In October 2014, a team from Blockstream introduced the innovative concept of “pegged sidechains” in their paper, “Enabling Blockchain Innovations with Pegged Sidechains.” The aim was to improve Bitcoin’s functionality by allowing BTC to be used outside the mainnet. A year later, they launched the open-source code for the Liquid Network, the first real-world implementation of a sidechain.
Today, sidechains are integrated into many prominent blockchains in various forms, though the concept remains complex and often misunderstood. CP Media breaks down what sidechains are and how they work.
What Is Sidechain?
A sidechain is a separate blockchain network connected to a primary chain through special mechanisms. Sidechains function independently, interacting with the main chain to transfer assets or data.
The primary mechanism involves issuing wrapped tokens linked to locked assets in the main chain. This process is managed by smart contracts and other tech, whereby tokens in the main chain are “frozen” and then “converted” into sidechain tokens. Interaction protocols and software guide token transfers and information exchanges.
Why Are Sidechains Useful?
Sidechains enable Layer 1 networks to expand their functionality without modifying the core protocol. They also allow experimentation with new tech while interacting with the mainnet.
Some practical uses include:
- testing code improvements for the mainnet without compromising its security and stability;
- providing faster and safer transactions for traders moving funds between exchanges and wallets;
- enhancing liquidity for exchanges and expediting deposits/withdrawals, boosting market efficiency.
For example, the Liquid Network sidechain enables BTC transfers between accounts across platforms in seconds. These transactions offer increased privacy with Confidential Transactions technology.
Read more about privacy-oriented cryptocurrencies in CP Media’s article.
Working Principles of Sidechains
Sidechains represent a decentralized infrastructure with advantages over main networks, such as:
- enhanced functionality;
- scalability options;
- faster transactions;
- lower fees;
- alternative consensus algorithms;
- increased privacy, etc.
In most cases, sidechains rely on the value of the underlying asset within the mainnet, which reinforces economic stability and community acceptance. For example, the Liquid Network enables the use of BTC without the limitations imposed by the Bitcoin mainnet. Key use cases for sidechains revolve around operations involving the underlying asset, which can be broken down into four primary stages:
- Sending. The underlying asset is sent to a cryptocurrency address on the main network, where it is “frozen.”
- Confirmation. The asset transfer is confirmed by the required number of network nodes. Some projects may use alternative validation methods, such as federated nodes or smart contracts.
- Receiving. An equivalent amount of wrapped tokens is received at a designated sidechain address, ready for full use.
- Return. To retrieve the underlying asset, wrapped tokens are sent to a “burn” address, unlocking the previously locked assets on the mainnet.
Each sidechain’s functionality can differ significantly. For instance, the Liquid Network focuses on handling BTC transactions outside the mainnet through its wrapped token, L-BTC, while the Rootstock sidechain offers broader functionality by enabling EVM-compatible smart contracts. This allows Bitcoin to interact within the Ethereum ecosystem via its wrapped token, RBTC.
Types of Sidechains
Several main types of sidechains are prevalent today, differing in how they interact with the main network and transfer value or data between chains:
- Pegged sidechains. Introduced by Blockstream in 2014, this technology operates through a “peg” mechanism. There are two types: a two-way peg, which enables asset movement between the main network and the sidechain in both directions, and a one-way peg, which allows assets to be transferred from the main network to the sidechain only, with no return option.
- Federated sidechains. Asset transfer here is managed by a group of trusted participants known as federated nodes. This sidechain model was detailed by Blockstream’s devs in the early 2017 paper “Strong Federations: An Interoperable Blockchain Solution to Centralized Third-Party Risks.”
- Non-pegged sidechains. These sidechains may have their own tokens and consensus mechanisms, interacting with the mainnet through smart contracts or bridges, without direct asset pegging.
Some technologies function similarly to sidechains but are technically not sidechains, which causes some confusion.
Sidechain or Not? Examining Related Technologies
Technologies that resemble sidechains include plasma chains, used within the Ethereum network. This technology provides a scalability solution that processes many transactions off-chain and periodically reports data to the main chain for security.
Another example is state channels, also used within the Ethereum ecosystem, allowing two or more participants to conduct an unlimited number of off-chain transactions, only recording the initial and final states on the blockchain. This approach improves transaction speed and reduces fees. A similar technique underpins the Lightning Network, which is considered Bitcoin’s Layer 2 solution.
Parachains in Polkadot and Kusama ecosystems offer comparable functionality to non-pegged sidechains. These are specialized blockchains that leverage resources from the main chain for security and interoperability. Additionally, rollup technologies, such as Optimistic Rollups and Zero-Knowledge Rollups, enable off-chain transaction processing, compressing them into a single transaction for recording on the main blockchain. Though they serve similar purposes, they aren’t technically sidechains.
Sidechains are often conflated with L2 and L3 solutions because they also aim to scale and expand the mainnet’s capabilities. However, sidechains have a key distinction. Layer 2 and Layer 3 solutions operate on top of the main blockchain (Layer 1) as an additional computational layer, while sidechains are independent blockchain networks with their own architecture, interfacing with the main network through mechanisms like pegs, bridges, and so on.
How Sidechains Drive Growth of Web3 Industry
The original idea behind sidechains has evolved significantly, giving rise to various methods for extending the functionality of main networks. For instance, the Ethereum ecosystem now supports numerous sidechains alongside the largest ecosystem of L2 and L3 solutions.
One of the most prominent Ethereum sidechains is Ronin, the blockchain supporting the popular Web3 game Axie Infinity. After experiencing a major attack with estimated losses of $625 million, the project not only recovered but grew substantially, becoming a specialized blockchain network for gaming Web3 projects and establishing its own ecosystem.
Ronin’s success lies in its simplicity — Ethereum’s base layer provides essential tools and infrastructure for interoperability, security, and compatibility, while the sidechain focuses on solving scalability and high-fee issues, delivering fast, affordable transactions for users.
Sidechains have also been implemented in ecosystems like BNB Chain, TRON, Cardano, Litecoin, Cosmos, EOS, Avalanche, Elrond, and others. They operate similarly to Ronin, targeting specific applications and offering tailored solutions based on the main network’s technological and reputational foundation. This approach suggests that sidechains will likely continue to emerge and evolve, serving as one of the key technological drivers for Web3’s ongoing development.
