Can Layer 2 Scaling Solutions Help Bitcoin and Ethereum Outperform VISA?

Layer 2 Scaling Solutions Help Bitcoin and Ethereum Outperform VISA

The concepts of blockchain and cryptocurrency have expanded immensely since the mining of Bitcoin’s genesis block a little over ten years ago. Ethereum added new concepts like smart contracts to the repertoire of blockchain networks. Countless more projects have targeted use cases big and small. But as the size and functionality of these networks has expanded, so too has network congestion, resulting in higher transaction times and costs, limiting their ability to scale. One of the biggest questions facing blockchain and cryptocurrency development and adoption is how can networks scale without sacrificing decentralization?

The Trouble with Transactions Per Second

Established payment networks like VISA are both completely centralized and highly efficient. Visa’s official website says its payment network handles 150 million transactions every day, with the capability to handle 24,000 transactions per second (tps). In contrast, etherscan.io shows that Ethereum’s peak daily transaction volume was attained on January 4, 2018, when 490,644 transactions were processed on the network. This works out at about 15.62 tps. Bitcoin fares even worse, with blockchain.com giving it’s all-time peak volume as 490,644 on December 14, 2017, working out at about 5.68 tps.

Other blockchains claim to massively outperform Bitcoin and Ethereum, though there has been controversy over some of their figures. According to eosmonitor.io, EOS has attained 3,996 tps. This claim was disputed by a Whiteblock report issued in November 2018, which alleged this figure was only achieved by ignoring complex transactions, and that EOS was only capable of around 50 tps in “real-world” conditions. EOS strongly refuted the report’s claims, arguing in a Medium post that the report contained “numerous errors, some quite basic.” But even if the 3,996 tps figure is completely legitimate, many argue that EOS only achieves these figures by comprising on true decentralization. Whereas Bitcoin and Ethereum rely on an open network of miners to verify transactions, EOS transactions are verified by 21 elected block producers.

XRP and TRON also claim to massively outperform Bitcoin and Ethereum on transaction speed, while also being criticized for lacking true decentralization. Ripple’s official website states that “XRP consistently handles 1,500 transactions per second, 24×7, and can scale to handle the same throughput as Visa,” having demonstrated an ability to scale to 50,000 tps in July 2017. TRON claims that “TRX consistently handles 2,000 transactions per second, 24×7.” Ripple argues that the concentration of mining hash rate within a few powerful mining groups on the Bitcoin and Ethereum networks means that XRP is as decentralized, “if not more so… than both Bitcoin and Ethereum.” Similarly, Tron Technical Manager Marcus Zhao claimed in an interview with the Crypto News Nakamoto Jedi YouTube channel that the wide geographical distribution of its 27 Super Representatives means it is more decentralized than Ethereum and EOS.

Both Ripple and Tron’s claims of decentralization have been widely disputed. Similar claims of sacrificing decentralization for superior transaction speeds have been leveled at many other networks, including IOTA and NEO. For Bitcoin, Ethereum, and virtually every other cryptocurrency and blockchain network, the big question remains: how can these networks scale without sacrificing decentralization?

The issue becomes even more pronounced when smart contracts are added to the equation. If Ethereum is to become the distributed global supercomputer it is aimed at being, then DApps and smart contracts deployed on the network will require a great number of micro-transactions to be effective. If Ethereum is to live up to its maximum potential, the 24,000 tps achieved by VISA still be insufficient.

The answer many have come to is to move transactions away from the main blockchain protocol and onto a second layer.

In an article published by CoinDesk in May 2018, Michael J. Casey, a senior advisor to MIT’s Digital Currency Initiative, wrote:

“We are now entering an exciting new phase of blockchain development in which… programming solutions that operate “on top” of existing blockchains promise big strides in scalability, interoperability and functionality… There is still much work to be done. The early tech is buggy, and new security and trust solutions must be figured out… But in mitigating the heavy, multi-party computation that blockchains carry while ensuring that transaction histories are at some point anchored by “on-chain” consensus algorithms, there’s something of a best-of-both-worlds promise in these ideas.”

Casey goes on to compare the Layer 2 scaling solutions proposed for blockchain networks to the Tim Berners-Lee’s Hyper-Text Transfer Protocol (HTTP), which was placed atop the Internet’s TCP/IP protocol, and ultimately made the immense diversity and functionality of today’s Internet possible. But “whereas HTTP was universally adopted as an almost immediate standard, there’s a great deal of competition in Layer 2 blockchain solutions.”

So what do these Layer 2 scaling solutions look like? And which are most likely to become HTTP-style blockchain standards?

Bitcoin’s Lightning Network

One of the most talked-about Layer 2 scaling solutions in the Lightning Network for Bitcoin. This allows the creation of off-chain payment channels, where deposited bitcoin balances can be used for making payments without being broadcast to the main blockchain network. These channels can be kept open for as long as either party to a transaction wants them to, then closed and broadcast to the network to finally be approved in one big transaction at the discretion of either party. The below video from the Simply Explained YouTube channel demonstrates how the Lightning Network could make it feasible to use bitcoin to pay for a cup of coffee.

The Lightning Network is already active, although its current form is considered a beta version of the platform. Statistics available on p2sh.info show a steady increase in Lightning Network activity since it went live. At the start of February 2018, there were almost 1000 active payment channels carrying 4 BTC in value. This had risen to 13,000 channels carrying 128 BTC by November 2018. Lightning Network activity has seen a huge surge since then, and there are currently more than 34,000 channels carrying more than 726 BTC. This means that the value of bitcoin being utilized for Lightning Network activity is approaching $3 million.

The Lightning Network has caused a long of excitement among Bitcoin supporters, as it neatly solves the problems of slow transaction times and high fees by making off-chain transactions possible. The growth in Lightning Network activity over the past year suggests it may prove to be the magic bullet scaling solution that makes Bitcoin usable as a currency. And as the Lightning Network’s system of payment channels is based on implementing smart contracts, it could transform Bitcoin’s functionality in even more profound ways.

As this article from Coin Central explains, the Lightning Network technically makes it possible to deploy Ethereum-style DApps on the Bitcoin blockchain. These decentralized Lightning Network apps – dubbed ‘LApps’ – are, like the Lightning Network itself, still in their infancy. At the moment, they are limited to providing payment solutions. But there is no reason that the types of complex DApps being dreamed up and developed for other networks couldn’t feasibly be deployed on Bitcoin using the Lightning Network, or another second layer protocol.

Layer 2 Scaling Solutions for Ethereum

While the Lightning Network’s second layer smart contract-based scaling solution neatly solves Bitcoin’s most pressing issues, Ethereum’s needs are more complex. Any Layer 2 scaling solution for Ethereum needs to preserve Ethereum’s capabilities as a platform for executing complex smart contracts. With that said, a tremendous amount of effort has been put into creating these solutions by Ethereum’s deep pool of developers. A few of the most talked about Layer 2 scaling solutions for Ethereum are:

  • State channels This solution is similar to Bitcoin’s Lightning Network, allowing the creation of ‘state channels’ directly connecting various parties away from the main Ethereum blockchain. As with the Lightning Network, these state channels can be kept open for an indefinite time period and broadcast to the main blockchain at any time.
  • Plasma With Plasma, ‘child chains’ are created that supplement the main Ethereum blockchain. Transactions can be conducted within these child chains and then ‘exited’ to the main chain at a later time.
  • TrueBit Truebit is a proposed solution for conducting computationally heavy processes away from the main Ethereum blockchain. If an Ethereum users requests the completion of a computationally complex task, Truebit would allow this to be competed off-chain, and then verified on-chain once it has been completed.

Each proposed Layer 2 solution has its own advantages and disadvantages, with some being more suited to particular use cases than others.

State Channels

Lightning Network-style state channels are the fastest and simplest way of directly connecting one user to another. They also shield the content of a transaction from the main Ethereum blockchain, which means they could be an elegant solution for sensitive data transfers. The content of all smart contracts deployed on the Ethereum’s main channel are stored in the public Ethereum blockchain, making them viewable by anyone. If these transactions were moved to a state channel, only the participants in each transaction would be able to view the details of their transactions. The only thing broadcast to the public blockchain would be the final balance settlement.

So state channels reduce network congestion, allow for participants to conduct transfers instantly without paying gas fees, and add a layer of privacy to interactions on Ethereum. Funds allocated to the state channel are held in a multi-signature smart contract, which allows for balances to be settled instantly between participants before later being broadcast to the main blockchain. Users are free to withdraw unused funds back to the main blockchain at any time.

There are many different projects which have brought differing versions of state channels to Ethereum, as Dmitry Berenzon explains on Medium. The Raiden Network is the most publicized, having raised more than $33 million in its 2017 initial coin offering (ICO). Raiden is popularly known as Ethereum’s answer to the Lightning Network, with a focus on facilitating retail payments, P2P payments and token swaps, and microtransactions within DApps. Other notable examples include Spankchain, which allows participants to make unidirectional payments to adult entertainers; Lightning Labs, a payment solution developed by the creators of Bitcoin’s Lightning Network; Funfair, a blockchain-based casino; and Fuel Games’ Ansible Channels, designed to allow for effective in-game microtransactions.

Plasma

Plasma’s system of child chains allows for more complex interactions between participants. These child chains essentially function as their own independent blockchains, only broadcasting updates to the main Ethereum blockchain when necessary. By moving transactions to a child chain, a great deal of flexibility becomes possible. Plasma-based child chains are able to have all the functionality of Ethereum, while being free to instigate their own consensus mechanisms and other network rules. Child chains can even be built on top of other child chains! But unlike a truly independent blockchain, these child chains can always connect and report back to Ethereum’s main chain, making them more accessible and adding the security of the established Ethereum network.

OmiseGO (OMG) has long been one of the best-known attempts to bring a Plasma-based scaling solution to Ethereum. As Coin Central’s guide to OMG explains:

“OMG is a decentralized bank, exchange, and asset-backed blockchain gateway… Think of a decentralized Ripple + universal remittance bridge to interconnect fragmented payment processors, legacy rails, and decentralized blockchains.”

Created by the Thai payment services company Omise, OMG was the first project to attempt to implement the plasma idea outlined in a white paper written by Ethereum figurehead Vitalik Buterin and Lightning Network co-founder Joseph Poon. Buterin and Poon are both listed as advisors to the projects, as is Bitcoin Cash figurehead Roger Ver. OMG’s investors include some of Japan’s biggest banks and financial services companies. This impressive cast of supporters helped OMG raised $25 million at ICO and soar to above $26 per token for a $2.7 billion market cap in January 2018. OMG has lost close to 95% of its value since then, with many online expressing frustration at the pace of progress on the project.

As CoinDesk reported in November 2018, Ethereum has turned to other short-term scaling solutions due to difficulties in getting plasma working as intended:

“[R]esearchers behind the tech have built five distinct versions of the protocol – but within these multiple iterations, there’s evidence that work isn’t proceeding as originally hoped, with little actionable code being put together well over a year since its inception.”

TrueBit

Described by CoinDesk as an “under-the-radar effort to supercharge ethereum smart contracts,” TrueBit has received less attention than state channels or plasma. When smart contracts are deployed on the Ethereum blockchain, their content needs to be verified by every node in the network individually. If the smart contract entails heavy use of computational power, this could prove incredibly expensive and ridiculously inefficient. TrueBit aims to allow participants to publish computational problems which can be solved by other participants off-chain. These problems are only pushed to the main chain for verification when disagreement arises over solutions. TrueBit incentivizes good behavior by punishing participants who push provably false solutions to claim rewards, and by punishing false claims of incorrect solutions by making the complainant pay the computation’s gas fees.

Additional applications can be built on top of TrueBit, with the CoinDesk article giving the example of Dogethereum, which allows for Dogecoin to be directly moved onto TrueBit’s second layer of the Ethereum blockchain. Another unique application is an art-creating digital autonomous organization (DAO). Truebit.io explains the logic behind the ArtDAO:

“A machine entity with blockchain-based financial resources and access to computational power could conceivably sustain itself by producing art, selling it, and using sale revenue to refine its own program code.”

TrueBit’s ArtDAO was demonstrated just over a week ago at Ethereum’s ETHDenver conference. Another application outlined on TrueBit’s website is Interactive Initial Coin Offerings (IICOs), which would allow ICO participants to make a ranged bid for ICO tokens, enabling a fairer distribution and valuation of ICO tokens.

TrueBit has yet to launch its own ICO, with various ICO sites simply listing the token sale date as “soon.”

Is Layer 2 the Answer?

Bitcoin and Ethereum aren’t the only blockchain networks turning to Layer 2 solutions to solve their scaling problems. As we reported in our article on NEO’s recent Seattle DevCon, the Trinity protocol will be used to add a Layer 2 payment solution to NEO.

And there are alternatives that don’t involve adding a second layer to the main blockchain. As we discussed in our article on Ethereum’s Constantinople upgrade, sharding is a long-term scaling solution that would split Ethereum’s main chain into smaller interconnected ‘shards,’ bringing many of the benefits of plasma without relying on a second layer.

Projects such as IOTA and NANO use direct acyclic graph (DAG) technology to solve scaling issues by redefining the whole concept of a blockchain-style distributed ledger. The DAG model sees transactions verified by other ‘neighboring’ transactions, rather than running through a centralized consensus mechanism. In theory, this makes DAG-based protocols infinitely scalable, with network speed actually increasing as more transactions take place. The downside is that these networks require a critical mass of transactions for this set-up to be truly effective, and most DAG projects currently rely on centralized coordinators or witness nodes to process transactions. Because of this, neither IOTA nor NANO have yet been able to demonstrate they are significantly faster than other blockchains in real-world use cases.

With Bitcoin’s Lightning Network growing at a seemingly exponential rate, Layer 2 solutions look like the best option for solving Bitcoin and Ethereum’s scaling problems in the here and now.

About Christopher Williams

Christopher Williams is a British writer based in South Korea with a strong interest in emerging technologies, cryptocurrency, and the development of decentralized apps.