This is the second in a two-part series on the mechanics of MakerDAO, POA Network, their native assets (dai and xDai), and state channels. If you have not yet read part one, we encourage you to do so before reading this article. Part one can be found here. In this series, we explain the fundamental mechanics of Ethereum’s most popular crypto-collateralized stablecoin and the methodology by which POA Network and state channels improve the transactability of Ethereum-based assets such as the dai stablecoin.
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While part one in this series explained the theory behind MakerDAO, POA Network, and their native assets, this section will take a more hands-on approach, explaining state channels and their practical usage.
Firstly, it is important to understand the difference between a state channel and a sidechain. While both state channels and sidechains have the same end-goal of scalability, they each take very different approaches.
Sidechains
As the name implies, a sidechain is a blockchain that operates alongside another (called the main chain) and is connected via two (or more) smart contracts (with at least one on each chain). These smart contracts lock up assets on one blockchain and issue them on the other, allowing them to pass back and forth between chains so as to make use of each’s features as desired.
Note that sidechains frequently use different consensus algorithms than their main chains in order to increase transaction throughput and that their security and immutability are separate and distinct to the that of the main chains.
State Channels
Much like sidechains, state channels require that a quantity of on-chain assets be locked up; unlike in a state channel, the assets are not then issued on a separate blockchain. Once on-chain assets are locked, the involved parties may then transact among themselves by signing transactions that can be submitted to the blockchain at a later date. As each new transaction has a nonce — the same way transactions on a blockchain have a nonce — state channel transactions have a provable topology which can be reconciled with the blockchain at a later time agreed upon by both parties.
By moving transactions off a blockchain and processing them in bulk at a later stage, significant improvements are made in both speed (as transactions are not limited by block time) and cost (as only two on-chain transactions need to occur for a state channel to be opened and closed).
It is important to note that the same cryptographic proofs that secure a blockchain also apply to state channels so—while open state channel transactions lack proof of work or any other consensus algorithm—the security of their transactions are comparable to that of an on-chain transaction.
Mike Ryan’s Chess Project
Mike Ryan is a software developer and information technology operations consultant specialized in building cloud infrastructure. On weekends, he likes to experiment with new technologies and sees Ethereum as an exciting sandbox for developers with an interest in blockchain.
Mike started developing on Ethereum last year when he built a Python library for Request Network’s API; he later launched SendCrypto Bot — a peer-to-peer (P2P) payments application that supports ether, dai, and various ERC-20 tokens on Twitter, Slack, Reddit, and Telegram.
On March 31, Mike announced his xDai-based chess project via Twitter and immediately caught the attention of Pink Sky Group. We quickly put out “Thinking Fifteen Moves Ahead: MakerDAO, xDai, and POA Network” and reached out to Mike to walk us through his project.
Here’s how it works:
- Alice and Bob create a new state channel on the xDai sidechain to play a game of chess, each sending their wager to the new channel.
- The game starts with a random state hash upon which both players agree before starting the game.
- Alice makes her move and the new hash is calculated by hashing the value of her move in Forsyth–Edwards Notation (FEN)—a shorthand designed to describe the movements of chess pieces—with the existing hash. For example, if Alice opens by moving her King’s pawn forward by two ranks, the input for the new hash will be current hash + e4.
- Alice sends a “State Change Proposal” to Bob, containing her move in FEN (e4), and the newly calculated state hash.
- Bob repeats the hashing calculation in step 3 in order to ensure that the move is valid before progressing the game.
- If the new hash calculated by Bob is the same as the one sent by Alice, he sends a “State Change Accepted” message to Alice and makes his move; if the hash does not match, he sends a “State Change Rejected” message and the game is aborted.
- The game continues until it is aborted or one player wins, in which case the players close the state channel and the winner collects their earnings.
The Endgame: Fostering Adoption
While there are a few bugs to work out — such as how to prevent a player from refusing a valid State Change Proposal— Mike’s chess project represents a compelling use of two important scaling solutions (state channels and sidechains) and a fun, simple use case for an important decentralized finance tool (xDai). More importantly, the project takes the industry one step closer to wider blockchain adoption and consumer appeal.
As is the case with many new blockchain technologies, Pink Sky Group expects the adoption of decentralized finance to begin with gaming. As evidenced by the ERC-721 token standard—which was popularized by CryptoKitties and paved the way for new technologies and use cases—blockchain-based gaming presents a fun and low-risk sandbox in which developers like Mike can build, fostering blockchain adoption step-by-step as the market broadens its appeal.
If you would like to learn more about the capabilities and use cases of state channels, Mike recommends Counterfactual’s resources, which can be found here.
NB: This article may contain terms with which you may not be familiar. Pink Sky Group maintains a glossary of blockchain-specific technical terminology for your convenience, which can be found here.
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