The ‘Blockchain Trilemma’ That’s Holding Back Crypto

The ‘Blockchain Trilemma’ That’s Holding Back Crypto

Most successful innovations take off in a similar way: You create something that people want and, when sales increase, economies of scale make it cheaper to produce, stoking more demand. For crypto, it’s not that simple. As the volume of activity involving tokens like Bitcoin and Ether grows, the slower and costlier it becomes to record and secure each transaction. There are various efforts to fix the problem, but all either make the system more vulnerable to bad actors or water down the decentralized model that’s key to crypto’s appeal. This “Blockchain Trilemma” is one of the thorniest challenges to mainstream adoption of crypto technology. 

Public blockchains are crypto’s engine room. 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, engenders the trust that allows dispersed groups of collaborators to work or transact together on blockchains without the need for an intermediary. That trust is reinforced by duplicating and verifying the information across multiple computers in a network. For this reason, many original blockchains can’t process more transactions than a single computer in the network can handle. This can lead to blockchains being overwhelmed by the volume of work, causing delays and exorbitant costs for users, especially during bouts of intense crypto market activity. As of September, Bitcoin was unable to handle more than about seven transactions per second and Ethereum, the second-most popular crypto 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 confers the transparency and user trust for it to function independently of third parties and governments, and its security (protecting the data from hackers). In short, you can have “scalability,” decentralization or security, but you cannot have all three. 

3. Did anyone see this coming?

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

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

• Bigger blocks: a blockchain is altered to bundle transactions into larger packets before they are validated and added to the network, improving its performance. This can be achieved by splitting a new blockchain off from the original one in a process known as “forking.” Bitcoin Cash is among the most prominent of these offshoots.

• New layers: A protocol built on top of an existing blockchain that can manage transactions independently — something more akin to what Finney was suggesting. Some examples of these so-called “Layer-2” protocols are Ethereum’s Polygon and Bitcoin’s Lightning Network.

• Sharding: Splitting chunks of data into smaller parts to spread the computational and storage workload across the network. The information in one shard can still be shared, helping to keep the network relatively decentralized and secure.

5. What’s the impact of the trilemma? 

It wasn’t a problem back when crypto was a niche technology used by a core of enthusiasts. Now that traditional finance and other mainstream industries are turning to blockchains as a transparent, 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 to rival blockchains such as Binance Smart Chain and Solana, which can be faster and cheaper as they are able to use fewer parties to order transactions. Between the start of 2021 and September 2022, Ethereum’s market share in DeFi, expressed in terms of total value locked, fell to 58% from 96%, according to data platform Defi Llama. Its backers hope to overcome these problems when they change the way the platform orders transactions. 

More stories like this are available on bloomberg.com

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