In part one of this series on side chains, we discussed the basic concept underpinning side chains. In this second part of the series, we will discuss the specific logic behind side chains. In order for you to trade a Bitcoin for another 'token' on a side chain, there a simple process involved. This is not like an exchange, where one user trades with you. Instead, the process is handled through the underlying protocol. This is a one-for-one trade, which means the side chain and the main Bitcoin blockchain are pegged. This could either be a one-way peg, or a two-way peg. The advantage of the side chain with regards to alt-coins is that it allows blockchains to be created with an entirely different set of rules, while not needing to have the value of each coin start from scratch and go through turbulent flucntions as a result of speculation, all of which is achieved through this pegging system.
A one-way peg, means that you could trade a Bitcoin for token on another blockchain, but it cannot be traded in the other direction. This involves the original Bitcoin being sent to a unique address, which is in fact so unique, that no one could possibly have access to it again. This is known as proof-of-burn, and can be seen as destorying the Bitcoin. Once this has been completed, a new token is issued on the side chain, to your address in a one to one ratio, and you are free to trade as normal, while using the rules specific to that side chain.
Being able to trade both ways is known as two-way pegging between the side chain and the Bitcoin blockchain. This trading process is slightly different. The one issue is that the bitcoin protocol cannot easily be modified to allow reverse trades, and in fact, it seems dangerous to change the code for this purpose. Instead, the side chain implements rules which allows access to the original Bitcoin later on, instead of destorying them.
When making a trade from Bitcoin to a side chain that is two-way pegged, you would send the Bitcoin to a unique address which acts as an escrow, and can only be accessed again with specific keys. In this process it's clear that no Bitcoins were actually destoryed, but rather just transferred to a vault, and a replacement on the side chain is issued. If the owner wishes to trade back their tokens on the side chain for Bitcoins, they can burn their tokens on the side chain by following the same process explained earlier, and they will be given the access details to the address where their original Bitcoins are stored.
This now allows multiple side chains to be created, and for trades to happen both ways, while pegging the value of the tokens on the side chains to Bitcoin's value. In the next part of this series we'll discuss some of the specific applications of this technology.