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Blockchain technology has come into play as a force of revolution in multiple sectors like finance, supply chain, healthcare, and entertainment.
However, blockchain has not solved its main challenge of scalability, which hinders its mainstream adoption despite its transformative potential.
The big challenge comes from the fact that Layer 1 (L1) blockchains such as Bitcoin and Ethereum are secure and decentralized, but cannot handle a high number of transactions very quickly and cost-effectively due to fundamental limitations.
That is where Layer 2 (L2) solutions come in, L2 solutions are technologies operating on top of already existing Layer 1 blockchains that bring scalability, reduce transaction fees, and enhance user experience while keeping security and decentralization of the base layer intact.
In this blog, we will be discussing what Layer 2 blockchain solutions are, how they work, the different types of L2 technology some of their advantages and some of their challenges, and their transformative potential for the blockchain ecosystem.
What are Layer 2 Blockchain Solutions?
Layer 2 builds on top of the base blockchain (Layer 1) to upscale its scalability and performance.
Layer 1 blockchains like Bitcoin and Ethereum perform important jobs like consensus and security, but Layer 2 solutions try to move these transaction processing tasks off the base layer where it would otherwise clog and cause costs and make transactions more costly and slower.
Layer 2 solutions seek to address these problems by tempering performance with the core principles of blockchain: decentralization and security.
Layer 2 solutions handle transactions off-chain (outside the Layer 1 blockchain) and settle them back on the main chain in batches or using cryptographic proofs to provide Layer 1 blockchains with faster, cheaper, more efficient scaling for blockchain applications.
The Need for Layer 2 Solutions
Let’s first look at why we need Layer 2; to understand its importance, it is only first because of the problems that Layer 1 blockchains suffer from. As popular as Ethereum and Bitcoin are, they face several key scalability challenges:
1. Low Transaction Throughput: While Bitcoin can only do about 7 TPS, Ethereum is able to handle roughly about 30 TPS. However, traditional payment systems such as Visa are designed to handle over 24,000 transactions per second, meaning that blockchain systems feel slow when handling many such use cases.
2. High Transaction Fees: Because more users are coming to blockchain networks, the transaction cost to do so goes up. Say, for example, when Ethereum is extremely busy, gas fees (transaction fees) can spurt up so that even small transfers become unaffordable.
3. Network Congestion: If the demand for block space leads to network congestion this can result in slower transaction confirmations and a tougher User experience. For applications such as decentralized finance (DeFi) or non-fungible tokens (NFT), speed and cost are critical, and this makes it especially problematic.
The scalability limitations of Layer 1 networks prevent many blockchain applications, particularly applications involving frequent microtransactions or substantial amounts of data, from using them.
Types of Layer 2 Solutions
Layer 2 solutions are a complex thing with myriad Flavors. Below are the most prominent types of Layer 2 technologies:
1. State Channels
State channels allow participants to perform multiple off-chain transactions privately without recording them on the main blockchain. When participants choose to settle or close the channel, we record the final state of the channel on the base layer.
If it’s a Layer 1 blockchain, it entails locking funds in a smart contract for a fixed period. Participants can then transact off-chain multiple times without fees or on-chain confirmations.
Once all transactions are completed, the final state is sent to the Layer 1 blockchain, finalizing the channel.
Participants use state channels to conduct multiple transactions off-chain, enabling private, two-way communication without the need to record every transaction on the main blockchain.
The final state of the channel is recorded on the base layer when participants choose to settle or close the channel.
How It Works:
• Two or more parties lock a certain amount of funds in a smart contract on the Layer 1 blockchain.
• The participants can then transact off-chain as many times as needed without paying fees or waiting for on-chain confirmations.
• When the transaction process is complete, the final state (i.e., the result of all the transactions) is submitted to the Layer 1 blockchain, closing the channel.
Examples:
• Bitcoin’s Lightning Network: A state channel payment protocol that supports fast and low-cost transactions.
• Raiden Network: It’s a state channel solution for Ethereum, building on this blockchain payments.
Advantages:
• Instant Transactions: The feature that state channels offer is instant transaction finality.
• Low Fees: For each interaction, the fees are minimized since transactions don’t need to be processed on the Layer 1 blockchain.
• Ideal for Micropayments: For small frequent payments i.e. use cases, state channels are efficient and have low fees.
Challenges:
• Limited to Two Parties: Usually state channels are built for private transactions between two parties and not multi-party applications.
• Channel Setup: It can be a barrier to entry, and you may need to lock funds in a smart contract that you wouldn’t want to.
2. Rollups
Layer 2 scaling solutions, and rollups, allow for transactions to be on the chain but aggregated data (or proofs) are submitted to the main blockchain for validation. Rollups broadly increase scalability without compromising security or decentralization from Layer 1 blockchains.
There are two main types of rollups: ZK-Rollups: composable ZK proofs of numbers and arithmetic on a blockchain. Optimistic Rollups: a dynamic pay model with smart contracts.
Optimistic Rollups
Traditionally, optimistic rollups make an assumption that all transactions are valid by default and perform full transaction validation alternatively. Instead, they rely on a dispute resolution mechanism: Challenging a transaction causes a fraud-proof process to verify its validity.
Examples:
Optimism
• Arbitrum
Advantages
• High Scalability: Rollups achieve a massive increase in throughput by batch transactions off-chain and only submitting minimal data to the base layer.
• Compatibility with Existing dApps: Ethereum apps can easily scale with Optimistic Rollups — creating it compatible with the existing Ethereum smart contracts.
Challenges:
The delay in transaction finality for Optimistic Rollups is mandated because sometimes the challenge period exists to resolve disputes.
The system is secure but smart enough that mistakes happen or fraud proofs are late processed.
Specifically, they employ zero-knowledge proofs—zkSNARKs or zkSTARKs—to prove the validity of off-chain transactions without revealing the details of those off-chain transactions.
In ZK-Rollups, only a cryptographic proof of transaction data is submitted to the base chain, instead, which enhances scalability while reducing costs.
Examples:
• zkSync
• StarkNet
Advantages:
• Faster Finality: The cryptographic proofs enable near-instant transaction finality using ZK-Rollups.
Zero-knowledge proofs secure and maintain the privacy of transactions. ZK-Rollup transactions cost significantly less in gas by relying less on data submitted to the main chain.
• Complex Implementation: Developing the ZK-Rollups is more sophisticated in terms of cryptographic knowledge and more complex in development than Optimistic Rollups.
• Interoperability Issues: ZK-Rollups will require modifying existing Ethereum dApps to use them.
3. Plasma
Layer 2, Plasma, is a scaling solution that parallels the main Ethereum blockchain using child chains (or “sub-chains”).
It treats plasma transactions as processing off the chain, before periodically submitting snapshots to the main chain of the chain’s state This increases scalability by allowing more transactions per second (TPS) while keeping the main chain at bay.
Essentially, mini blockchains surgically process transactions through the main chain. The main blockchain periodically verifies these child chains, committing summarized data (Merkle roots) transactions without revealing the details of those transactions.
ZK-Rollups submit only a cryptographic proof to the base chain, rather than the full transaction data, which improves scalability and reduces costs.
Examples:
• zkSync
• StarkNet
Advantages:
• Faster Finality: ZK-Rollups provide near-instant transaction finality because of the cryptographic proofs.
• Security: The use of zero-knowledge proofs ensures that transactions are both secure and private.
ZK-Rollups reduce gas fees by requiring significantly less data to be submitted to the main chain.
Challenges:
• Complex Implementation: ZK-Rollups require sophisticated cryptographic knowledge and more complex development compared to Optimistic Rollups.
Existing Ethereum dApps may need to be modified to work with ZK-Rollups due to interoperability issues.
3. Plasma
Plasma is a Layer 2 scaling solution that creates child chains (or “sub-chains”) that run in parallel to the main Ethereum blockchain.
Plasma allows for the processing of transactions off-chain and then submits periodic snapshots of the chain’s state to the main chain. It increases scalability by enabling more transactions per second (TPS) without overwhelming the main chain.
How It Works:
• Plasma chains are essentially mini-blockchains that process transactions independently of the main chain.
• These child chains periodically commit summarized data (Merkle roots) to the main blockchain for verification.
Advantages:
• High Scalability: Processing transactions off-chain (costing more to maintain) enhances throughput by allowing for faster transactions.
• Security: Regular checkpoints on the main chain are what keep the security and decentralization of Ethereum by maintaining a network of plasma.
Challenges:
• Exit Challenges: There are several situations where users face difficulty in exiting Plasma chains and rehoming their funds on the Main Chain.
4. Sidechains
A sidechain is simply a separate blockchain running in parallel to the main blockchain but with its own rule of consensus. Assets can be transferred between the sidechain and the main blockchain using a two-way peg.
Examples:
• Polygon (formerly Matic Network): It’s a popular sidechain solution for Ethereum, lowering transaction costs and increasing throughput.
• Liquid Network speeds up or ‘confidentiality’ transactions on a sidechain.
Advantages:
• Full Customization: This allows sidechains to have their consensus mechanisms giving more flexibility for the developers.
• Higher Throughput: Since sidechains process transactions in parallel to the main chain, it makes scaling easier.
Challenges:
• Security Concerns: Sidechains are as secure as the consensus mechanism on which they are based and may or may not be as secure as that of the main chain.
• Cross-Chain Interoperability: It can get very complicated bridging to/from the main chain and side chains and carry risks.
Benefits of Layer 2 Blockchain Solution
Layer 2 solutions bring several benefits to blockchain ecosystems:
1. Scalability: The layer 2 solution takes transactions from blockchains and offloads them onto secondary layers in order to vastly increase transaction throughput which also helps blockchains scale better by being able to deal with more users and data.
2. Lower Transaction Costs: Layer 2 solutions reduce the need for chain transactions, and therefore reduce transaction fees for blockchain applications, particularly small or frequent transactions.
3. Faster Transaction Speeds: Transactions on Layer 2 solutions happen almost instantly, much faster than Layer 1.
4. Improved User Experience: Layer 2 solutions provide a better user experience by creating a smoother, faster transaction process. This makes Bitcoin and blockchain accessible to run-of-the-mill users.
Conclusion
Layer 2 blockchain solutions will be essential for true blockchain scalability in the future, allowing for untethered growth while maintaining irrelevance in decentralization and security.
From state channels and rollups to plasma and sidechains, each Layer 2 layer has its benefits and solves for varying limitations of Layer 1 blockchains.
Using these technologies, blockchain networks will be able to support tons of use cases, including of course not limited to, decentralized finance, gaming, and supply chains, all without bottlenecks and high fees that other blockchain platforms currently have.
The growing adoption of blockchain technology will continue to drive the development and adoption of Layer 2 solutions to successfully implement decentralized technologies.
Layer 2 solutions will improve user experience, help reduce costs, and enhance the scalability of blockchain, helping it fulfill its potential to be an enormously disruptive force in different industries.