Layer 2 solutions were created in response to issues of blockchains like Bitcoin or Ethereum. They esentially serve as another layer on top of the main chain that processes transactions in a faster and cheaper manner.
Kacper Tomasiak
SoMe & Content Assistant at Swapped.com
In the world of cryptocurrencies, some cryptos, such as Ethereum, struggle with high fees and slow transactions. When sending a transaction, you may wait hours for it to complete and pay absurd fees. The concept of Layer 2 solutions was created to solve this issue. Higher fees aren’t common among the latest Layer 1 blockchains, such as Solana, but they come with their own sets of problems. Are Layer 2 solutions the right answer to the existing problem, or should we strive to enhance the existing protocols?
Types of blockchain layers
Layer 1s are the original protocols that serve as a base. A Layer 2 is an overlay to these blockchains to enable faster and cheaper transactions.
What is Layer 1?
Most of the blockchains you know are, in fact, Layer 1s. They are the main protocols—think Bitcoin, Ethereum, or Solana. Layer 1 is responsible for the security and decentralization of a blockchain network. Coins like BTC and ETH need to use another solution on top of the main layer, while Solana is so fast and cheap that it doesn’t need one.
Layer 2 solutions were developed because of these 2 burning issues.
Limitations
Despite being established and reliable, especially older generations of L1 blockchains face issues and have their limitations that affect user experience.
Scalability is the main issue in most cases when a blockchain is unable to process as many transactions as required during network congestion. For instance, Bitcoin’s TPS averages around 7, and Ethereum’s is not much more at just 30. Transaction fees are another big problem that impacts users. Paying a few hundred dollars for a transaction to be confirmed during peak times isn’t just right.
What are Layer 2 solutions?
Layer 2 solutions offer unparalleled security matched with great user experience.
Definition
Layer 2 solutions are protocols built on top of existing Layer 1 blockchains. The reason for building another layer is to enhance scalability and efficiency without sacrificing security or decentralization. By processing the transactions on the second layer, the main blockchain is not clogged anymore, and transactions are faster and cheaper than ever before.
How do they work?
What Layer 2 solutions do is handle transactions outside of the main chain, on their own layer, while still providing a safe and secure way to transact.
Off-chain transactions are one of the features of Layer 2 solutions. Layer 2s process transactions off-chain without the need to record them on the main chain. Layer 2s usually have a higher block time; thus, the speed and amount of data are different. To maintain integrity, they manage their own state independently from the main chain. Finally, the final proof of processing the transactions is published on Layer 1 periodically to ensure security.
Types of Layer 2 solutions
Not every L2 solution is created equal. There are noticeable differences in performance and infrastructure.
Here are sidechains, Optimistic rollups and ZK rollups compared side by side.
Sidechains
A sidechain is a completely separate blockchain connected to the main chain via a two-way peg. This peg is a mechanism that locks the coins on the main chain and issues an equivalent on the sidechain. Although it operates independently, it interacts with the main chain when transferring assets. Polygon is an example of a sidechain.
Rollups
The name “rollups” comes from the way these solutions work. They bundle together multiple transactions into a single one and submit it as proof to the main chain. There are two major types of rollups: optimistic rollups like Arbitrum or Optimism and ZK rollups such as zkSync.
Validium
Validium is similar to ZK rollups because it uses zero-knowledge proofs but differs in how and where the data is stored. In a validium, the data is stored off-chain, unlike ZK rollups, which store the data on-chain.
What is the Lightning Network?
The Lightning Network is a decentralized second-layer solution to enhance Bitcoin’s scalability and transaction speed. It allows users to create payment channels with each other, where transactions can occur but don’t have to be recorded on the blockchain. The only time the data is recorded on the blockchain is when the channel is closed. It is perfect for micropayments, and because of that, El Salvador utilizes the technology to expand the adoption of Bitcoin within the country.
Lightning Network enables near-instant transactions and minimal fees for Bitcoin.
Pros of Layer 2 solutions
Layer 2 solutions are innovative projects in constant development, designed to provide users with the blockchain experience as it was meant to be.
Scalability
The most significant improvement over L1 blockchains is their ability to scale. Their infrastructure allows them to handle thousands of transactions per second. With increased speed, more sophisticated dApps can be created that require high throughput.
Lower costs
By bundling multiple transactions, they are able to lower fees drastically, making it more affordable for Web3 users to interact with the protocol. Low-cost transactions enable users from all around the world to participate, thus fostering adoption. Fees on Layer 2s are connected to the main chain, so as costs rise on, for instance, Ethereum, you will experience higher fees on the second layer, but at a discounted rate.
Faster transactions
Waiting for a transaction to confirm can be really annoying, but with the near-instantaneous confirmations that Layer 2 solutions offer, it’s not an issue anymore. During times of high demand, they adapt and can handle the traffic. The smoother and more polished these become, the better the user experience and overall satisfaction.
Challenges and limitations
Layer 2 solutions offer an array of benefits but also come with their own challenges and limitations.
Security
Layer 2 protocols aren’t time-tested solutions and introduce more complex systems, which may involve smart contract bugs or flawed mechanisms, posing security risks. Also, these protocols are tied to the security of the underlying Layer 1. In short, if the foundation collapses, so does the structure built on top of it.
Complexity
Developing a Layer 2 solution requires a team of experienced and knowledgeable individuals. The complex nature of these protocols makes it challenging to avoid errors and vulnerabilities.
Interoperability
Interoperability is key in ensuring that Layer 2 solutions correctly interact with Layer 1 blockchains and each other. With each protocol being built using different technologies and with a divergent vision in mind, it becomes increasingly difficult to ensure cross-chain compatibility.
Centralization
Layer 2 solutions will always be more centralized than the main blockchain, mainly due to the limited number of validators. This causes users to place trust in entities or mechanisms that could be compromised in the future. Being concerned about centralization is natural, as it undermines the basics of blockchain technology.
User experience
Switching between different chains and layers can become a daunting task for the end user. Developing new tools to simplify processes and always prioritizing user feedback is the ultimate approach.
Examples of usage
Layer 2 solutions were created because of high fees and slow transaction times on blockchains such as Ethereum. There are many ways they could be used.
Decentralized finance
Having scalable and highly efficient decentralized applications built on Layer 2s is ideal. In fact, many popular dApps, like Uniswap, are already up and running on chains like Arbitrum or Optimism. Swapping, lending, and borrowing are like never before, thanks to affordability and speed.
NFTs
By using a Layer 2 network, minting an NFT doesn’t have to cost the earth. No matter if you’re a creator, a collector, or a trader, fees start as low as a fraction of a cent. Additionally, many networks have vibrant NFT marketplaces and a constant inflow of users.
The future of L2s
With an upcoming Ethereum 2.0 upgrade and many failed launches, a question can be raised about the sustainability of the emerging Layer 2 market.
Ethereum 2.0
The Ethereum network is already operating under the Proof of Stake consensus. The next big upgrade, however, is what everyone is waiting for. Sharding is supposed to increase throughput up to 100,000 transactions per second and decrease fees to just a few cents.
This upgrade may spark both joy and concerns. Are Ethereum Layer 2s likely to become utterly useless?
New innovations and trends
As Ethereum completes its final upgrade, Layer 2 solutions are bound to adapt. They will probably scale alongside Ethereum and come up with an idea to persuade users to continue using them. One thing is sure: we will either see a massive ecosystem of Layer 1s and Layer 2s connected with each other or Ethereum becoming a leader showing no mercy to competition.
Dilution of capital
Without the inflow of new capital and new Layer 2 protocols popping up every day, the dilution of money is imminent. We’ve already seen it multiple times that only established players with large user bases remain and others fade into insignificance.
Fast recap
Layer 2 solutions have been providing an affordable way to transact and interact with decentralized applications for a very long time. By leveraging mechanisms such as sidechains or rollups, these solutions have been able to reduce fees without compromising security. With Ethereum's largest and most important upgrade, however, they may go out of business in the near future. It’s crucial to understand that the landscape is continuously evolving, making it harder to predict the future.
Do you want to build something cool or experience Ethereum as it should be? Check out various Layer 2 solutions and let the fun begin.
Resources
If you're interested in diving deeper and expanding your knowledge of Layer 2 solutions, here are some suggestions:
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