Sidechains are an essential innovation in the blockchain field with some interesting long-term implications and effects on the broader interoperability and scalability of blockchain networks.

They are effectively extensions of existing blockchains that increase their functionality and allow for validation of data from other blockchains and for assets to be seamlessly transferred between them.

There are already some recent developments in their live implementation including the Loom Network’s DPoS sidechains for scalable dapps and gaming on Ethereum as well as Blockstream’s Liquid sidechain for enabling fast, confidential, and secure Bitcoin transfers.

Background and How They Work

Sidechains have been a concept for a relatively long time in the cryptocurrency space. The idea took flight in 2014 when several eminent figures in cryptography and early digital currency innovations published an academic paper introducing Pegged Sidechains.

Several of the authors are central figures at Blockstream, who is at the forefront of innovation in sidechains and other Bitcoin developments.

The paper outlines some critical developments and associated problems that were both currently trending and forward-thinking at the time, many of them still very much relevant today.

At the time, altcoins were quickly gaining prominence and the problems associated with their volatility, security, and lack of interoperability with Bitcoin raised concerns.

The paper primarily addressed 6 issues that pegged sidechains aimed to provide a solution:

Trade-offs between decentralization and scalability as well as security and cost. Trade-offs in specific blockchain features (i.e., Bitcoin’s scripting language compared to Ethereum’s Turing-completeness) Assets besides currencies that can be traded on blockchains (i.e., smart contracts, bonds, stocks, derivatives, real-estate) Risk of monoculture in Bitcoin Potential of new features with advancing technology not originally foreseen with Bitcoin’s creation Broad consensus is required to upgrade Bitcoin, resulting in slow and cautious processes.

As you can see, several of these real-world demands for the evolution of the initial Bitcoin implementation are still highly relevant. Trade-offs between scalability and decentralization are demonstrated with Ethereum’s focus on decentralization first and resulting complexities in developing scalable solutions.

The increased emphasis on smart contract functionality, pegging real-world assets to blockchains, and experimentation of altcoins that are currently ongoing also represent the forward-thinking ideas outlined in the paper.

Sidechains are blockchains that allow for digital assets from one blockchain to be used securely in a separate blockchain and subsequently returned to the original chain.

The term “sidechain” in this case is used for context, in that the paper initially refers to Bitcoin as the “parent chain” and connected blockchains (altcoins) as “sidechains,” but the term is interchangeable so that altcoins interacting with each other can each be a parent chain interacting with sidechains. You may have also heard of “childchains,” which are also sidechains.

An important distinction to be made about sidechains that needs to be understood is that sidechains themselves help to fuel innovation through experimentation. Rather than providing scalability directly, they allow for trivial experimentation on sidechains with various scalability mechanisms.

Using sidechains, one can avoid the problems of initial distribution, market volatility, and barriers to entry when experimenting with altcoins due to the inherent derivation of their scarcity and supply from Bitcoin. That being said, each sidechain is independent and flexible to tool around with various features.

A pegged sidechain has several important properties that are worth taking into account:

Assets moved between sidechains should only be able to be moved back to the original chain by the holder of the original asset.

Assets should be moved without counterparty risk.

Transfers should be atomic.

Sidechains should be independent, meaning changes or bugs in one sidechain should not affect other sidechains, even if they are connected to it. This also includes blockchain reorganizations (i.e., orphans in PoW blockchains).

Users should not be required to track sidechains they’re not using.

Pegged sidechains employ a two-way peg to transfer assets between chains, and they consist of providing proof of possession in the transferring transactions.

The idea is to enable the capability of locking an asset on an original parent chain, which can then be transferred to a sidechain before eventually being redeemed on the original chain.

Notably, the original asset on the parent chain is locked in a specific output address and is not destroyed like early implementations of sidechains.

The two-way peg is vital to the overall concept so let’s examine it further.

Two-Way Pegged Sidechains

The two-way peg is the mechanism for transferring assets between sidechains and is set at a fixed or predefined rate. Bitcoin’s Dynamic Membership Multi-Party Signature (DMMS) plays a vital role in the functionality of the two-way peg.

The DMMS is one of Bitcoin’s lesser known but incredibly important components. It is a group digital signature — composed of the block headers in Bitcoin — that has no fixed size due to the computationally powered PoW nature of its blockchain.

The Pegged Sidechain paper further describes it as:

“Further, contribution is weighted by computational power rather than one threshold signature contribution per party, which allows anonymous membership without risk of a Sybil attack (when one party joins many times and has disproportionate input into the signature). For this reason, the DMMS has also been described as a solution to the Byzantine Generals Problem[AJK05].”

The DMMS is also cumulative, so due to the use of DMMS as a signature based on computational power rather than secret knowledge, the signers of the DMMS are known as miners and contribute to why there is no fixed size of the group digital signature.

In the context of the two-way peg, the DMMS is represented by the Simplified Payment Verification Proof (SPV Proof), which is a DMMS confirming that a specific action on a PoW blockchain occurred.

The SPV Proof functions as the proof of possession in the initial parent chain for its secure transfer to a sidechain. Symmetric two-way pegs are the primary type of two-way peg so we will only be referring specifically to the symmetric (compared to asymmetric) peg in this piece.

We can break down the two-way peg process to transfer an asset from a parent chain to a sidechain into 4 steps:

The asset (i.e., native coin of a blockchain) is sent to a special output address that locks the asset on that chain. It can only be locked by the SPV Proof on the sidechain. Confirmation Period – Period during which the coin is locked on the parent chain and a reference transaction is subsequently created on the sidechain referencing the special output on the parent chain, known as the SPV Proof. Contest Period – Period during which a newly created asset on a sidechain cannot be used. Designed to prevent double-spends from potential blockchain reorganizations of the parent chain. Redeem on Parent Chain – This process mirrors steps 1-3 but instead sends the asset to an SPV-locked asset on the sidechain and unlocks the initially locked output on the parent chain.

Sidechain transactions using a two-way peg effectively only allow for intra-chain transactions.

A transfer from Bitcoin (parent chain) to Ethereum (sidechain) would allow a user to use the functionality of Ethereum (i.e., fully expressive smart contracts), but the underlying original asset would remain precisely that, Bitcoin. So, a Bitcoin on an Ethereum sidechain technically remains a Bitcoin.

Federated Sidechains

A federation is a group that serves as the intermediary between a parent chain and its corresponding sidechain. It is an additional layer in the protocol but serves a key function and is what Blockstream’s Liquid sidechain uses.

Due to the lack of expressiveness of Bitcoin’s scripting language, an externally implemented and mutually distrusting set of members form a federated peg.

The federated peg model intentionally compromises trust for increased functionality including better privacy, faster speeds, and overall security efficiency.

However, they are an additional intermediary layer and go against the general trend in Bitcoin adoption despite providing some valuable performance upgrades.

Potential Issues

Sidechains do come with their security concerns, notably surrounding their potential for risks of soft forks resulting from their complexity and the risk of mining centralization due to the presence of merge mining.

Further, despite sidechains being independent of each other, they are responsible for their individual security and need the requisite mining power to remain secure.

Bitcoin’s blockchain has sufficient PoW mining power to remain secure even from the most coordinated of attacks, but many more nascent sidechains lack the necessary network effects and mining power to guarantee security to users.

This need for mining power may ultimately influence the centralization of miners because it will create a high barrier to entry for smaller-scale miners who cannot compete with miners that mine on multiple blockchains, reaping more considerable rewards.

Use Cases and Sidechains Today

Sidechains have come a long way since the introduction of the pegged sidechain in 2014. Not only used in Bitcoin, but sidechains have also notably been implemented and are in development in a variety of platforms with some fascinating use cases.

Rootstock

Rootstock — Bitcoin’s smart contract platform — uses a two-way peg to Bitcoin and adds smart contract functionality to Bitcoin. It rewards Bitcoin miners through merge mining and allows for near-instant transactions and better scalability. It will first rely on a federated sidechain model before transitioning to an automatic peg.

Loom Network

The Loom Network recently released their SDK which supports what they call “Dappchains,” an Ethereum layer-2 sidechain solution with each sidechain comprised of their own DPoS consensus mechanism.

This enables highly scalable dapps, specifically games built using their tools. Loom emphasizes the earlier comment about sidechains enabling innovation in scalability, rather than providing it directly.

Loom’s sidechains have their own set of rules and are used to offload computation from the primary Ethereum chain. Their sidechains are application-specific, meaning that they enable highly scalable dapps through an efficient consensus mechanism and can periodically be settled on the main Ethereum chain depending on their security needs.

Ardor

Ardor is a blockchain platform predicated on childchains (sidechains) that use proof of stake (PoS) consensus. It uses the primary chain as a security chain and the childchains for processing transactions to increase scalability.

Their design is specifically focused on speed and efficiency through PoS consensus and removing blockchain bloat through pruning.

There are many more projects and developments out there utilizing sidechains in some form or another including Plasma and experimentation with the concept on Hyperledger.

Conclusion

Sidechains are a unique and diverse solution for disparate blockchain networks to experiment and interact with each other.

Developments within sidechains will go a long way in fueling better liquidity, interoperability, and scalability of the broader blockchain and cryptocurrency ecosystem.

The further developments in tying physical and traditional financial assets to blockchains will only increase the prevalence and need for solutions involving sidechains in some format.

For now, there are a lot of moving parts in their development, but their implementations and advantages have come a long way since their original inception.