The concept of sidechains and their impact on cryptocurrencies are examined
The last month has had the Bitcoin community brimming with excitement about the Sidechains concept. However there seems to a lot of foggyness to the topic and misnomer about the challenges and problems about sidechains in general.
It was then that multiple people, such as Vitalik Buterin (the chief scientist of the Ethereum Project), stepped in and tried to dispel some of the confusion and optimistic euphoria by writing his own article summary on the topic.
You can go ahead and read it here.
However even then, as concise Buterin’s writing was – it still seemed to draw a number of deaf ears and confusion.
Let’s change that.
So first, a little bit of history.
A couple of years back, after the fiasco with the 2012 Bitcoin hard-fork – which lead to a split into 2 Bitcoin ledgers, a lot of developers started asking the question on how to more adequately respond to such a problem.
Additionally with the advent of the Bitcoin 2.0 concept – some thought it would be a good idea to come up with a way for people to be able to transition from the older version to the newer version without the hassle of Bitcoin 1.0 and Bitcoin 2.0 challenging each other.
To put it into a one line question: How would people transition from a hard Bitcoin fork?
And thus arose the idea of one-way pegging.
So let’s say I have Bitcoin Version 1 aka “V1″ the old version and suddenly a new Bitcoin version 2 aka “V2″ came out that was incompatible with the old version.
The new Bitcoin Version (v2) however, has a rule that states whomever destroys their old Bitcoins gets issued new version Bitcoins in return.
To destroy my Bitcoin I can simply send them to an address so unique – such that it’s pretty much guaranteed that i cannot retrieve them (or anybody else for that matter).
This destruction of Bitcoins is called a proof of burn.
Once a proof of burn has been verified by miners of the new Bitcoin network, I would be then issued my newly minted v2 Bitcoins in a precise 1:1 ratio.
What about the opposite? What if instead I wanted to trade new Bitcoins for old Bitcoins?
While one-way pegging works one way, it works only one way for a reason — it implies that the rule for issuance is encoded within the new version — without having the need to change the old version.
The way to do this without changing the old version is called two-way pegging.
Instead of destroying the old coin, two-way pegging involves the idea of sending the old coin into a special address that only releases its coins once given a specific digital signature.
Coincidentally this “digital signature” can be a proof of burn, except this time the new coin is sent into the trash address, and the sender of that new coin then is allowed by the network to “unlock” the old coin from its storage.
At the heart of the two-way pegging system, is the special address script that acts as the “posterboy/escrow” to facilitate the exchange.
So what are Sidechains again?
At this point it’s pretty obvious – but if not, think about what if instead of two-way pegging new and old versions of Bitcoin, why can’t we also peg a completely other altcoin as well?
By using two-way pegging for an altcoin instead, you could now have an altcoin that was pegged to the value of a Bitcoin and “borrowed” it’s value, a concept which is what was termed a sidechain.
Instead of starting from scratch and organically raising it’s value from the market like all altcoins (including Bitcoin) have done to this day – a new altcoin can become a sidechain and simply peg it’s value to an already existing ledger such as Bitcoin.
To the more classically minded the closest layman description of this can be described as a cryptographically decentralized (non-fractional) IOU.
The heart of Sidechains however — the two-way pegging mechanism — has several problems and a quite a number of notable weaknesses.
Issuance and miner incentive
In a normal cryptocurrency blockchain, the verification of transactions and coin minting are bonded together to incentivise miners to join the network – which is what entailed in Satoshi’s genius.
In a sidechain however, since the value of a sidechain coin is pegged to another crypto coin, it can only mint a sidechain coin when it is pegged by an already existing crypto coin.
The difference in supporting a sidechain or a crypto coin becomes apparent when while a crypto coin awards miners with transaction fees and issuance of new coin, a sidechain can only award it’s miners with transaction fees.
This leaves Sidechains in a position where they simply cannot supply the incentive for miners to support their network.
One approach to the problem is merge mining.
Merge mining facilitated the idea of a sidechain “piggybacking” not only on the value of a Bitcoin, but also the mining process as well.
This would allow a miner to validate sidechain transactions without having to switch it’s mining chain. Thus being issued not only Bitcoins and Bitcoin transaction fees, but sidechain transaction fees as well.
This however presents a problem as this makes the Sidechain much more vulnerable to attacks. In a normal altcoin chain, when an attacker initiates an attack he is forced move his hashing power towards the altcoin blockchain, thus losing potential gains from Bitcoin mining during the frame of time of the attack.
In a merge mining attack things are different.
With a merge mining in place, since mining a Bitcoin block also produces a valid sidechain block an attacker can attack a sidechain without losing any potential gains from normal mining. This makes attacking a sidechain not just cheap, but profitable as well.
Not mentioning the security implications of merge mining, merge mining also facilitates stronger dependence and consensus from pool operators.
Conclusion: Revolutionary but not new
Sidechains by all things considered are not new, but even with as they stand — by still not “technologically ripe for picking” — they do provide a significant allure in their possible applications.
Sidechains as a concept are not ready yet, but dismissing them at this point would not be so wise – any idea no matter how trivial, sets sparks upon the imagination of others and sometimes brings out even better solutions before them.
Rephrasing from Larry Summers: to reject innovations in the crypto currency world with complete certainty, as flawed they presently may be, would be a decision on the wrong side of history.