The blockchain usually operates on a couple of principles including but not limited to: decentralization, speed, security. These three topics are usually at the current most discussed topics relating to the blockchain trilemma. Individuals believe that you can only provide 2 out of the 3 guarantees simultaneously, meaning that you have to sacrifice one of the above core principles. It is important to understand each component in the blockchain thoroughly. I covered decentralization previously so I will talk about security and speed in this entry.
To increase network throughput on a blockchain network, there’s an incentive to reduce the distribution of blockchain nodes either geographically, in number, or both. However, this pivot towards greater centralization reduces security on Proof-of-Work (PoW) networks. When consensus is achieved on an open network with limited nodal distribution, a 51% attack is more likely to occur as hackers can amass hashing power with greater ease. By overwhelming a network, hackers can hijack the network and manipulate transactions for financial gain. For example: in August 2020, the Ethereum Classic (ETC) blockchain — which is unrelated to Ethereum itself — suffered three 51% attacks that reorganized over 4,000 blocks, thus allowing the perpetrators to manipulate data and double spend its ETC currency, resulting in the loss of millions of dollars in value on the network. Blockchain security is a critical network aspect that cannot be compromised.
Speed or scalability refers to its ability to support high transactional throughput and future growth. This means that as use cases expand and adoption of blockchain tech accelerates, the performance of a scalable blockchain won’t suffer. Blockchains that perform poorly as adoption increases are said to lack scalability. The blockchain trilemma tells us that greater scalability is possible, but security, decentralization, or both will suffer as a consequence. Scalability is the only way for blockchain networks to reasonably compete with legacy, centralized platforms whose network settlement times and usability are, at this point, far superior. While many blockchain platforms have established decentralization and security, achieving scalability remains the major challenge for today’s leading decentralized networks.
So how can we solve the blockchain trilemma and achieve decentralization, security, and scalability simultaneously? The answer comes in the form of Layer-1 and Layer-2 solutions.
What are Layer 1 Solutions?
In the decentralized ecosystem, Layer 1 refers to blockchain protocols like Bitcoin, Litecoin, and Ethereum. There are a number of methods currently in development or practice that seek to improve the scalability of blockchain networks directly.
Consensus Protocol Improvements: Proof of Work is the consensus protocol currently in use on popular blockchain networks like Bitcoin. Although PoW is secure, it’s also slow. For instance, Bitcoin only achieves seven TPS. That’s why many blockchain networks — perhaps most notably Ethereum’s upgrade to Ethereum 2.0 — favor the Proof-of-Stake (PoS) consensus mechanism. Instead of requiring miners to solve cryptographic algorithms using substantial computing power, the PoS consensus protocol determines validator status based on a stake in the network. This is expected to dramatically and fundamentally increase the capacity of the Ethereum network, while increasing decentralization and ensuring security. Another popular blockchain network, Solana, uses Proof-of-History (PoH) to allow for extremely fast network transactions, around 2500 TPS! However, it has suffered network congestion issues multiple times, dropping the TPS to around 800.
Sharding: Sharding is adapted from distributed databases and has become one of the most popular Layer-1 scaling solutions, despite its somewhat experimental nature within the blockchain sector. Sharding breaks transactions into smaller data-sets called “shards.” These shards are simultaneously processed in parallel by the network, allowing for sequential work on numerous transactions simultaneously. Further, instead of having each network node hold a copy of every block from genesis to present, this information could be split and held by different nodes, with each remaining consistent with itself. Shards provide proofs to the mainchain and interact with one another to share addresses, balances, and general state using cross-shard communication protocols. Ethereum 2.0 is one high-profile blockchain protocol exploring the use of shards, along with Zilliqa, Tezos, and Qtum.
What are Layer 2 Solutions?
In blockchain, Layer 2 refers to a network or technology that operates atop of an underlying blockchain protocol to improve its scalability and efficiency. For instance, Bitcoin is a Layer-1 protocol, and the Lightning Network is a Layer-2 solution built to improve transaction speeds on the Bitcoin network. Layer-2 protocols have undergone immense growth in recent years, and are proving the most efficient way to overcome scalability challenges for PoW networks in particular.
Nested Blockchains: A nested blockchain is a decentralized network infrastructure that utilizes a main blockchain to set parameters for the broader network, while executions are undertaken on an interconnected web of secondary chains. Multiple blockchain levels are built on this main chain, with these levels using a parent-child connection. The parent chain delegates work to child chains that send it back to the parent after completion. The underlying base blockchain does not take part in network functions unless dispute resolution is necessary. The OMG Plasma project is an example of Layer-2 nested blockchain infrastructure that is utilized atop Layer-1 Ethereum to facilitate faster and cheaper transactions. The distribution of work under this model reduces the processing burden on the mainchain to improve scalability exponentially.
State Channels: A state channel facilitates two-way communication between a blockchain and off-chain transactional channels using various mechanisms to improve overall transaction capacity and speed. A state channel does not require immediate miner involvement to validate the transaction. Instead, it is a network-adjacent resource that is sealed off by using a multi-signature or smart contract mechanism. When a transaction or batch of transactions is complete on a state channel, the final “state” of the “channel” and all its inherent transitions are recorded to the underlying blockchain. The Liquid Network, Celer, Bitcoin Lightning, and Ethereum’s Raiden Network are examples of state channels. In the trilemma tradeoff, state channels sacrifice some degree of decentralization to achieve greater scalability.
Sidechains: A sidechain is a blockchain-adjacent transactional chain used for large batch transactions. Sidechains use an independent consensus mechanism to that of the original chain, which can be optimized for speed and scalability, while a utility token is often used as part of the data transferral mechanism between side and main chains. The primary role of the mainchain is to maintain overall security and dispute resolution. Sidechains differentiate from state channels in a number of integral ways. Firstly, sidechain transactions aren’t private between participants — they are publicly recorded to the ledger. Further, sidechain security breaches do not impact the mainchain or other sidechains. Establishing a sidechain requires substantial effort as infrastructure is built from the ground up.