State channels are a way to address blockchain scalability by securely handling transactions off the blockchain. Ethereum allows to abstract from payment channels to universal state channels.

1. STATE
CHANNELS
BLOCKCHAIN SCALABILITY VIA STATE
CHANNELS

2. PROBLEMS ADDRESSED
BY STATE CHANNELS
Scalability - Tens of thousands transactions per second
possible
Privacy - None public transaction possible
Confirmation delay: instant transaction confirmation possible
-> Still trustless/ without counter party risk

3. BITCOIN - PAYMENT
CHANNEL
Alice wants to charge a E-car and pay Bob every second
A locks money in a multisig address (2 out of 2)
100mBTC in multisig:
1) Alice signs transaction with two outputs 1mBTC to Bob, 99 to Alice
2) Alice signs transaction with two outputs 2mBTC to Bob, 98 to Alice
3) Alice signs transaction with two outputs 3mBTC to Bob, 97 to Alice
….
Only Bob can submit transactions because his signature is missing
Bob would only submit the latest transaction

4. BITCOIN - PAYMENT
CHANNEL
Limitations: Payments only in one direction
Next step: Lightning network - invalidate older transactions by punishment
transaction
1) Alice signs transaction with two outputs 1mBTC to Bob, 99 to Alice
2) Alice signs transaction with two outputs 2mBTC to Bob, 98 to Alice
3) Alice signs transaction with two outputs 3mBTC to Bob, 97 to Alice
Bob signs a transaction that would spend the 3mBTC
With Ethereum: Much simpler and in a general way possible

5. SEQUENCE OF STATE
CHANNELS
1. two (or more) people lock up some tokens or any state description
they totally control.
2. this state can only be updated on the blockchain with a signed
message of all group members
3. the members of the group can internally do transactions by creating a
new state and letting it sign by everyone. The new state also has a
nonce (sequence number)
4. if members of the group stop cooperating the latest state can always
be written on the blockchain
5. to write the state on the blockchain anyone can submit a signed state
and a small security deposit - this will trigger a challenge period. During
this period a newer state (higher nonce) can be submitted, in this case
the first submitter would lose its deposit.
6. If a state remains unchallenged it will be written on the regular
blockchain

6. EXAMPLE -
PREDICTION MARKET
Alice and Bob wants to bet against each other.
1. Lock money
2. First transaction: Alice bets on Hillary, Bob on Sanders
(could sign the transaction or just the resulting state)
seq. nr. 0 | (A:50ETH/B:50ETH) |
seq. nr. 1 | (A:40ETH, 20 Hillary shares/B:
40ETH 20 Sanders shares) | signatures

7. EXAMPLE -
PREDICTION MARKET
3. Second transaction: Alice makes another bet on Hillary
seq. nr. 2 | (A:25ETH, 40 Hillary shares/B:
35ETH 40 Sanders shares) | signatures
seq. nr. 1 | (A:40ETH, 20 Hillary shares/B:
40ETH 20 Sanders shares) | signatures
4. Sanders wins
4a. If they cooperate they can just update the off-chain state to:
seq. nr. 3 | (A:25ETH,/B:75ETH) | signatures
4b. If Alice does not cooperate Bob can settle state 2
(submit it to the blockchain)
4c. Alice could try to cheat and settle state 0 or 1 - > Bob can
challenge this by submitting state 2 during the challenge period

8. HASHLOCK - (1/2)
TRANSITIVE TRANSACTIONS
Alices - Bob Bob - Charly
seq. nr. 0 | (A:50ETH/B:50ETH) | seq. nr. 0 | (B:50ETH/C:50ETH) |
Alice wants to send Charly 10 ETH but hasn't locked money
with him.
seq. nr. 1 | (A:40ETH/B:60ETH
) | signatures | HASHLOCK (only
known by Alice)
Solution - Alices sends 10 ETH to Bob in channel 1 and Bob
sends 10 to Charly in channel 2
Problem - Who makes the first transaction? -> Hashlock
seq. nr. 1 | (B:40ETH/C:60ETH
) | signatures | SAME HASHLOCK
(only known by Alice)
Alice can publish the HASH-LOCK

9. HASHLOCK - (2/2)
TRANSITIVE TRANSACTIONS
seq. nr. 1 | (A:40ETH/B:60ETH
) | signatures | HASHLOCK (only
known by Alice)
seq. nr. 1 | (B:40ETH/C:60ETH
) | signatures | SAME HASHLOCK
(only known by Alice)
What if
a) Alice creates the transaction to Bob but Bob does not create the
transaction to Charly
-> than Alice does not reveal the Secret
b) Alice reveals the secret of the transaction only to Charly?
-> as soon as Charly puts the secrete on the Blockchain Bob knows it
as well
c) What if Alices does not reveal the secret at all?
-> there needs to be an expiry date where funds are freed anyway
Alices - Bob Bob - Charly

10. CODE REVIEW

11. FINAL THOUGHTS
- more money locked than necessary
- make a bid - revoke the bid
mini - side chain
The court

12. READ MORE
Off chain trading on Gnosis
http://forum.groupgnosis.com/t/how-offchain-trading-will-
work/63/13
Intro to state channels
http://www.jeffcoleman.ca/state-channels/
Universal Payment Channels
https://gist.github.com/jtremback/058daafe1116435b6a2e
Bitcoin Lightning Network
https://lightning.network