A Cryptocurrency Transaction Layer
I’m currently working for Herdius, a blockchain startup from Berlin. The team is working on some very interesting technology. But to me, the most relevant aspect is what said technology amounts to and whether or not it has the potential to make an impact. One term that we use a lot when discussing Herdius is cryptocurrency transaction layer.
Today, I want to shed some light on this concept.
Since this year’s blockchain and cryptocurrency-related headlines were dominated by Bitcoin’s price surges and flash crashes — which of course meet many of the media’s 24/7 news cycle eligibility requirements — it’s all too easy to forget that we are still in the early stages of the technology’s development. Many challenges remain to be solved and fundamental questions to be answered. Just read Preethi Kasireddy’s excellent post to get a good idea of what I’m referring to:
Fundamental challenges with public blockchains
There’s no question that blockchain technology has enormous potential.
Why is a transaction layer necessary?
Today, when users transact cryptocurrencies, those transactions are usually handled by the blockchain of the respective cryptocurrency. And if a trade involves multiple cryptocurrencies, all the different blockchains are required to verify the transactions. Which would be fine if all those blockchains were (1) scalable systems that can handle a high volume of transactions and (2) interoperable, i.e. able to directly communicate with each other.
Since neither condition is currently met, two problems are being introduced. For one, transactions can, depending on the respective blockchain, take a fair amount of time before being processed. It’s not unusual for a Bitcoin transaction to take 20 minutes before being validated. Moreover, transactions can become fairly expensive, as the validating nodes (e.g. “miners” in Bitcoin) usually increase their transaction fees if their services are in high demand.
Moreover, as the interoperability between blockchains is limited, users rely on cryptocurrency exchanges like Kraken or Bitfinex to make their exchanges (atomic swaps are still in early experimental stages). Today, basically all relevant exchanges are central entities. Now, while the very word centralized sounds problematic to many in the blockchain community, it’s not an issue per se. However, in the case of cryptocurrency exchanges, it introduces some very real concerns.
Most fundamentally, it requires users to trust the entity that operates the exchange. While a core innovation of blockchain systems was to enable peer-to-peer systems that operate reliably without trust between the peers (by making the systems Byzantine Fault-Tolerant), today’s exchanges make trust a factor again. It matters in several ways: centralized entities introduce counterparty risk, they often become targets for hackers, and their software quality is highly important. They present single-points-of-failure in an ecosystem that was created to get rid of those.
Introducing the transaction layer
The idea of a cryptocurrency transaction layer is pretty straight-forward. It is a highly-scalable, trustless peer-to-peer system that provides a great user experience for transacting and trading all kinds of crypto assets. It, thus, sits between the users of crypto assets and the root blockchains (or tangles, or hashgraphs) on which those assets are issued. Below is a picture from a Herdius presentation that illustrates the idea:
Why is a transaction layer necessary?
The number of cryptographic assets has increased dramatically over the last few years (coinmarketcap now lists almost 1,400 cryptocurrencies and tokens). As blockchain technology becomes more popular and better understood, it is likely that the number will continue to increase as more and more use cases are being implemented (e.g. tokenized contracts, tokenized assets etc.)
Yet interoperability between the different systems and consensus mechanisms will likely remain an issue for the foreseeable future. The same goes for scalability. In the case of the best-known blockchain, bitcoin, we just witnessed (pun intended) the segwit2x debate and the eventual cancellation of the update that would have helped bitcoin to scale. The case illustrates nicely that it’s not simple to make fundamental changes to established blockchain systems, particularly not to those that don’t have a central entity in control.
So, in order for cryptocurrencies and other crypto assets to be technologically ready for mainstream adoption and large-scale use cases, it will take a different solution. Namely, a transaction layer.
Transaction Layer Requirements
Now, there are several conditions a transaction layer should meet.
For one, it should be a distributed system, not a centralized one. The reason to build a transaction layer is to create a valuable piece of infrastructure for the blockchain ecosystem. Therefore, it needs to be a trustless system. It’s a philosophical requirement — as getting community support is otherwise unlikely — and also a practical one: building, maintaining and growing the technology and the ecosystem that is required to implement a transaction layer is clearly not a small endeavor. So it will take buy-in from many different ecosystem participants. And the resulting technology should clearly be an open protocol, not proprietary technology, if adoption is a major goal (which it clearly is).
Moreover, the system needs to be able to handle any kind of crypto asset. As, per my prior assumptions about the market’s future development, it’s fair to assume that most crypto assets haven’t been created yet. That turns handling them in a non-centralized way into a technological challenge. But it is feasible. For example at Herdius, the solution centers around the one common feature of all crypto assets: they use private keys which are stored inside of wallets. So, instead of building a solution that require nodes of all the blockchains to cooperate, Herdius focuses on distributed, virtual wallets (DIVIWA) which handle private keys in a distributed way, thereby eliminating the downsides that centralized wallets come with.
Finally, the purpose of a transaction layer (as well as the applications built on top of it) is to function as the interface between users and the rootchains of the various crypto assets. Thus, the user experience needs to be a major area of focus. That goes for the user experience of end users and institutional users alike (the latter would be a key beneficiary of such a system!). The core of a great user experience are short transaction times across all crypto assets, high security standards and, of course, applications with a great usability.
The idea of a transaction layer for cryptocurrencies is, in my estimation, a very interesting approach that has the potential to make cryptocurrencies and other assets more accessible to new users. While it is hard to predict the future in emerging technology markets, I believe that transaction layers present a path to mainstream adoption. As such, it is an idea that I think is definitely worth pursuing. If you are interested in the concept, check out what Herdius is doing (here’s a good starting point). And if you have any feedback or questions, leave a comment.
Disclaimer: Herdius is a project by the Berlin, Germany-based Herdius GmbH. Herdius will start its initial coin offering (“ICO”) in Q1 2018. All relevant information regarding Herdius and the initial coin offering can be accessed at www.herdius.com.