Thursday, 18 November, 2021
Blockchains hold the promise for money for the internet, world computer, the future of finance, the metaverse and more. However, because of their decentralised architecture, they are struggling to support even a fraction of the user base of the older centralised systems. Scaling solutions can help blockchains achieve their lofty goals. In this edition of the Bridge, we cover the need for scalability, the various scaling solutions available and the trade-offs they make.
In the interplay between the blockchain trilemma, chains can usually achieve two of the three. For a given security level, scalability is inversely proportional to decentralisation. Hence, a blockchain must make trade-offs. We invite readers not familiar with the blockchain trilemma to read our earlier publication on the topic, “The Bridge – The Blockchain Trilemma”“The Bridge – The Blockchain Trilemma”link1.
Table 1: Cheap fees allow for the unlocking of new use-cases
Source: Vitalik Buterin, SEBA Bank
These issues are most prominent on older generation blockchains like Ethereum and Bitcoin. Figures 1 and 2 show the mean price of transaction fees of Bitcoin and Ethereum in USD and their capacity utilisation. Note that Ethereum's capacity utilisation has dropped to about 50% recently – the target level – as illustrated in figure 1 because of the implementation of EIP-1559. Post EIP-1559, whenever block space utilisation is above 50%, fees increase and vice versa.
Figure 1: Ethereum mean transaction fee (in USD) and block utilisation
Source: Coin Metrics, SEBA Bank
Regarding Bitcoin, the link between capacity constraint – lack of scalability – and the fee is direct. When the system is in high demand, congestion occurs and fees spike.
Figure 2: Bitcoin mean transaction fee (in USD) and block utilisation
Source: Coin Metrics, SEBA Bank
Compared to traditional financial solutions, the ratio of transaction speed to cost is unfavourable on older blockchain networks. Visa's payment processors execute around 1,700 transactions per second (TPS) and can scale up to 65,000 TPS. For comparison, a blockchain like Ethereum can process only 15 TPS. Because of this limitation, contenders such as Binance Smart Chain, Solana, Polkadot have emerged to provide higher TPS, often at the cost of higher centralisation. Table 1 shows the TPS comparison of various blockchains platforms versus VISA and PayPal.
Table 2: TPS of Blockchain platforms vs VISA and PayPal
Source: SEBA Bank
While talking about the problem of scalability, Elon Musk tweeted about Dogecoin, quoting, “Ideally, Doge speeds up block time 10X, increases block size 10X & drops fees 100X. Then it wins hands down.” As enticing as it sounds, there is a price for it.
Can we do what Elon proposes?
One of the core tenets of blockchain is to minimise trust, as the saying often goes – “Don’t trust, verify”. A blockchain should strive to provide minimum hindrance if a user wishes to run a node and “verify” the blockchain themselves. This helps maximise decentralisation and allows the blockchain to remain censorship-resistant, providing security against attacks. Bitcoin overcame the ban on Chinese miners because it was decentralised enough to keep the network running even as the most significant contributor fell off.
Are there any solutions?
Fortunately, several different scaling solutions are emerging. Some are already live, in different stages of rollouts, while others are still under development. Each of these solutions provides unique trade-offs and can be fundamentally categorised as follows:
Figure 3: A selection of promising scaling solutions
Source: SEBA Bank
To illustrate the layer-1 scalability solutions, we present the case of Ethereum, which has started its upgrade to ETH 2.0. For readers interested in this matter, we recommend reading the two Digital Investors we wrote on this topic – "Ethereum 2.0Ethereum 2.0link1” and “Phase 0Phase 0link1”.
Figure 4: ETH 2.0 Sharding Structure
Source: Vitalik Buterin’s website, SEBA Bank
There are five types of approaches through which layer-2 solutions are deployed (see figure 3). We present all of them in this section.
State channel solutions allow users to transact multiple times on a different chain (layer 2). In contrast, the main chain (layer 1) processes only two transactions, one when the channel is opened and one when the channel is closed. By doing this, the main chain does not process all the transactions but still provides the same level of security in transaction finality. Once the transactions are complete and the channel is no longer required, the participants submit their copies of transaction history to cross-verify their copies of data to ensure there are no discrepancies. Post this, the final net transaction is uploaded on-chain, and the channel is closed.
Figure 5: State channel and the steps involved in doing a transaction
Source: SEBA Bank
Plasma (Child chains)
Plasma consists of multiple copies of the main chain running alongside it. Thousands of transactions are processed in these child chains, bundled up and sent back to the main chain as a single transaction. By definition, a child chain is a trustless and non-custodial chain where users control their funds. Hence if there are any errors or exploits, they can refer to the latest correct snapshots of the plasma chain and restore their tokens.
Sidechains and child chains (plasma) are similar except for one element: security. While plasma chains rely on the security of their main chain in a trustless environment and are optimised for high throughput performance and security, side chains are separate blockchains running in parallel with the main chain and have their own consensus mechanisms and security algorithms.
Rollups bundle thousands of transactions into a single rollup block, publishing only summary data on the main chain. It can potentially provide a 100X increase in throughput as all the computation and storage happens outside the main chain.
Zero-Knowledge (ZK) Rollups
Validium uses validity proofs similar to zk rollups but keeps the data off-chain instead of sending it to the Ethereum main chain. Since all the data is kept off-chain, Validium can achieve an even higher TPS per validium chain of up to 20,000.
Table 3: Comparison between different layer-2 solutions and the trade-offs they make
Source: Matter Labs, SEBA Bank
For blockchains and crypto assets to achieve their lofty promises of world computers and money for the internet, they must be able to scale sustainably. For this, a combination of both layer-1 and layer-2 solutions will be required. Currently, chains are sacrificing decentralisation to achieve scalability, or a hotchpotch of solutions are being implemented with limited integrations between them, worsening the user experience and fragmenting the user base. Solving scalability will not be a winner-take-all scenario, and different use-cases will require different scaling and security needs. Improvements in scalability from layer-1 and layer-2 solutions will multiply in the future, leading to sustainable, scalable blockchains.
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