TL;DR
Crypto has grown exponentially in popularity. As a result, the number of users has grown substantially and so is the number of transactions. Blockchain is a revolutionary technology, yet its scalability - a system's ability to adapt to increasing demand - has always been a challenge. Decentralized, secure public blockchain networks often have trouble achieving high throughput.
This is known as the Blockchain Trilemma, which states that it is impossible for a decentralized protocol to simultaneously achieve equal high levels of decentralization, security, and scalability. From a realistic vantage point, blockchain can only have two out of the three factors.
Fortunately for us, the crypto world has attracted an incredible amount of innovators and talent to the space who are actively trying to work on scaling solutions. Some of the solutions are in the form of changing the architecture of blockchains (layer 1) while others focus on layer 2 protocols that operate on top of these blockchains.
Introduction
Cryptocurrencies have come a long way since Bitcoin first came into the scene. Now, there are thousands upon thousands of cryptocurrencies that are available out there. In fact, so much so that you might not know if you're invested or using a Layer 1 or Layer 2 chain.
There can be advantages in hiding blockchain complexity, however, it is always good to understand something, especially if you are investing in it. In this post, you'll come out with a new understanding of the differences between Layer 1 and Layer 2 blockchains and various scaling solutions.
What is a blockchain Layer 1 vs. Layer 2?
Layer 1 is the base level of blockchain architecture. Blockchain networks are based on Layer 1. BNB Smart Chain, Ethereum, and Bitcoin are examples of Layer 1 blockchains. A Layer 2 network is built over a Layer 1 blockchain. Therefore, if Bitcoin is a Layer 1, the Lightning Network that runs on top of it is an example of a Layer 2.
Scalability improvements for blockchain networks can be classified into Layer 1 and Layer 2 solutions. Layer 1 solutions will alter the rules and mechanisms of the original blockchain directly. For Layer 2 solutions, a parallel external network is used to facilitate transactions away from the main chain.
Why is blockchain scalability important?
Blockchain is known to be facing scalability issues. To see why let’s think of a growing city and the ongoing construction of a new highway connecting it to its suburban sites. As the traffic increases, it may take longer for people to get from point A to B. That’s because road infrastructure has limited capacity, and therefore can’t handle all the demand for the given area.
One solution would be to improve the highway itself, adding extra lanes to each side of the road. This, however, is not always practical as it is an expensive solution that would cause considerable trouble to those already using the highway. An alternative is to get creative and consider various approaches not associated with making changes to the core infrastructure.
In the world of blockchain technology, a Layer 1 solution is the primary highway while Layer 2 solutions are secondary service roads that can improve overall capacity.
Blockchains can be hard to scale, and it’s one of the biggest limitations facing the technology. Layer 2 scaling solutions aim to solve this by allowing transactions to happen off the main network, freeing up capacity for more transactions. One example is Polygon, which uses Ethereum as a baseline but is run separately and has its own native currency that exists on top of Ethereum. Bitcoin, Ethereum, and Polkadot are all considered to be layer 1 blockchains. These are the base layer blockchains that process and record all transactions made over the network. They typically have their own native currency that is used to pay for network fees and can also have broader use.
Scalability refers to the number of transactions that a blockchain is able to process per second, and is one of the most important considerations for designers of blockchain platforms. Layer 1 blockchains, such as Bitcoin and Ethereum, rely on Proof of Work (PoW) algorithms to process transactions. These algorithms are very resource intensive and require people or companies (miners) to solve mathematical problems before they can verify transactions. This can lead to scalability challenges as the number of people using the platform increases.
Current Layer 1 issues
Bitcoin and Ethereum are examples of Layer 1 networks with scaling issues. Both secure the network through a distributed consensus model. This means that all transactions are verified by multiple nodes before being validated, creating bottlenecks during peak usage times.
Scalability is an issue across the board. The idea behind the blockchain was to provide a nearly unbreakable method of recording data, secured against malicious actors. However, as blockchains become more popular and more applications use them for their data storage needs, miners will have to face increased demand and transaction volumes. As a result of this, popular blockchains like Bitcoin or Ethereum, face lots of throughput demand which creates slower confirmation times and higher transaction fees.
How do Layer 1 scaling solutions work?
Layer 1 blockchains can increase throughput and overall network capacity. In the case of blockchains using Proof of Work, a transition to Proof of Stake could be an option to increase transactions per second (TPS) while reducing processing fees. Still, there are mixed views in the crypto community regarding the benefits and long-term implications of Proof of Stake.
Scaling solutions on Layer 1 networks are typically introduced by the project’s development team. Depending on the solution, the community will need to hard fork or soft fork the network. Some small changes are backward compatible, such as Bitcoin’s SegWit update.
Scaling solutions on Layer 1 networks are introduced by the developers of the specific blockchain project. They typically require hard forking or soft forking of the network. In the case of Bitcoin's SegWit update, some changes can be backward compatible.
Ultimately, bigger block sizes would require a hard fork. This creates two versions of the blockchain, one with the update and one without. For example, Bitcoin Gold (BTG) hard forked from Bitcoin (BTC) in order to make mining easier with its new algorithm. Another option to increase a network’s throughput is sharding. This splits a blockchain’s operations across multiple smaller sections that can process data simultaneously rather than sequentially.
How do Layer 2 scaling solutions work?
As discussed, Layer 2 solutions rely on secondary networks that work in tandem or are independent of the main chain.
Rollups
Zero-knowledge rollups are the most common kind of scaling solution. They bundle off-chain Layer 2 transactions into one transaction on the original chain, then use validity proofs to check that this is true. By doing so, you can enjoy many of the benefits of a mainnet with less resource expenditure.
Sidechains
Sidechains are independent blockchain networks with their own sets of validators. This means the bridging smart contract on the main chain doesn’t verify the validity of the sidechain network. Therefore, you need to trust the sidechain is operating correctly as it’s able to control assets on the original chain.
State channels
A state channel is a two-way communication environment between the transacting parties. The parties seal off a part of the underlying blockchain and connect it to an off-chain transaction channel. This is usually done via a pre-agreed smart contract or a multi-signature.
The parties then execute a transaction or a batch of transactions off-chain, without immediately submitting transaction data to the underlying distributed ledger (i.e., the main chain). Once all transactions in the set are complete, the final “state” of the channel is broadcasted to the blockchain for validation. This mechanism allows to improve transaction speed and increases the overall capacity of the network. Solutions like the Bitcoin Lightning Network and Ethereum's Raiden operate based on state channels.
Nested blockchains
This solution relies on a set of secondary chains that operate on top of the main blockchain. They follow the rules and parameters set by the parent chain but don’t involve a majority of transactions in the network. The day-to-day work is delegated to "child" chains that return processed transactions to the main chain upon completion of their functions. OmiseGO's Plasma project is an instance of this type of nested blockchain solution.
Limitations of Layer 1 and Layer 2 scaling solutions
Each solution has its own advantages and disadvantages. When it comes to improving large-scale protocols, Layer 1 can provide the most effective solution. The downside is that validators will also need to be convinced to accept changes via a hard fork.
Changing from Proof of Work to Proof of Stake is one possible example of where validators may not wish to do this. By switching to a more efficient system, miners will lose income, disincentivizing them from improving scalability.
Scalability can be improved much more quickly through Layer 2. You can, however, lose much of the original blockchain's security depending on the method used. Ethereum and Bitcoin are trusted by users for their security and resilience. When you remove aspects from Layer 1, you are often forced to rely on your Layer 2 team and network to handle efficiency and security.
What’s next after Layer 1 and Layer 2?
When Layer 1s become more scalable, will we even need Layer 2 solutions? New blockchain networks are already being created with good scalability, and existing blockchains are improved. However, improving system scalability won't be a quick process, and it's not a guarantee. Most likely, layer 1 networks will focus on security, while layer 2 networks will tailor their services to meet specific needs.
Large chains like Ethereum are likely to remain dominant in the near future as a result of their large developer and user communities. Yet, its large, decentralized validator set and trusted reputation create a solid foundation for targeted Layer 2 solutions.
Final Thoughts
As cryptography developed, the search for improved scalability led to a two-pronged approach with Layer 1 improvements and Layer 2 solutions. There's a good chance that you already have exposure to both Layer 1 and Layer 2 networks if you have a diverse crypto portfolio. With this understanding, you now know the differences between the two as well as the approaches to scaling that they offer.
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