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The interconnection of different cryptocurrency networks and reducing dependence on centralized exchanges represents a crucial challenge, parallel to the issue of network scalability. Currently, when users wish to exchange one cryptocurrency for another (such as Bitcoin for Litecoin), they must use intermediary platforms and pay associated fees. Sidechain technology offers a potential solution to this challenge. Let's explore what sidechains are.
UNDERSTANDING CRYPTOCURRENCY SIDECHAINS
A sidechain represents an independent blockchain that maintains a bidirectional connection with a primary blockchain. It functions as a distinct chain built upon another blockchain, capable of both receiving and sending back transactions. This innovation emerged in 2014, with Blockstream pioneering the concept through their White Paper, which detailed the sidechain mechanism. We've previously explored sidechain fundamentals and operational principles in our earlier content.
CRYPTOCURRENCY SIDECHAIN PURPOSES
Sidechains serve three key functions:
- Testing Environment: They provide a platform for testing main blockchain updates without risking the primary chain.
- Business Applications: They enable more cost-effective transfers, as demonstrated by Blockstream's Liquid platform, which serves trading platforms and payment processors.
- Cross-Network Transactions: They facilitate efficient, economical transfers between different cryptocurrency networks.
These capabilities suggest that sidechains could revolutionize the cryptocurrency ecosystem, expanding user possibilities significantly.
LIMITATIONS OF CRYPTOCURRENCY SIDECHAINS
The primary drawback lies in the requirement for federations - intermediary bodies between the main chain and auxiliary blockchains. These federations control the freezing and release of coins transferred from the parent chain. This structure introduces centralization risks, as sidechain developers can influence federation composition.
Currently, several projects implement sidechain technology, including Blockstream's Liquid, Rootstock, and Ardor. The Lisk team is also exploring this technology's potential.
