Sidechain technology was proposed in 2014 by Blockstream. This is the name given to add-ons to popular networks such as Bitcoin and Ethereum. Sidechains are tied to the main blockchain, but function according to their own rules. This allows for fast and virtually free transactions. Due to the two-way binding to the main network, users can transfer funds to the sidechain and vice versa at any time. In the article – about the popular Bitcoin sidechains. Liquid Network is used for private liquidity exchange between institutional investors. Rootstock is based on smart contract technology, allows transferring coins to DeFi and deploying proprietary dApps.
What sidechains are for
Bitcoin is one of the most secure and decentralized cryptocurrencies, but its bandwidth is low. In some cases (such as international transfers), BTC transactions are faster than traditional transactions. But for everyday payments, Bitcoin is inconvenient. You have to wait about 10 minutes for transaction confirmation. However, recipients in the form of exchanges and other companies sometimes require several confirmations for security purposes, so replenishing an account or paying for goods can take up to 1 hour.
Sidechains are more flexible. These add-ons to the core network have features:
- They don’t use the Proof-of-Work algorithm. For security, they can trust one or more validators or come up with their own set of rules. This allows for virtually unlimited bandwidth expansion.
- Updates can be made that are not on the main chain.
- If critical errors occur, problems will not affect the parent network.
How Sidechains Work
A sidechain is a double-sided technology. This means that coins can be freely sent into and out of the parent blockchain to the sidechain. The principle of operation of second-level networks is as follows:
- Bitcoin is blocked on a special address. At the same time, the same number of L-tokens are minted in the sidechain. They can be exchanged for BTC at any time at a ratio of 1 to 1.
- The user performs transactions in the sidechain. They are confirmed using a simplified algorithm.
- The client submits a request to transfer tokens to the parent chain. All transactions in the secondary chain are merged into one and confirmed in the parent blockchain. In the BTC blockchain browser, 2 transactions will be visible – input of assets into the sidechain and output from it. The L-token in the secondary chain is burned.
Bitcoin sidechain platforms
Shortly after the launch of the Bitcoin blockchain, it became apparent that the first cryptocurrency had flaws. Developers sought to increase network bandwidth and privacy, reduce fees, and add smart contract technology. However, most participants voted against significant changes to the source code. They wanted to leave it as Satoshi Nakamoto had realized it.
Some developers started creating new cryptocurrencies based on the modernized Bitcoin code. Others proposed improvements to the underlying blockchain and began producing second-level blockchains.
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Sidechains increase the scalability of the parent network without making changes to the code.
Liquid Network
Blockstream released documentation of the project in 2014. Liquid Network has open source code. It was published in 2015. Developers were invited to check the code for bugs and experiment with the features of Bitcoin’s first layer 2 network.
In 2017, the founders updated the consensus method and the security algorithm (added refunds to the Bitcoin network). The sidechain was launched on the main chain in 2018 after 4 years of testing. Liquid Network became the first sidechain for commercial use. The project was supported by partners Atlantic Financial, OkCoin, Xapo, Bitfinex, Bitmax and BitMEX.
Liquid Network is a separate network with a link to the parent blockchain. The second-level chain is based on micropayment technology, which offers virtually unlimited scalability. Users exchange their bitcoins for L-BTC at a 1-to-1 exchange rate. Fast (confirmation time is 2 minutes), confidential transactions can be conducted inside Liquid Network. Transactions cannot be tracked within the Liquid Network. They appear in the Bitcoin block browser after L-BTC is converted back.
RootStock
Sidechain was proposed in 2014 by Sergio Demian Lerner. But the launch on the main network took place only in 2018, after four years of testing. The project, just like Ethereum, used smart contracts.
Rootstock (RSK) not only provides fast and confidential transactions, but also offers to use BTC in DeFi applications. Developers can deploy their own smart contracts on the network. Bitcoin miners join Rootstock to generate additional income in the main cryptocurrency. There is no need to increase the processing power of the hardware.
In 2023, BTCPool, ELOIPool, Stratum-mining and CKPPool support the federated mining feature. Rootstock has blocked BTC totaling $83.8 million (equivalent). The average monthly transaction volume is 79.4 thousand. Earlier, in 2022, the developers announced plans to release NFT on the network.
Rootstock operates native DeFi tokens backed by bitcoin. Among them:
- Dollar on Chain (DOC) stable coin. Its price is pegged to the U.S. dollar and does not change due to Bitcoin fluctuations. If a user enters 1 BTC into Rootstock at an asset price of $15 thousand, he will get back more or less coins when the exchange rate rises or falls. This way it will be possible to save their funds in dollar equivalent.
- BTCPro token. Its price changes proportionally to the BTC rate. When bitcoin rises or falls, BTCPro holders gain or lose.
Advantages and risks of bitcoin sidechains
Layer 2 networks solve Bitcoin’s low bandwidth problem. However, it comes at the price of less decentralization and security.
Attackers can attack validators or sidechain miners. This happened in 2022 with Ethereum’s second-tier network, Ronin. Hackers managed to steal cryptocurrencies totaling $625 million. Attackers gained access to 5 validator nodes out of 9 and were able to manage the withdrawal of assets.
The advantages and disadvantages of sidechains are collected in the table.
| Pros | Minuses |
|---|---|
Conclusions
The use of sidechains greatly expands the capabilities of Bitcoin and other popular crypto networks. Developers can experiment with new technologies without the risk of damaging the security of the underlying chain. Thanks to the second-level blockchain, investors utilize smart contracts and exchange liquidity with virtually no fees.
Sidechains increase Bitcoin’s bandwidth but reduce decentralization. Therefore, sidechains are less secure compared to the parent network.
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Author: Saifedean Ammous, an expert in cryptocurrency economics.
