Going Off-Chain To Turbocharge Asset Swaps Across Exchanges

Every blockchain has a scalability problem, as they struggle under the weight of increased workloads as their user bases grow. When we talk about scalability, we’re referring to the blockchain’s ability to process a high volume of transactions at reasonable speed. 

Blockchains must find a way to achieve high scalability if cryptocurrencies are ever to become mainstream. Otherwise, we will reach a point at which they can no longer process everyone’s transactions in good time. If they cannot do this, users will reject blockchains and continue to use traditional payment mechanisms. 

So far, blockchains have proven themselves to be inadequate. The world’s most famous cryptocurrency Bitcoin is well known for processing transactions at a snail’s pace, with its scalability limited to a miserable 7 transactions per second. Ethereum doesn’t do much better, with its 20 TPS rate. Compare this to Visa, which can process a whopping 24,000 TPS, and it’s clear that blockchains have a major problem. 

Why Can’t Blockchains Scale?

There are a number of factors that determine the scalability of blockchains. The major one is their throughput, which is a measure of how many actions they can perform over a certain period of time. In the case of blockchains, transaction throughput relates to the speed at which they can validate and add transactions. 

Meanwhile, the blockchain network itself has an impact on scalability. Blockchains are decentralized networks made up of hundreds, if not thousands of individual nodes, and every transaction that is mined must be broadcast to the others. Doing this requires a lot of time and resources, and often leads to delays in block confirmation and consequently, network congestion. 

Another issue relates to capacity. Blockchains are a ledger that records every transaction ever made, and the more they grow, the more data they store. The more this data increases, the greater the storage resources required by each node. As such, it’s not only throughput that determines blockchain scalability. For instance, if we were to speed up Bitcoin’s throughput to 1,000 TPS, it still wouldn’t scale because of the time it takes to confirm each block. 

It’s also necessary to mention the age-old “blockchain trilemma”, which refers to the fact that blockchains cannot achieve decentralization, security and scalability at the same time. The architecture of blockchains means that one must always be sacrificed in order to achieve the other two. This is because blockchains are peer-to-peer networks. We’ve already mentioned that an increase in nodes has a negative impact on scalability. But if we decrease the number of nodes, this results in a more centralized network that’s inherently less secure. Because decentralization and security are so essential to the belief in Web3, it’s usually always scalability that gets sacrificed. 

Scaling Transactions Off-Chain

Numerous scaling solutions have been proposed and implemented to help blockchains achieve the scale necessary for wider adoption, and many of the most promising ideas involve processing transactions off-chain in order to reduce network congestion. 

Many of these Layer-2 scaling solutions work great for individual users and decentralized applications, but they can be complex to implement in the crypto trading world, where numerous exchange platforms require a way to process high volume transactions with one another at near instantaneous speeds. 

To solve the problem of cross-chain asset swapping between exchanges, a more advanced solution is required and for that, we can turn to the Layer-3 network Yellow. 

Yellow has created a cross-chain and peer-to-peer network overlay that can facilitate transactions between numerous parties at once by pooling available liquidity from many different networks and participants. It acts as a kind of clearing house for centralized and decentralized exchanges to trade with one another off-chain using state channels. 

The constituents of Yellow’s architecture include a Financial Information Exchange, which serves as a relay network that enables CEXs, DEXs and other brokers to send messages that facilitate individual transactions between one another. The Electronic Communication Network optimizes buy and sell order matching for these participants, while state channels are opened to facilitate the rapid off-chain exchange of assets. When opening a state channel, each participant must deposit collateral within its governing smart contract to cover the balance of all of the traders they plan to make.

Yellow provides a way for numerous parties to engage in high volume trading with immediate finality, with its state channels aiding scalability by only settling the final “state”, or balance at the end of a string of transactions, on the blockchain when it’s closed. Using state channels, governed by Yellow’s architecture, exchanges can essentially perform an unlimited number of cross-chain asset swaps without overwhelming the underlying blockchains. Because the final transaction is recorded onto the blockchain, the system remains as secure as the blockchain itself. 

Within a state channel, each individual transaction is signed by both parties and settled immediately, off-chain, with a smart contract keeping a track of the balance. To close a channel, all participants are required to sign the final transaction before the sum of all of those transactions is verified by the blockchain. 

The beauty of state channels is that each message contains something known as a “nonce”, which can be thought of as a timestamp. Using the nonces, the smart contract can understand the chronological order in which each message, signed by all counterparties, was sent. The smart contract will always settle the state based on the final message that’s signed by all participants within the channel. This prevents foul play, such as one party attempting to close the state channel with an earlier message that doesn’t reflect the true balance of all of the transactions. 

Infinite Scalability

By utilizing state channels as a Layer-3 infrastructure, Yellow Network promises to transform digital asset swaps between crypto exchanges by providing the rapid cross-chain interoperability they need to transact in real-time. 

The network operates independently of the underlying blockchains, enabling them to scale to an infinite degree. In this way, Yellow can potentially process millions or even billions of individual transactions every hour of every day, for any blockchain platform. It has created the infrastructure that’s required to make high-frequency cross-chain trading a reality for every exchange, and with that, crypto finally has the ability to reach mainstream adoption.