The Blockchain Trilemma
Trade-offs between decentralization, scalability and security
he invention of Bitcoin brought innovations to accounting, and storing and exchanging value. Ethereum iterated on Bitcoin by making it possible to support programmable smart-contracts transforming the functionality of a blockchain beyond to allow a bigger range of contractual logic. On such a platform, applications are then built that attempt to find product-market fit in the blockchain ecosystem such as Aave, Uniswap or Chainlink. One might wonder, why are there so many different blockchains to build upon, and are any of these ‘alternative Layer-1’ blockchains investable from a crypto asset management perspective?
From the top-100 digital assets by market capitalization on Coinmarketcap.com, 56 crypto assets can be designated as a Layer-1 blockchain, showcasing that a majority of large and mid-cap digital assets are currently a base-layer. The core reason for the proliferation of more and more blockchains is the blockchain trilemma.
The blockchain trilemma refers to the idea that a blockchain needs to make a trade-off amongst the following 3 core attributes: Security, Scalability, Decentralization.
Decentralization refers to how control is distributed amongst the node participants of the blockchain network. A high amount of decentralization refers to many node participants using their computing power and/or staking power to control a small part of the network. A low amount of decentralization means that one, or a few entities can control a blockchain network, therefore sacrificing a core property of why blockchains can be better than centralized web2.0 systems. Metrics such as the Nakamoto Coefficient attempt to measure such decentralization.
Scalability in blockchains is largely similar to web2.0 systems referring to the number of transactions and throughput a network can handle. Scalability is important for mass adoption, particularly in blockchains that are not the Bitcoin network (store-of-value), since otherwise the utility of a utility blockchain is fairly limited.
Blockchains are inherently secure, by the way of their design. While scalability focuses on the upside of the utility of the network, security focuses on the downside. More specifically, preventing the downside by having a good security model. Promising blockchain use cases have faced setbacks that stifled their growth, such as the notorious DAO attack resulting from improper source code security.
Does the trilemma exist?
All Layer-1 blockchains attempt to differentiate themselves from the pack with a big set of different design choices. Some attempt to ‘solve’ the trilemma by attempting a design that supposedly does not have any of the trade-offs. Others try to fill a market need that is/was not filled by the Layer-1 Blockchain Ethereum. Ethereum is high on decentralization and security, but compared to many alternative Layer-1 blockchains, low on scalability. An example of a design trade-off to this extent is for example the BNB-chain that has a higher throughput that scales better but a lower amount of decentralization and security showcased by the limited number of validators for the network.
There is no law stating that the 3 aspects cannot be achieved. But to date, teams have worked on different approaches in an attempt to maximize decentralization, scalability, and security. In general, any of the layer-1 projects or projects building on top of layer-1 blockchains attempt to mitigate the trilemma by any of the following design choices:
- Innovate a new layer-1 blockchain and claim to innovate to have fewer/none of the trade-offs in the trilemma (e.g., Solana, Aptos, Sui) - Design a blockchain of blockchains in a certain manner that share security but increases throughput and scalability of the total network (e.g., Cosmos Ecosystem, Polkadot + parachains, Avalanche + subnets, Ethereum + Layer-2s like side-chains/ roll-ups.) - Interoperate your decentralized application by using multiple blockchains, letting each blockchain service the needs of your application with different types of interoperability middleware (first cross-chain applications expected to launch at the end of 2022). - Execute, less critical, but computationally expensive parts of your smart-contract off-chain, with or without decentralized oracle networks making off-chain computations secure.
Investing in alternative Layer-1s?
Fourstack carefully follows the Layer-1 ecosystem and is an investor in alternative Layer-1s through our Ophir offering. These Layer-1s offer a different set of attributes than Ethereum. The future is likely multi-chain with Ethereum + its scaling solutions alongside a few other dominant Layer-1 blockchains. Alternative layer-1 blockchains are important to investigate as they play a pivotal part in the progression and adoption of blockchains. We will map out the different dominant Layer-1 blockchains in the future with their up and downsides, for now Ethereum is the dominant Layer-1 with a market share in DeFi of approximately 56%.