on-chain vs off-chain – TechTalks

Blockchains and related technologies represent a fundamental breakthrough in computer science. In the future, we’ll look back and consider these breakthroughs as a catalyst that unlocked untold human potential. The printing press, the steam engine, the internet, and blockchain technology.

That being said, we’re still in the early innings of this revolution. In order for this technology to reach its full potential, the scalability challenges need to be addressed. Put bluntly, we have a long way to go before blockchains can be used in daily lives of 7 billion people.

In this article, we’re going to explore blockchain scalability from two angles: on-chain scaling and off-chain scaling. We’ll explore the merits of each approach and where we might end up in the future.

Scaling blockchains is a hard problem

First off, it’s important to establish how hard scaling blockchains really is. Fundamentally, a blockchain is a time-linked, distributed database. Each computer (node) in the network must retain a copy of the ledger. This redundancy reduces the risk of corruption by any individual person or group inside the network.

One tradeoff with distributed systems is that since each computer must retain a copy of the database, which constrains the throughput of the system. Essentially, the system only works as fast as any single computer can process transactions.

Most current blockchains were designed with scaling as an afterthought. Instead blockchains like Bitcoin chose to prioritize features like security, decentralization, immutability, and censorship resistance.

There are two main approaches for scaling blockchains: improve the base layer blockchain (on-chain scaling) or a layered approach with multiple protocols working together (off-chains scaling).

Let’s examine the pros and cons of each method.

Pros and cons of on-chain scaling

On-chain scaling methods include improving the throughput of the base layer of the network. For existing chains, this means improving latency in the peer-to-peer (p2p) layer, reducing the size of transactions and messages, etc. One example of on-chain scaling success is Bitcoin’s implementation of Segregated Witness as a soft fork. SegWit reduced the size of Bitcoin transactions that ultimately get stored in the blockchain forever.

Unfortunately, making scalability improvements to existing blockchain base layers are unlikely to achieve the level of scalability needed to reach a mainstream global audience. Even if Bitcoin improves the base-layer scalability by 10x, it still wouldn’t satisfy the needs of a global economy’s method of payment. This is why Bitcoin is focused on “off-chain scaling” which we’ll cover below.

If we extrapolate Bitcoin’s base layer scaling limitations into the future, most transactions will likely occur on second layers which don’t come with the same security guarantees as on-chain transactions.

This may lead to a situation where only banks, corporations, and the wealthy can afford on-chain Bitcoin transactions. Meanwhile, most people in developing nations could not afford the high on-chain transaction fees. Arguably, the areas where censorship resistant, hard money is needed most (developing nations) would be priced out of on-chain Bitcoin transactions.

Another way to radically improve on-chain scaling is to create a new network with a new consensus mechanism that prioritizes scaling instead of other potentially desirable features. Ideally, this method would make on-chain transactions available for the average person. This means finding an alternative to existing consensus mechanisms such as Proof of Work (Bitcoin), Proof of Stake (Ethereum 2.0), or Delegated Proof of Stake (EOS).

Pros and cons of off-chain scaling

Off-chain scaling means creating alternative protocols that live “on top” of a blockchain. These protocols unlock new functionality for the digital asset with different design tradeoffs. For reference, our current internet is built in layers.

Scaling in layers is supported by Gall’s Law, which states:

“A complex system that works is invariably found to have evolved from a simple system that worked. A complex system designed from scratch never works and cannot be patched up to make it work.”

Bitcoin’s Lightning Network is the most prominent off-chain scaling solution in the market. The Lightning Network is a clever solution using payment channels to defer settlement to the base layer. It provides a trustless way to process bitcoin transactions fast and cheap but doesn’t quite provide the same security assurances as on-chain transactions. The Lightning Network is only 18 months old and there are still many challenges ahead.

Downside of Lightning Network #1: Time value of capital

In order for the Lightning Network to be successful, there needs to be a large amount of liquidity locked up in the network. In other words, users will need to keep their bitcoins on the Lightning Network to make them available to route payments. The question becomes, will people decide to keep their bitcoin capital on the Lightning Network instead of putting it to “work” somewhere else with a larger return? Without high levels of liquidity, the network risks becoming centralized or unable to support a mainstream user base.

Downside of Lightning Network #2: Businesses and governments won’t like it

Lightning Network provides users with increased privacy when they transact with bitcoin. This is a good thing for individuals, however  governments and businesses don’t want their citizens to transact privately. Instead, our largest institutions support “surveillance capitalism.” In other words, they benefit from spying on their citizens and customers.  Governments and big businesses protect their interests and could attack Bitcoin from a regulatory standpoint in the future.

Blockchain solutions are just getting started

We’ve seen incredible progress from the blockchain industry so far. Bitcoin proved to the world that we create a new form of money that’s not controlled by governments or any other entity.

However just because we’ve seen some mild success doesn’t mean we should stop researching new solutions with potentially better tradeoffs. In fact, we still have a long way to go before this industry matures. It’s time to build. The sky’s the limit.

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