As we all know, blockchain technology is revolutionary in its own right, offering unique opportunities, and in many cases ones never seen before in terms of decentralization, immutability and censorship resistance. Nevertheless, ecosystems based on blockchain have known limitations, the main ones being limited scalability, as well as interoperability with other ecosystems, both blockchain and non-blockchain.
The blockchain trilemma
In the world of blockchain technology, there is the so-called blockchain trilemma, which includes three parameters: decentralization, scalability and security. Conventional wisdom says it is possible to achieve only two of these, not all three at the same time. For example, the Bitcoin network is great for providing decentralization and security, but not scalability. And Ripple achieves good scalability and security, but does so at the expense of greater centralization, and so on.
One of the solutions to these problems is the creation of Layer 2 systems, most of which are aimed at solving the scalability problem, which rests primarily on the throughput of blockchain networks (quantity and speed of transactions).
There are a number of basic options for technological solutions used in Layer 2, including:
- Payment channels
- Generalized state channels
Bitcoin and Ethereum communities are quite developed and numerous, and therefore they can afford to create Layer 2 projects aimed at improving the scalability of their own ecosystems only. At the same time, there are Layer 2 projects that are not tied to a particular blockchain.
Proposed by Joseph Poon and Thaddeus Dryja in 2016, Lightning Network is a decentralized payment P2P protocol that runs on top of the Bitcoin blockchain to speed up and reduce its transactions and micropayments. All this should contribute to improving the scalability of the entire ecosystem, in which participants are able to make payments in large volumes and at high speed, and also without having to turn to a custodian service since all operations in payment channels are backed by real cryptocurrency funds stored at multi-signature addresses on the blockchain.
LN uses bidirectional payment channels for this. The principle of their work is that on-chain transactions in the Bitcoin blockchain are made at the moment of opening and closing of the channel between two participants only, and all intermediate transactions are performed in Lightning Network itself, i.e. outside the main blockchain and without the need to confirm each transaction with a standard Bitcoin network-wide consensus.
Thus, if there is more than one transaction between participants, then first there are savings on the transaction fee, and second, it is possible to carry out transactions much faster than happens on-chain.
On a technical level, Lightning uses multi-signature addresses and its own smart contract language. The protocol is still under development.
There is a usage fee on Lightning Network, which consists of the actual LN network routing fee (currently set to zero, since the number of LN nodes is relatively small so far, with the fee sure to increase in the future), but the size of this fee will always be less than the corresponding fee on the Bitcoin network itself (otherwise users can always stop using Lightning and transfer their transactions to the main network). Moreover, there are fees for Bitcoin network transactions made when an LN payment channel is opened or closed.
At the same time, LN does have certain issues. For example, there is the possibility of a significant increase in the cost of Bitcoin transactions, which is only a part of the payment for using LN, but still an essential component. If this happens, it can also affect Lightning, namely the level of its distribution and adoption among merchants (in particular).
The need for an LN node to be constantly online for making payments is perceived by many as a disadvantage, since the node becomes vulnerable to various attacks. In addition, the cold storage of funds in LN is made impossible, as it can be done on the Bitcoin network itself (this method is perceived to be the safest for storing cryptocurrency).
Also, if a node is offline for a lengthy period of time, one-way closure of the channel (known as fraudulent channel close) can be made by one of the parties to the payment channel, which can also lead to loss of funds by the other party. To prevent such a scenario in LN, there is a period of time during which it is possible to dispute a channel closure, but this interval is not infinite, which means that a sufficiently long offline stay can lead to undesirable results.
Another risk of LN is that it is not completely decentralized, since natural hubs can be formed there – nodes with a large number of payment channels (for example, nodes of popular outlets, etc.). This can lead to the fact that taking down such hubs will lead to an inoperability of significant network arrays. In fact, we can see here that the aforementioned blockchain trilemma does not disappear here, and in LN, scalability is achieved to the detriment of decentralization.
Thus, although the Lightning Network is a promising development, this project (at least in its current form) is hardly a panacea for the problems Bitcoin faces.
Scalability for Ethereum
A peculiar analogue of the Lightning Network in the Ethereum ecosystem is called Raiden Network. The Raiden project was designed taking into account Ethereum’s unique features.
Like Lightning, Raiden processes transactions without first sending them to the Ethereum blockchain. Raiden does not need a third party to process transactions. This is possible because Raiden uses the smart contracts that exist on the Ethereum network. Therefore, there is no need for an intermediary, since the process is delegated to an autonomous system. However, in the Raiden network, all this is not done on the Ethereum blockchain, but within a separate secure communication network deploying direct payment channels between users. Each channel remains open and can be used any number of times until one of the parties decides to close it. The Ethereum blockchain is used only at the moment of a channel opening and closing, when the initial and final transactions occur, respectively.
This can solve the problem of scalability and speed up payments in Ethereum, which the developers of this network have been trying to solve since 2015. Low transfer fees also make micropayments possible.
Raiden Network uses its own RDN token and transaction fees go to developers who improve the network. The Raiden network also supports any compatible ERC20 tokens.
Raiden is a long-awaited project for the Ethereum community, but it is not yet clear whether it will become the scalability solution for the ecosystem, because there are other alternatives. In addition, there is a possibility that the Ethereum developers themselves will be able to solve this problem by means of the system itself in future updates.
Scalable for Ethereum and its smart contracts
Counterfactual also sets a goal of scaling the Ethereum ecosystem. However, unlike Raiden Network, this project aims not only at the improvement of Ethereum transactions but also at the smart contract system itself. In contrast to Raiden, this is achieved by using generalized state channels instead of payment channels.
Thus, Counterfactual consists of several components: a library for stand-alone applications, an intuitively understandable protocol of generalized state channels and a set of Ethereum smart contracts.
The Counterfactual client library, similar to Web3, can be used by applications to create and send messages to their counterparties using the off-chain protocol. Instead of signing and sending transactions directly to the Ethereum network, users can sign (sometimes automatically) commitments that could be written to the blockchain, but instead send them directly to their counterparties. All transactions that participants sign when using the protocol are ultimately designed in such a way that they can be placed on the blockchain if the party does not respond or otherwise deviates from its obligations.
In its work, Counterfactual relies on research from projects such as L4, Magmo, Sprites, Perun and many others.
Scalable for any blockchain with a focus on dApps
Celer Network is a multi-layered technology that provides network scaling for existing and future blockchains. A Celer-based network can scale to billions of secure private transactions per second. Celer Network’s goal is to unlock the full potential of the blockchain and revolutionize the creation and use of decentralized applications such as games, online auctions, insurance, market forecasting as well as decentralized exchanges.
The main advantage of Celer technology is the multi-layered nature of its architecture with a convenient cross-level interface. The technology stack used by Celer is called cStack and consists of the following layers:
- cChannel: the bottom layer of the Celer Network technology stack, which has a certain degree of abstraction, and uses generalized state channels (namely, an approach similar to the one originally proposed by the developers of Lightning Network) and sidechains to communicate with various blockchain systems.
- cRoute: Celer payment routing module, which is represented by Distributed Balanced Routing (DBR), directing payment traffic using distributed congestion gradients. cRoute has such characteristics as: fault tolerance, provably optimal bandwidth, transparent channel balancing, anonymity and complete decentralization. Each node communicates only with its neighbors, significantly reducing the need for signal trafficking in the whole network. The anonymity of routing in the Celer network is achieved via the use of so-called onion-nodes, which decipher addresses of next payment destination layer by layer.
- cOS is a development framework presented in the form of an operating system, which greatly simplifies the development and use of stand-alone applications on various platforms.
CELR, an ERC20 token, is the basis of Celer’s crypto-economy (cEconomy). The task of cEconomy is to balance the problems of liquidity and availability of service, arising in the case of the network scalability improvement. The plan to achieve this relies on three principal components:
- Proof of Liquidity Commitment (PoLC). This is a virtual mining process that works on the basis of “freezing” external digital assets (for example, other cryptocurrencies), which should guarantee liquidity when scaling a system.
- Liquidity Backing Auction (LiBA). This mechanism helps to achieve liquidity through crowd-lending at negotiated interest rates. There is a ranking mechanism for lenders.
- State Guardian Network (SGN) is a special compact sidechain designed to store user channels’ state while they are offline.
One of the main focuses declared by the Celer Network developers is a Layer 2 network for the rapid creation and use of highly scalable decentralized applications (dApps).
Universal scalability plus interoperability between blockchain and non-blockchain systems
GEO Protocol is a universal off-chain open-source protocol that provides the ability to scale blockchain systems, as well as to provide interoperability between different blockchain ecosystems, and between the worlds of blockchain and traditional finance.
Also, GEO Protocol is an open technology that allows for developing new decentralized and distributed services and solutions for a wide variety of use cases, including various payment and clearing systems, local currencies, etc, as well as a number of non-financial solutions, for example, scoring systems, delegated democracy systems, loyalty programs and others. In addition, it is possible to digitize physical and other non-digital assets, with the subsequent turnover of such assets in the global GEO network.
Scalability issues are solved by creating a truly distributed off-chain network, where secure transactions are confirmed by local consensus (that is, not by the entire network, but only by members directly involved in each individual transaction). At the same time, the GEO Protocol provides cross-chain atomicity of such transactions, which in turn allows real interoperability between different blockchains.
Such a network will have virtually unlimited bandwidth, and hence the appropriate scalability. Moreover, it will also be very undemanding to communication and computing resources, which means that a GEO network node can be installed on almost any device, including mobile. At the same time, the atomicity support system guarantees operation even in unstable network connection environments – ergo, mobile networks.
The main task that the GEO Protocol developers set for themselves was to create a basic protocol solution for the Internet of Value, i.e. a global financial network that unites all possible “local area networks of value” such as cryptocurrencies, fiat currency systems, banking and financial institutions, exchanges and trading platforms, various asset registries, including ownership rights registries, etc.
In such a global network, ultrafast and extremely cheap transfer of value of any kind would be possible, regardless of its nature and/or origin.
Several dozen projects are seeking to devise appropriate approaches to various aspects of the blockchain system’s scalability problem. Communities gathered around the most developed ecosystems (such as Bitcoin and Ethereum) create solutions aimed at improving their own particular ecosystem. These projects include Lightning Network, Raiden Network, and Counterfactual.
However, there is a possibility that the problem will be completely or partially solved by the developers of the main blockchains themselves in their future updates (for example, we expect Ethereum 2.0 at the beginning of 2020).
Other Layer 2 projects focus on solving scalability problems for a wider range of ecosystems, not limited to any particular one of them, which makes them more versatile and useful. The cohort of such projects includes Celer Network.
Finally, Layer 2 projects like GEO Protocol, apart from solving the problem of scaling a wide range of blockchain systems, also solve the problem of their mutual interoperability – not only limited to the world of blockchain itself – allowing them to effectively connect with the world of traditional finance and thus form a single global network of seamless value transfer exchange.