↔️State Channels

"State channels are a very broad and simple way to think about blockchain interactions that could occur on the blockchain, but instead get conducted off of the blockchain, without significantly increasing the risk of any participant."

Jeff Coleman

Scenario 🌟

Imagine a scenario where Emily owns a cozy coffee shop ☕, and Jack is a frequent customer. Jack prefers to pay for his coffee in small increments, at a rate of $2 per cup. To streamline this process and avoid numerous small transactions, they decided to use a Layer 2 solution: a state channel.

Here's the process:

1. Initial Setup: Jack deposits $20 (or its equivalent in ETH or a stablecoin) into a smart contract. This deposit is like a prepaid coffee card ☕💳, intended for his future purchases.

2. Purchasing Coffee: Each time Jack buys a cup of coffee, he sends an off-chain digital "ticket" 🎫 to Emily. The first ticket is marked "$2", representing his payment for the first cup. For his second cup, he sends a ticket marked "$4", and this pattern continues with each purchase.

3. Closing the Tab: When Jack decides to settle his bill, Emily presents the last ticket he sent – say it's "$16" after 8 cups of coffee – to the blockchain. The smart contract verifies the signatures of both parties, transfers $16 to Emily, and refunds the remaining $4 to Jack 💰.

4. Security Measures: If Emily, for any reason, doesn't close the channel, Jack can initiate a withdrawal period, like 7 days 🗓️. If Emily fails to submit the highest-value ticket within this period, the smart contract automatically refunds Jack's full deposit. 🛡️🔒

Ups and Downs ⬆️⬇️

Upsides:

1. Efficient Microtransactions 💰: In scenarios like Emily's coffee shop, state channels enable small, frequent transactions (like buying coffee) without congesting the blockchain. This is similar to Jack buying his $2 coffee without needing a blockchain transaction for each cup.

2. Flexible and Versatile 🤹: These channels can handle various types of transactions, from simple payments to complex contracts. For instance, if Emily decides to offer a loyalty program or special discounts within the same channel, it can be easily integrated.

3. Interconnected Networks 🔗: If Emily has a channel with Jack, and Jack has another with another vendor, transactions can be indirectly facilitated, creating a network of interconnected channels.

4. Strong Privacy Properties 🕵️‍♂️: Transactions within a state channel are private, and shared only between participants.

5. Instant Finality ⚡: State updates are considered final as soon as both parties sign, offering a high guarantee of enforceability on-chain.

Downsides:

1. Limited to Chain Participants 🔒: Channels cannot be used to send funds off-chain to people who are not yet participants.

2. Capital Lockup 💸: Jack's initial deposit is locked in the channel until transactions are settled. This can be a downside for users who don't want their funds tied up, similar to how larger, more complex channels require significant locked capital.

3. Operational Complexity 🛠️: Managing a state channel, especially for more complex arrangements, can be technically challenging. In the coffee shop scenario, if Emily wants to integrate more sophisticated services into the channel, it would require a deeper understanding and management of blockchain technology.

4. 100% Availability Requirement 🚨: All participants must be constantly available, as unavailability could be costly. While representatives can be used, they pose risks of attack or bribery.

Optimal for 🎯

Defined Participant Sets

State channels require known participant addresses, and changing participants necessitates contract modifications, unlike sidechains.

Long-Term, Frequent Exchanges

Due to the initial cost of setting up a channel, they are most efficient for long-term use with many state updates.

Examples and resources 📚

1. State Channel Applications by Liam Horne - Medium: This article can provide insights into, why it is difficult to design state channels on Ethereum now, how state channels could be applied in various business models and a technical overview of the needed layers in a state channel
2. Building a State Channel Application - Devcon Archive: Tom Close's talk from Magmo, where he talks about the hardships of building state channels and state management in the context of a rock paper scissors game they built with state channels.
3. Difference Between SideChains and State Channels - Thomas J. Ackermann: Useful for understanding the technical aspects of state channels, which could be beneficial for complex implementations in a business setting.
4. State Channel as a Service Based on a Distributed and Decentralized Web - IEEE Xplore: This resource explores advanced applications of state channels, which could inspire innovative uses in various business models, including retail or service industries like a coffee shop.
5. An Incomplete Guide to Rollups: Vitalik Buterin's 2021 Jan 05 article to Rollups
6. State Channels: Jeff Coleman's article provides a comprehensive explanation of state channels and their components