When it comes to taking blockchain technology mainstream, scalability is a major issue. While established companies like VISA can process thousands of transactions every second (with a peak of 56,000 per second) blockchain networks are several orders of magnitude slower. Ethereum currently has an estimated capacity of 20 transactions per second.
That’s why the idea of payment channels built from Ethereum smart contracts is so attractive. The Raiden Network is a project aiming to use these channels to enable near instant asset transfers, and micropayments. Transactions would be confidential and would scale linearly with users, potentially reaching 1-million transactions per second. This is all possible because these transactions would happen off-chain.
Basically, two parties would enter an amount of Ether into a smart contract. Then, using signed transfer agreements they could send any amount of Ether back and forth, using Raiden nodes. These Raiden nodes would be implemented as an Ethereum extension through an API, so any funds transferred would happen off-chain, in Raiden. Due to this, there is no gas cost, so fees are incredibly low. Parties would even be able to send payments to users they’re not directly connected with by chaining transactions through a mutual party. That intermediary could collect a small fee for their service, and allow for these lightning fast transfers to occur, all outside of the Ethereum blockchain.
These transactions can happen in millionths of a dollar, so the applications are wide, especially regarding potential uses in the Internet of Things, and machine-to-machine transactions. The blockchain would mainly act as an arbiter in case of an off-chain dispute.
In a functional, healthy system between two parties, if one needed to close out the channel, they would simply call a function on the smart contract using a signed state message. This action initiates a settlement period for the other party to either confirm the state, send a more up-to-date signed state message, or just wait out the settlement period. The most recent, signed state message is what determines who actually holds what funds. After one of those scenarios unfolds, the channel is closed, and both parties’ funds are released to them. It’s only then that anything is recorded in the blockchain. Any small transfers back and forth, no matter how many, are all off-chain until someone calls in a function to close the contract.
Since the parties interacting are confirming their transactions through signing them, the exchange works via the same cryptographic protocols that keep on-chain Ethereum transfers safe. While thousands of simultaneous transfers could bottleneck in Ethereum, a system like Raiden could solve a serious scalability issue by handling them all simultaneously.
Raiden is still under development, but could be implemented with the current version of Ethereum. They expect to have a minimum viable product by the beginning of 2017.