What is a sidechain and how does it work?

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Waht is sidechain and how does it work

Cryptocurrency is a form of digital currency based on the principle that a coin occupies a block of digital space.  A good guess will lead you to the conclusion that the blockchain is simply a digital ledger where the transactions are recorded chronologically and publicly.

This sets the scene for the concept of a sidechain, albeit with a lot of confusion about exactly what it means, whether they are trustworthy, and why they seem to be necessary.

Sidechains have been an integral part of blockchain technology capabilities since inception. Initially, they were put in place to overcome system limitations on the time it took to settle transactions.

So, a sidechain allows agreeing parties to send each other transactions privately without the need to put the transactions on the blockchain. Remember that the result can be put on blockchain by anyone of the parties in the future if they decide to do so.

Sidechains sound confusing, don’t they?

Well yes, it can seem a bit complicated.  So, let’s think of this who process like getting a loan from the bank in order to create value. For example, I have agreed with the bank to commit to some value between us (this is called pegging in blockchain jargon).   I then do all sorts of weird and wonderful things to create value for me, independent of the bank – as long as the account is settled in full, the main blockchain doesn’t need to verify everything in real time. In crypto-speak, the bank represents the players providing the blockchain assets (e.g. a number of coins at an agreed price), I then do what I need to, without waiting for transaction settlements or worry about price volatility, and possibly most importantly, without the need for anyone really knowing who else is involved (at this point).  Then, should I decide to do so, I can the details public.

Why would you need a sidechain

Why would you need a sidechain?

Until recently, sidechains were used primarily to test Beta releases of altcoins or software updates, and as you can imagine, this is quite useful to prevent inadvertent downtime.  (If you are aware of the lag when coins introduce new algorithms or new functionality, you will understand how this could create undue negative publicity which in turn might be detrimental to the coin’s reputation.)

You may also have read from time to time that transaction settlement times have lagged, or perhaps noticed a purchase or sale of coins was delayed.  The use of sidechains through the use of parallel computing could reduce this by taking authority/responsibility for a subset of transactions – much like going to a different branch of the bank because the queues are quicker.

So in short, the theory is that either that they will hit the ledger eventually, or that it doesn’t matter if they hit the ledger, as long as both parties can get on with what they need to do.

Let’s take another example to explain this.  Say I’m a retailer selling clothing in a traditional fashion, I have a lot of upfront costs, overheads and ancillary costs associated with each sale.  If I were to take payment via cryptocurrency rather than fiat, the buyer’s perception of the product’s cost would change on a minute by minute basis. By pegging the value of my outlays ahead of sales, I can offset some of the risks of price changes on costs.  Bitmain, an ASIC miner supplier, do limited variations of this with some of their products – so you will find that the fiat amount to purchase an item will vary. However, they also revalue their products frequently, so when you spot that deal, you need to make that transaction quickly.

By allowing payment by crypto, I can broaden the appeal.  If we take a look at Bitcoin prices, the highest price was over the US $19k in December 2017; in May 2018, the price was not above the US $10k. A sidechain won’t stop the value of Bitcoin waxing and waning, but it will allow me to not worry about the settlement times to the main blockchain so that I can smooth my business.  I might then decide to fluctuate the amount of coin needed, rather than the amount of fiat needed to purchase items. At that point, I can decide whether to sell off the coin or retain for future gains in value.

As you might expect, massive growth is expected for sidechains to prove the foundation for massive blockchain scalability, to allow these types of “smart contracts” and the settling of transactions more quickly and at reduced rates etc.

Security and hedging of risk are other important being sought – with scams becoming ever more supplicated, these important features will help allay the fears for those who have not investigated the strategic value of cryptocurrencies to.  Already, some countries are introducing regulatory control for crypto businesses and trading.

How do sidechain really work

How do sidechains really work?

With so many possibilities and so many possible ways to implement a sidechain, there are only a few key players involved.  Let’s call them the “user” (e.g. the customer), the “gatekeeper” (e.g. all the bits in the middle), and the “supplier” (e.g. like the bank).    

First the user triggers a function to lock a value (deposit) coins from the main blockchain (e.g. BTC, ETH, etc) into the sidechain to buy local units of whatever cryptocurrency takes their fancy – usually called the “altcoin” (for alternative coin whose features could include lower fees, faster settlement, anonymous transaction, more robust security, etc).  

Next, these units are transferred from the user to a “gate” contract with the main coin network.

Simply put the transactions agreed between the user and the supplier are monitored by the gatekeeper to ensure that the gate contract is fulfilled on both sides by the authorized parties.

Potential applications for sidechains are evolving almost faster than the technology allows, extending blockchain technology far beyond the vision of the founders.  From financial services to secure storage of personal information, new worlds of possibilities are being developed on a daily basis. Virtually every new ICO (initial coin offering) in 2018 comes with the promise to implement smart contracts, scaling for data-intensive projects, incorporating anti-counterfeiting properties, etc.

Coming back to the here and now, here are some platforms already/soon to be ready for commercial purposes to give you something more to think about.

  • Rootstock (RSK) is based on Bitcoin and rewards miners via merged mining.  Rootstock aims to enable smart contract capabilities and transact payments much quicker.
  • Ardor’s Blockchain encompasses the blockchain-as-a-service philosophy
  • Blockstream and SONM aims to build or offer paid side stream services
  • Blockchain technology is being considered as a tracking system to help overcome current monitoring deficits in the trade of radioactive materials.
  • Zeepin, a new ecosystem – targeting the creative industries, aims to protect intellectual copyright, using blockchain technology to distribute profits.
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