactions are assumed to be valid but can be challenged after the fact. Zero-knowledge rollups, on the other hand, use validity proofs, enhancing privacy.

There’s also a scaling solution called “validium” that uses validity proofs just like zero-knowledge rollups but doesn’t store transaction data on the mainnet. This means data is available off-chain, which has its own risks, but validiums can provide massive TPS gain.

Benefits of Sidechains

Sidechains are among the most widely used scaling solutions for both Bitcoin and Ethereum because of:

• Maturity. As a technology, sidechains are well-established compared to validiums and, to a lesser extent, rollups. They’ve had extensive research and improvements in design and have been shown to work well.
• Compatibility. Sidechains are often purpose-built, and are fully compatible with every aspect of the mainnet. In Ethereum’s case, sidechains are EVM compatible and can run Ethereum-native decentralized applications.
• Low fees. Fees are a famous barrier to adoption for major networks like Bitcoin and Ethereum, with the former’s suitability as a payment network for smaller transactions diminishing as a result. Sidechains can use any consensus model they want to reduce fees to a much more manageable level for the average end user.

Downsides of Sidechains

While there are considerable advantages to be had by using sidechains to scale blockchains like Bitcoin and Ethereum, the technology does have tradeoffs compared to other scaling solutions. Some of the downsides include:

• Security. Sidechains are independent blockchains, which means that they have their own consensus models. It’s extremely unlikely that these sidechains will be more decentralized and expensive to attack than the blockchains they help scale—this would, in fact, make one of the two redundant.
• Validator risk. The likelihood is that the sidechain, therefore, will have fewer validators than the extremely secure and decentralized mainnet. Fewer, less capitalized validators means compromising the sidechain is easier than a rollup, which uses the mainnet’s security and validators.
• Blockchain trilemma. While sidechains aren’t necessarily insecure, they have to make compromises on speed, security, or decentralization to establish a certain level of speed. It’s generally decentralization that suffers as a result.

Examples of Sidechains

As mentioned, sidechains have existed for a while and seen plenty of research and development over the last few years. Let’s take a look at some of the best examples of the industry’s currently operational sidechains.

#1. Polygon

Polygon is one of the leading sidechains for Ethereum and has itself become a blockchain of note, with its MATIC coin entering the top 10 cryptocurrencies by market capitalization. It has recorded well over a billion transactions, and with almost 3 million monthly active users, Polygon is considered one of the best, if not the outright leader, in Ethereum sidechains and scaling.

Polygon uses an extremely robust bridging framework called “Plasma” and a decentralized network of proof-of-stake validators for consensus.

#2. SmartBCH

SmartBCH is a sidechain for the Bitcoin hard fork Bitcoin Cash, using BCH as a native gas-paying token while also offering EVM compatibility. It provides high throughput for dApps in a fast, secure, and decentralized manner, expanding the BCH mainnet’s ecosystem thanks to its ability to support EVM smart contracts.

#3. Gnosis Chain (Formerly xDai)

One of the first Ethereum sidechains under its previous xDai identity, Gnosis Chain makes node operation permissionless and easy. Far more decentralized than most other blockchains, Gnosis Chain features over 100,000 validators and applies community governance. It’s EVM-based, supported by at-home stakers worldwide, and costs a fraction of the mainnet to use.

#4. Liquid Network

Created by Adam Back-led technology firm Blockstream, the Liquid Network is an open-source sidechain that helps to scale Bitcoin. It features a one-minute block time, ten times shorter than Bitcoin’s, and it can also obscure the amount and nature of assets being transferred.

Key Takeaways

Sidechains are independent blockchains that help popular blockchains like Bitcoin and Ethereum offset some of the transaction volume that causes network congestion and elevated fees.

They aren’t unique in what they do, and other scaling solutions do exist. Rollups, be they zero-knowledge or optimistic in nature, offer several advantages over sidechains, chief among which is the fact that they can leverage the mainnet’s own consensus and security.

However, sidechains remain a viable and trusted solution for scale, and multiple sidechain projects provide Bitcoin and Ethereum with the invaluable service of keeping blockchain speeds up and costs down.