A ledger that runs parallel to a blockchain. There is a link between the primary chain and sidechain, enabling two-way communication.
Sidechains are important for the scaling of blockchains. These are considered Layer 2 solutions.
To envision how sidechains fit, picture a global network of decentralized blockchains. They each had their own rules, purposes, and use cases. Each is independent yet they form on major ecosystem.
The best example of a sidechain is the Lightning Network that is interacts with the Bitcoin network.
Scalability
Many feel that sidechains will be necessary moving forward. There is already a question about scalability with blockchain networks. Sidechains allow for the integration of more nodes, allowing for transactions to be moved off the main network.
The analogy of digital real estate helps to explain this concept.
Consider the main blockchain to be pristine real estate. This is the high rent district. Since blockchains are ledgers, data is stored in a decentralized manner. This provides immutability and censorship resistance to whatever is posted.
Not everything needs to be housed in the most expensive part of town. Users will have the option of where to post the data. Sidechains can be thought of as industrial areas where the real estate is far less expensive. While there are not as many features available, such as the censorship resistance, the cost is more palatable.
Interoperability
As the blockchain world expands, interoperability is vital. The early chains such as Litecoin and Ethereum utilize different languages. For this reason, the ability to bridge between different networks and access the features is going to be vital.
One area this is applicable is with smart contracts. We are looking at some systems that do not have these at the base layer. Sidechains allow projects to be built while tapping into multiple chains.
The second chain has its own consensus protocol which allows for it to integrate additional privacy and security measures.
A bit part of the interoperability is allowing tokens and other digital assets to move between the chains. This allows for the blockchain to operate in a more decentralized manner.
Two-Way Peg
One requirement is for sidechains to remove counterparty risk. This is done by having a two-way peg on assets showing up on both chains. This allows for seamless transfer of value over the different network, eliminating costs that would typically be an opportunity for arbitrage.
Also, because of the peg, nobody can stop the transfer from happening.
Transfer is a conceptual term since the original assets never leave the original chain. There is an equivalent produced on the other chain. This is often called a wrapped token which is an replica of what is on the main chain, with the value transferred to the new chain.
This allows for it to be "transferred" back and forth between both networks.