What Does Layer 2 Blockchain Mean for the Future of Crypto
Often referred to as off-chain solutions or second-layers, layer-2 platforms are commonly thought of as the magic bullet to many of the challenges currently faced by the blockchain industry.
But what exactly are layer 2s? And how do they tie into the blockchain landscape of today? Let’s dive in to find out!
Why Layer 2 is Important for Blockchain’s Future
Modern blockchains are widely hailed as perhaps one of the most important innovations of this century, with proponents arguing that Bitcoin, Ethereum, and several other blockchains will eventually grow large and powerful enough to replace traditional financial incumbents and tech infrastructure.
But there’s a problem. While most blockchains offer incredible security and flexibility, they typically have a number of drawbacks that can make them unsuitable for a number of applications. In the case of Ethereum, these primary limitations are its limited transaction throughput (i.e. the number of transactions it can process per second) as well as the cost of executing transactions on the platform.
In its current iteration, Ethereum has a throughput that ranges somewhere between 7–14 transactions per second, whereas the average transaction fee now comes in at more than $45 (as per BitInfocharts). This arguably makes it too slow and too expensive for broad adoption while limiting its utility in many cases.
Furthermore, many first-generation and second-generation blockchains suffer from a variety of other challenges, including low energy efficiency, congestion, a lack of smart contract functionality, and zero interoperability with other platforms. This has caused blockchains like Bitcoin and Ethereum to be subjected to a great deal of scrutiny, as well as government crackdowns and business boycotts.
Layer-2 solutions were designed to resolve these challenges. These are separate platforms and protocols that work on top of or alongside existing layer-1 blockchains to improve their capabilities or address some of their limitations.
Generally, the purpose and utility of layer-2 solutions can be assigned to one or more of the following categories:
Blockchains like Ethereum and Bitcoin have been frequently lambasted for their high energy usage. Layer 2 technologies can help mitigate these energy concerns by reducing the reliance on Proof-of-Work (POW) blockchains.
Most blockchains operate independently of one another — unable to exchange data or value with other chains. Interoperability-oriented layer-2s can help bridge this gap by providing the middleware between chains.
Bitcoin and many other blockchains lack advanced smart contract functionality, which limits their utility. Some layer 2 solutions aim to augment the capabilities of layer 1 chains to improve their smart contract functionality.
Most blockchains lack the scalability necessary to compete with centralized payment systems like Visa. Second-layer solutions can often dramatically improve scaling by reducing the transaction and computational burden on layer-1 chains.
The vast majority of blockchains operate a public ledger which some argue can lead to invasions of privacy. A number of layer-2 solutions are in the works to boost privacy through an anonymized sidechain.
While some argue that these are the inherent limits of blockchain technology and cannot be avoided on layer-1 chains (hence necessitating layer-2 solutions), others believe that it’s just a matter of time before major blockchains like Bitcoin and Ethereum incorporate the upgrades necessary to overcome their early growing pains — potentially rendering layer 2 offerings obsolete.
This is already being seen with Ethereum’s long-anticipated move to Proof-of-Stake which should see its throughput and efficiency improve by several orders of magnitude, as well as Bitcoin’s recent Taproot upgrade, which improves its scripting capabilities (helping to power DeFi on Bitcoin).
Which Solutions Are Running Right Now?
Once billed as a blockchain technology of the future, there are now well over a dozen different layer-2 solutions in operation. The vast majority of these are designed for the Ethereum blockchain, but several can be applied to a variety of blockchains.
Right now, some of the most popular layer-2 solutions that are up-and-running include:
- Optimism: Optimism is a solution that allows users to dramatically reduce the cost and latency of their Ethereum-based transactions by using a technology known as optimistic rollups to run the computational data associated with each transaction on a second layer. Dozens of major DApps have already deployed on Optimism, including the likes of Synthetix, Uniswap, 1inch, The Graph, and more.
- Arbitrum: Arbitrum is another second-layer solution that leverages optimistic rollups to reduce the computational load on the Ethereum network — resulting in higher throughput, as well as lower fees and latency. Transactions completed on Arbitrum are logged on Ethereum and secured by its node network. Arbitrum is unusual among layer-2 solutions in that it natively works with all EVM languages and tooling with no special adapters required.
- Plonky2: Formerly known as Matic Network, Polygon recently announced the launch of its own layer-2 solution, known simply as “Plonky2”. The platform leverages a technology known as recursive SNARKs to operate up to 100x faster than similar layer-2 solutions while keeping the verification cost on Ethereum incredibly low. The solution is currently operational, but due to its recentness, no apps have yet integrated it.
- xDAI: xDAI is a dedicated sidechain designed to help offload some of Ethereum’s transaction load onto a faster, more efficient partner network that leverages Proof-of-Stake (POS) to achieve a high throughput and 5-second block times. It also provides a bridge, allowing users to easily move their assets between Ethereum and xDAI. Depending on your view of what constitutes a layer-2 solution, xDAI (and several other blockchains including Polygon) since it has its own network of nodes and can operate independently of the layer-1 chain (in this case, Ethereum).
- Metis: The recently launched Metis Andromeda network is a layer-2 scaling solution that leverages Optimistic Rollups to make transacting on Ethereum faster and cheaper. As an open protocol, any developer or team is able to quickly and easily deploy their project on Metis’ EVM equivalent solution — helping them and their users benefit from dramatically improved gas efficiency and scalability.
There is also a range of application-specific layer-2 solutions, including Immutable-X, which is primarily designed to help reduce the environmental impact and costs associated with creating, using, and trading NFTs. Like many other Ethereum layer-2s, Immutable X leverages ZK-rollups to dramatically reduce the footprint of transactions that are finalized on the Ethereum mainnet (more on ZK-rollups later).
Dozens of other layer-2 solutions are either still in their testing phases or have yet to release a publicly accessible product. Some of the most prominent names that fit this category include Skale,
How Do Different Second Layers Work?
Broadly speaking, the vast majority of layer-2s look to accomplish the same thing — to offload the bulk of the heavy lifting associated with securely completing transactions to a more efficient second layer chain before finalizing the transaction on the mainchain by posting a small verification or proof transaction on it. This proof transaction tends to be dramatically smaller than a regular one, helping to keep transaction costs low — since gas costs are directly related to the size of the computation.
That said, the specifics of how they go about this can vary considerably between platforms, though most will leverage one or more of the following techniques and technologies:
- Rollups (e.g. optimistic and zk-rollups): These work by aggregating a batch of transactions off-chain (including their computational and storage data) in a smart contract, before posting a small receipt of this work to the main chain to achieve finality.
- Nested blockchain: As its name suggests, a nested blockchain is essentially a blockchain operating within or on top of another blockchain. These multi-level blockchains can use a variety of child blockchains to process general or specialized tasks before returning the results to the parent layer.
- Sidechains: These are accessory blockchains that are used to improve or augment the functionality of an associated main blockchain. These typically have their own consensus system and security network and communicate with the mainnet via a two-way bridge.
- State Channels: State channels are used to provide two-way communication between a blockchain and an external network. These allow users to complete an arbitrary number of state updates on an external network before recording the final state of these transactions to an underlying blockchain. For example, two users could play a game of chess, with each move being represented as a transaction passed through the state channels, whereas the final outcome of the game (i.e. the winner) is recorded on the blockchain).
Beyond this, some argue that the inherent limitations of blockchain technology will always remain a problem, and will ultimately limit the scope, adoption, and utility of decentralized applications. For this reason, a number of alternative distributed ledger technologies (DLTs) have been invented — each of which claims to offer some improvement over blockchain technology.
Some of the best-known examples include Tangle (e.g. used by IOTA) and Hashgraph (e.g. used by Hedera Hashgraph). These are both built on a relatively new type of data architecture known as a Directed Acyclic Graph (DAG), which completely eliminates transaction blocks and instead uses an ordered, branching array of transactions to keep a record of events.
For more details on the differences between blockchain and DAG, see this recent post by CoinTelegraph.
Bitcoin Layer-2 Solutions
Today, the vast majority of layer-2 solutions are designed to support smart contract-capable platforms, like Ethereum (and other EVM compatible blockchains). But Bitcoin also has its fair share of layer-2 platforms, most of which look to either improve its throughput, enhance its capabilities or both.
By far the most well-known of these is the Bitcoin Lightning Network, which is an off-chain payment network designed to dramatically improve the speed, efficiency, and cost-effectiveness of transacting on Bitcoin. It achieves this through a network of payment channels through which users can exchange value with one another, before settling the final value owed to each user on the Bitcoin blockchain.
This solution significantly increases the throughput of the Bitcoin blockchain, while enabling a range of new use cases, including micropayments and recurring payments.
Portal is another platform looking to augment the functionality of Bitcoin using a layer-2 solution. The platform aims to improve Bitcoin’s DeFi capabilities through the use of a Fabric-based layer-2 solution that leverages a combination of atomic swaps and off-chain computation to enable a powerful array of smart contracts.
The platform also touches on the concept of a “layer 3” or the application layer. This is essentially the network of applications built on top of layer-1 blockchains typically using layer 2 solutions. These often mask the technical aspects of the underlying blockchain-based infrastructure to make accessing and using these applications more akin to using a regular WebApp.
The Future of Layer-2
Layer 2 technologies have been around for more than half a decade now, and while they are quickly growing in popularity and usage, they still haven’t disrupted the blockchain industry as a whole.
Indeed, as per data from L2BEAT, even the most popular layer 2 platforms still have just a fraction of the TVL of the blockchain/s they are designed to work with.
This may be due to the growing pains many of these platforms have felt as their user counts and transaction loads swelled in the wake of an ultra-congested Ethereum. Indeed, a number of layer-2 platforms, including Arbitrum, and Polygon have seen downtime in recent months. While many layer-2 platforms have failed to catch on in a big way.
Nonetheless, if layer 1 chains fail to evolve quickly, there is a strong chance that their limitations will instead be resolved using one or more second-layer platforms. Rollups, in particular, have seen a dramatic surge in momentum recently, and have been praised by industry figureheads like Ethereum Co-Founder Vitalik Buterin, who believes the technology can help to scale Ethereum without sacrificing decentralization.
About Master Ventures
Master Ventures is a blockchain-focused venture studio helping to build the next generation of blockchain-based Web 3.0 system innovations within the crypto industry. Launched in 2018 by Founder and CEO Kyle Chassé, the company’s ethos can best be summarized in the acronym #BeBOLD: Benevolent, Open, Love, Decentralized.
Master Ventures co-creates with entrepreneurs and businesses worldwide to turn the best ideas into innovative and disruptive products. They do this by investing as strategic partners through offering advisory services to the projects they believe in. To date, Master Ventures has invested in over 40 crypto projects, including the likes of Kraken, Coinbase, Bitfinex, Reef, DAO Maker, Mantra DAO, Thorchain, and Elrond.
For any questions, please feel free to reach out to us on: