What is a Sidechain in Crypto?
Sidechains are adjacent blockchains that run parallel to a main blockchain network. They allow users to transact on a faster and cheaper secondary blockchain but often offer similar decentralized applications (dApps) as found on the main chain. Some sidechains even expand upon the functionality of purpose-built chains like Bitcoin. Sidechains use their own validation networks, with a bridge connecting them to the Layer 1 chain.
Well-known blockchains like Bitcoin and Ethereum are extremely secure but also pretty slow in comparison to traditional payment networks like Visa, which can handle up to 65,000 transactions per second (TPS). Bitcoin can process about 7-10 TPS, whereas Ethereum can theoretically process between 60 and 120 TPS. In practice, these networks typically see slower real-world throughput, and they can get expensive to use when network traffic increases.
Several scaling solutions, including rollups and sidechains, aim to improve transaction speeds and reduce costs. In this guide, we’ll discuss sidechains in crypto but also touch upon rollups as a basis for comparison. Let’s start with an overview of how sidechains work.
How do Sidechains Work?
One way to understand how sidechains work is to think of main chains as main roads and sidechains as side roads or service roads. Traffic can get busy on the main road, making service roads a faster way to reach your destination.
Most sidechains support the Ethereum Virtual Machine (EVM). This means they can support popular decentralized applications available on Ethereum, such as decentralized exchanges (DEXs) and crypto lending protocols.
Sidechains operate indepedently and use their own consensus mechanism to validate transactions and use a two-way bridge to transfer assets from the parent chain to the side chain and back again. For example, spearate blockchain, Rootstock (RSK) uses RBTC to power its sidechain. Users lock BTC in exchange for RBTC using a bridge. Then, they can transact in RBTC on RSK and use EVM-compatible smart contracts that are not supported by the Bitcoin network itself.
The bridging process can take a few forms, including a federation that helps ensure a one-to-one relationship between the value of tokens moving to and from the main chain and sidechain. Smart contracts offer another type of bridge between sidechains and main chains.
Sidechains are responsible for their own security and use their own consensus mechanisms to validate transactions. For example, Rootstock uses its own proof-of-work (PoW) mining, allowing merged mining with Bitcoin. Over 60% of the Bitcoin mining network also provides PoW security for RSK.
By contrast, rollup chains, such as Arbitrum and Base, process transactions on their own chains but then pass the transactions back to the main chain in batches. Rollups inherit security from the main chain.
On Rootstock, just one example of a sidechain, users lock BTC in exchange for RBTC. The RBTC token can be exchanged for an equivalent amount of Bitcoin through the bridge, so it maintains a peg to Bitcoin’s price. When on the Rootstock sidechain, users enjoy faster transactions with lower costs, in addition to being able to access dApps not available on the Bitcoin network.
The concept of sidechains dates back to a 2014 whitepaper authored by Adam Back and several colleagues. Adam Back also developed Hashcash, a process designed to combat email spam, which later became the basis for Bitcoin’s proof of work.
What are Sidechains Used For?
Sidechains offer several key benefits to the ecosystem: scalability, cost savings, dApp availability, and specialized use cases, including private networks. However, most well-known sidechains, such as Polygon PoS, focus on scalability and cost savings.
- Scalability: Polygon has a maximum transaction speed nearly seven times that of Ethereum. Transaction finality is also nearly four times faster.
- Cost Savings: The average transaction cost on Polygon is about $0.01, whereas the transaction cost on Ethereum is $0.55 as of this writing and often spikes to $1.00 or higher.
- dApp Availability: Polygon offers many of the same applications available on Ethereum mainnet. However, a better example of expanded ecosystems include Bitcoin sidechains, such as Merlin and RSK. These sidechains feature EVM compatibility, allowing Bitcoin holders to use their BTC stored value in decentralized finance (DeFi) applications or other dApps.
- Private Networks: The concept of sidechains also allows permissioned chains for specialized use. Companies like Kaleido specialize in designing permissioned sidechains for businesses.
What are the Best-Known Examples of Sidechains?
Still wondering what is a sidechain in crypto? Let’s explore some examples. Polygon offers the best-known example of a sidechain. However, several high-traffic sidechains exist, including the Merlin chain, which attracted more than $3 billion in Total Value Locked (TVL). Let’s explore a few.
Polygon POS (Ethereum Sidechain)
The Polygon sidechain launched in 2017, quickly becoming a popular alternative to Ethereum with many of the same apps supported. Polygon offered a less expensive way to interact with decentralized applications ranging from metaverse apps, like Decentraland, to perpetual futures platforms like dYdX. The Polygon sidechain has also become a hub for low-cost non-fungible tokens (NFTs),
The Polygon Bridge uses a smart contract to bridge ETH to the Polygon network. However, once bridging is complete, you’ll need to use the MATIC token for gas fees. Popular Ethereum-compatible wallets, such as MetaMask, support Polygon.
Merlin Chain (Bitcoin Sidechain)
Launching in 2024, the Merlin chain gained massive popularity in a short period of time, attracting more than $3.6 billion in TVL. The Merlin chain is a sidechain for Bitcoin, allowing users to bridge bitcoins to the chain and take advantage of EVM-compatible apps. The Bitcoin network itself offers only limited smart contract support. Merlin unlocks full EVM compatibility, allowing any EVM app to easily deploy to the Bitcoin-funded chain.
The Merlin chain uses a bridge to lock BTC on one side of the transaction and release MBTC for use on the Merlin EVM chain.
Gnosis (Ethereum Sidechain)
Like other sidechains, Gnosis uses its own consensus mechanism, leveraging more than 215 thousand validators worldwide to confirm transactions. Although Gnosis provides EVM compatibility, the chain has become a haven for decentralization purists who prefer a DAO-managed chain to Ethereum’s off-chain governance. GnosisDAO (decentralized autonomous organization).
Unlike rollup-based Layer 2 chains like Arbitrum, Base, and Optimism, which use ETH to power transactions, Gnosis uses xDai to pay transaction fees. The xDai token holds a stable value of $1, making it an attractive option to ETH, which fluctuates in price. A second native token, GNO, is used by a worldwide network of stakers to secure the network. Staking yields often exceed 10%, dwarfing ETH staking yields (usually about 3%), and node operators can begin with just 1 GNO token compared to the 32 ETH required to run an Ethereum validator.
What’s the Difference Between Layer 2 Blockchain and Sidechain?
The difference between Layer 2 blockchains and sidechains sometimes stirs controversy. However, the sidechain meaning in crypto refers to a chain that uses a bridge to and from another Layer 1 chain but which also validates its own transactions. By contrast, a Layer 2 chain typically refers to a rollup chain that processes transactions on its own network but then passes bundled transactions back to the Layer 1 chain for security.
Types of Layer 2 chains include optimistic rollups and ZK rollups. Optimistic rollups send the transactions in batches, with the Layer 1 chain having a “fault challenge period” during which invalid transactions can be challenged. ZK rollups instead submit a proof to the Layer 1 chain. By contrast to these two scaling solutions, sidechains provide their own security using proof of stake, proof of work, or another consensus method performed on the sidechain itself.
How Can You Access Sidechains?
To use a sidechain, you’ll need to use a bridge from the Layer 1 network, although some bridges support transfers from other chains as well. For example, to use Gnosis, you would use the Gnosis bridge. However, you can also bridge supported assets from Arbitrum or another EVM chain using jumper.exchange or shapeshift.com.
Bitcoin sidechains are less flexible. Bridging digital assets to a Bitcoin sidechain like RSK or Merlin requires using a specific bridge built for that purpose. You would deposit Bitcoin, which is then locked to receive an equivalent token on the sidechain, such as RBTC (Rootstock) or MBTC (Merlin). Because these tokens can be exchanged for BTC when bridging back to the Bitcoin network, they maintain their price peg to BTC.
EVM-compatible sidechains use popular Ethereum wallets like MetaMask. You can manage assets and make transactions just as you would when using the Ethereum mainnet.
Advantages and Disadvantages of Sidechains
The proliferation of Layer 2 rollup chains like Base and Optimism creates less need for Ethereum sidechains in many use cases. However, sidechains still play an essential role, although they have advantages and disadvantages. Let’s explore the pros and cons of sidechains versus Layer 1 and Layer 2 solutions.
Sidechain Advantages
The benefits of sidechains range from testing environments to specialized private chains. However, one of the most compelling advantages centers on the ability to use Bitcoin’s stored value in decentralized finance.
- Use Bitcoin in DeFi: Bitcoin’s limited support for smart contracts makes it better suited for a payment network. However, sidechains like Rootsock and Merlin unlock the value of Bitcoin for use in DeFi protocols, gaming, or whatever types of decentralized applications reach adoption on these chains.
- Test new protocols: Sidechains offer a testing environment for protocols without burdening Layer 1 chains.
Different governance models: Sidechains like Gnosis offer a more decentralized governance model compared to Ethereum, which uses off-chain governance. - Higher throughput: Expect a higher TPS with sidechains compared to Layer 1 chains. This increase in throughput can come from an optimized validation or reduced traffic compared to their Layer 1 counterparts.
- Cheaper transactions: Transactions on sidechains typically cost a small fraction of the cost compared to leading blockchains like Bitcoin and Ethereum. Transactions on RSK typically cost about $0.05, compared to $0.55 for Ethereum and $0.64 for Bitcoin. Both Bitcoin and Ethereum fees often spike much higher during periods of high network congestion.
Sidechain Disadvantages
Despite several advantages, sidechains also bring some disadvantages. Complexity tops the list. However, it’s also important to consider lower liquidity and potential security risks.
- Complex to use: Unlike main chains like Bitcoin and Ethereum, sidechains need to use a bridge, a way to move assets from one chain to another. While the process usually isn’t difficult, it can be offputting to newer users. There may also be a considerable delay (sometimes up to 7 days) when moving assets to and from sidechains.
- Security concerns: Sidechains bring at least two key security risks. First, the bridges themselves may be vulnerable to attacks. The now-infamous Ronin Bridge hack cost nearly 174,000 ETH. Hackers attacked the nine validators overseeing the bridge transactions. Secondly, a comparatively small number of validators makes some sidechains more susceptible to 51% of attacks.
- Centralization concerns: Some critics point to bridges or federations as signs of centralization. Who controls the lion’s share of validators may also be a concern.
- Lower liquidity: Sidechains face similar challenges to Layer 2 chains in that fewer people use these chains than their Mainnet counterparts. Lower liquidity can lead to inefficient swaps or less favorable borrowing costs on DeFi platforms.
- Fewer dApps: Lastly, sidechains typically offer fewer protocols compared to Ethereum. For some types of transactions, Mainnet may still offer the best options.
Conclusion
Sidechains are a scaling solution for busy Layer 1 networks like Ethereum and Bitcoin, offering faster transactions, faster transaction finality, and lower transaction costs. However, they can also bring additional features lacking from protocols like Bitcoin. The Merlin network allows Bitcoin holders to put their bitcoins to work in an EVM-compatible chain. Sidechains also offer a perfect testing environment and a way to host gaming chains or private chains.
FAQs
What are sidechains in crypto?
Sidechains are blockchains connected to a main chain through a bridge that validates transactions independently of the main chain.
Are sidechains and Layer 2 blockchains the same thing?
While similar in their ability to improve scalability, sidechains, and Layer 2 chains differ in one key area. Sidechains have their own consensus mechanism to validate transactions, whereas Layer 2 typically refers to rollup chains that use the main Layer 1 chain to secure transactions.
What are some examples of sidechain crypto?
Polygon POS and Gnosis are both sidechains of Ethereum. Merlin Chain and Rootstock are sidechains for Bitcoin.
What are the key benefits of sidechains in crypto?
Sidechains offer cheaper and faster transactions compared to many Layer 1 chains. Other advantages include better blockchain scalability, more attractive governance models in some cases or, in the case of Bitcoin sidechains, robust support for smart contracts.
Why are off-chain transactions cheaper?
Sidechains often see less traffic compared to main chains, creating less competition for transactions to be included in a block. This leads to lower transaction fees. Sidechains may also use differing consensus mechanisms that may bring additional efficiencies.
References
- Enabling Blockchain Innovations with Pegged Sidechains (blockstream.com)
- Ethereum Average Transaction Fee (ycharts.com)
- Merlin Chain Launches MERL: A Major Leap Forward in Bitcoin Layer 2 Solutions (finance.yahoo.com)
- How to stake your ETH (ethereum.org)
- Explained: The Ronin Hack (March 2022) (halborn.com)