Most successful innovations take off in a similar way: You create something people want, and as sales increase, economies of scale make it cheaper to produce, increasing demand. For crypto, it is not so simple. As the volume of activity involving tokens like Bitcoin and Ether grows, the slower and more expensive it becomes to record and secure each transaction. There are various measures to fix the problem, but all of them either make the system more vulnerable to bad actors or dilute the decentralized model that is key to crypto’s appeal. This “Blockchain Trilemma” is one of the most difficult challenges for mainstream adoption of crypto technology.
The “Blockchain Trilemma” Holding Back Crypto
Public blockchains are the engine room of crypto. These digital ledgers record account balances, contract codes and other data using complex digital keys. The knowledge that these records are public, and cannot be deleted, changed or copied, creates the trust that allows dispersed groups of collaborators to work or trade together on blockchains without the need for an intermediary. This trust is reinforced by duplicating and verifying the information across multiple computers in a network. For this reason, many original blockchains cannot process more transactions than a single computer in the network can handle. This can cause blockchains to be overwhelmed by the volume of work, causing delays and exorbitant costs to users, especially during intense crypto market activity. As of September, Bitcoin was unable to handle more than around seven transactions per second, and Ethereum, the second most popular crypto network, was limited to around 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 properties: its decentralized structure, which provides 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 can’t 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 cannot scale on their own. He proposed adding a simpler, more efficient secondary system on top of the main blockchain. “Bitcoin by itself cannot scale to have every single financial transaction in the world broadcast to everyone and included in the blockchain,” Finney wrote in a forum back in 2010. Ethereum co-founder Vitalik Buterin coined the term “Blockchain trilemma” in 2017, lays 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 dilute decentralization or security for the sake of scalability. Here are some approaches:
• Larger blocks: a blockchain is modified to aggregate transactions into larger packets before they are validated and added to the network, improving performance. This can be achieved by splitting a new blockchain 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 proposed. Some examples of these so-called “Layer-2” protocols are Ethereum’s Polygon and Bitcoin’s Lightning Network.
• Sharding: Break chunks of data into smaller parts to spread the workload of computation and storage across the network. The information in one shard can still be shared, which helps keep the network relatively decentralized and secure.
5. What is the impact of the trilemma?
It wasn’t a problem 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 a hindrance. Ethereum’s periodic congestion and high fees have seen it lose market share in decentralized finance applications to competing blockchains such as Binance Smart Chain and Solana, which can be faster and cheaper as they can use fewer parties to order transactions. Between the start of 2021 and September 2022, Ethereum’s market share in DeFi, expressed in 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.
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