The “blockchain trilemma” holding back cryptocurrencies

The most successful innovations take off in a similar way: you create something people want, and when sales increase, economies of scale make it cheaper to produce, fueling more demand. For cryptocurrencies, it’s not that simple. As the volume of activity involving tokens such as Bitcoin and Ether increases, the slower and more expensive it becomes to record and secure each transaction. There are various efforts to fix the problem, but all of them make the system more vulnerable to the bad guys or water down the decentralized model that is the key to the appeal of cryptocurrencies. This “blockchain trilemma” is one of the thorniest challenges for mainstream adoption of crypto technology.

Public blockchains are the engine room of cryptocurrencies. These digital ledgers record account balances, contract codes and other data using complex digital keys. The knowledge that those records are public and cannot be deleted, altered or copied generates the trust that allows dispersed groups of collaborators to work or trade together on blockchain without the need for an intermediary. This trust is strengthened by duplicating and verifying information on multiple computers in a network. For this reason, many original blockchains cannot process more transactions than a single computer on the network can handle. This can lead to blockchains becoming overwhelmed by the volume of work, causing delays and exorbitant costs for users, especially during periods of intense cryptocurrency market activity. As of September, Bitcoin was unable to handle more than about seven transactions per second, and Ethereum, the second most popular cryptocurrency network, was limited to about 15 per second – a lifetime compared to conventional electronic exchanges.

2. Why is this a trilemma?

Because expanding a blockchain beyond a certain point inevitably compromises two of its fundamental characteristics: its decentralized structure, which gives it transparency and trust to the user to function independently from third parties and governments, and its security (protecting data from hackers). In short, you can have “scalability”, decentralization, or security, but you can’t have all three.

3. Has anyone seen it coming?

Yes. Computer scientist Hal Finney, who received the first Bitcoin transaction from pseudonymous token founder Satoshi Nakamoto, pointed out early on that blockchains in their original design cannot scale on their own. He proposed adding a simpler and more efficient secondary system on top of the main blockchain. “Bitcoin itself cannot be scaled so that every single financial transaction in the world is broadcast to everyone and included in the blockchain,” Finney wrote in a forum in 2010. Ethereum co-founder Vitalik Buterin coined the term “Blockchain trilemma “in 2017, defining the trade-offs needed to achieve” scalability “.

There have been several innovations to improve blockchain performance, but a closer look shows that they all water down decentralization or security for scalability reasons. Here are some approaches:

• Larger Blocks: A blockchain is modified to group transactions into larger packets before they are validated and added to the network, improving its performance. This can be achieved by separating a new blockchain from the original one in a process known as “forking”. Bitcoin Cash is among the most important of these offshoots.

• New Layers: A protocol based on an existing blockchain capable of handling transactions independently, something more like what Finney suggested. Some examples of these so-called “Layer-2” protocols are Ethereum’s Polygon and Bitcoin’s Lightning Network.

• Sharding: Splitting blocks of data into smaller pieces to distribute the processing and storage workload across the network. The information in a shard can still be shared, helping to keep the network relatively decentralized and secure.

5. What is the impact of the trilemma?

It wasn’t a problem when cryptocurrencies were a niche technology used by a core of enthusiasts. Now that traditional finance and other traditional industries are turning to blockchains as a transparent and trusted environment for exchange and collaboration, these limitations are increasingly an obstacle. Ethereum’s periodic congestion and high fees have led to it losing market share in decentralized finance applications compared to rival blockchains such as Binance Smart Chain and Solana, which can be faster and cheaper as they are able to use fewer parts to order. transactions. Between early 2021 and September 2022, Ethereum’s market share in DeFi, expressed in terms of total value locked, dropped to 58% from 96%, according to the Defi Llama data platform. Its supporters hope to overcome these problems when they change the way the platform orders transactions.

More stories like this are available at bloomberg.com

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