As blockchains continue to gain momentum across various sectors, scalability has emerged as a critical challenge that has hindered widespread adoption. Layer 1 (L1) blockchains, such as Bitcoin and Ethereum, face expense and speed limitations, leading to network congestion and high transaction costs during periods of increased demand.
Enter Layer 2 (L2) scaling solutions, which were developed to accelerate transactions and reduce expenses while inheriting the base layer’s security and decentralization. L2s achieve this by offloading the heavy computation associated with transaction execution from the base layer (the L1). They execute numerous transactions and batch them together. They then produce a result (either a proof or a condensed version of the transactions—more on that later) and send it to L1 for settlement. By processing transactions as batches rather than one at a time, L2s enable quicker and cheaper transactions, enhancing the overall scalability of the blockchain ecosystem.
Types of Layer 2 solutions
State channels
State channels are two-way communication channels that allow participants to interact and transact offchain, with the final state being settled on the main chain. They are particularly useful for scenarios involving high-frequency transactions between a fixed group of participants. Examples of state channel implementations include the Lightning Network for Bitcoin and the Raiden Network for Ethereum.
In a state channel, participants lock a portion of their assets in a multisignature (multisig) smart contract on the main chain. They can then conduct an arbitrary number of offchain transactions by exchanging signed messages and updating the channel’s state. Once the participants decide to close the channel, the final state is submitted to the main chain, and the assets are distributed accordingly.
State channels offer high transaction throughput and near-instant finality, as parties don’t have to wait for blockchain confirmation for the transaction to go through as long as they’ve each signed it. State channels also provide greater levels of privacy, as transactions are not broadcast to the entire network. However, state channels have limitations, such as the need for participants to be online and the requirement for pre-defined participant groups.
Rollups
Rollups are Layer 2 solutions that bundle multiple transactions offchain and submit them to the main chain as a single transaction. They come in two main varieties: optimistic rollups and validity rollups.
Optimistic Rollups assume that transactions are valid by default and only execute computation, via a fraud proof, in case of a challenge. They rely on a dispute resolution mechanism where anyone can contest the validity of a transaction within a specified time frame. If no challenge is raised, the transactions are considered valid and settled on the main chain.
Validity Rollups, on the other hand, use validity proofs to confirm the validity of the transactions executed and bundled offchain each time they settle on the base layer. They generate cryptographic proofs that attest to the validity of the offchain computations without requiring the base layer to re-execute them. These proofs are then submitted to the main chain for verification, ensuring the integrity of the transactions.
Rollups offer significant improvements in scalability, as they allow processing a large number of transactions offchain while still maintaining the security of the main chain. They also support general computation and smart contract execution, making them suitable for a wide array of applications.
Sidechains
Sidechains are separate blockchain networks that operate independently but are connected to the main chain through a two-way peg. They have their own consensus mechanisms, block parameters, and security models, allowing for greater flexibility and customization.
Transactions on sidechains are processed separately from the main chain, and the sidechain periodically communicates with the main chain to transfer assets between them. This enables quicker transaction processing and lower fees on the sidechain while still benefiting from the security of the main chain.
However, sidechains have some trade-offs compared to other Layer 2 solutions. They rely on their own consensus mechanisms and have a different security model than the main chain. Additionally, sidechains require a higher level of trust, as the sidechain operators have control over the funds locked in the sidechain.
Benefits and limitations
Layer 2 scaling solutions offer several advantages that address the scalability challenges faced by blockchain networks:
Higher transaction throughput: By processing transactions offchain, Layer 2 solutions can handle a significantly higher number of transactions per second compared to the main chain.
Reduced transaction expenses: Layer 2 solutions minimize the gas fees associated with onchain transactions, making it more cost-effective for users to interact with the L1.
Faster transaction finality: Offchain transactions can achieve near-instant finality, providing a better user experience and enabling real-time applications.
Improved privacy: Some Layer 2 solutions, such as state channels, offer increased privacy by keeping transaction details offchain and only settling the final state on the main chain.
However, Layer 2 solutions also have certain limitations and trade-offs:
Increased complexity: Implementing and integrating Layer 2 solutions can introduce additional complexity to the blockchain ecosystem, requiring specialized knowledge and tools.
Security trade-offs: While Layer 2 solutions inherit the security of the main chain to a certain extent, some might introduce new attack vectors or trust assumptions that need to be carefully evaluated.
Liquidity fragmentation: The presence of multiple Layer 2 solutions can lead to fragmentation of liquidity, as assets are spread across different networks and require bridging mechanisms to move between them.
Dependency on L1: Layer 2 solutions still rely on the main chain for settlement and security, meaning any issues or congestion on the main chain can impact the performance of L2 networks.
Real-world applications
L2 scaling solutions have found numerous real-world applications across various domains:
Payments: Layer 2 solutions like the Lightning Network enable fast and low-cost micropayments, facilitating everyday transactions and enabling new use cases such as streaming payments.
Decentralized exchanges (DEXs): L2-based DEXs offer quicker and cheaper trading experiences, reducing the impact of high gas fees and enabling more efficient order matching and settlement.
Gaming and NFTs: Layer 2 solutions provide a scalable infrastructure for blockchain-based gaming and non-fungible token (NFT) marketplaces, enabling seamless in-game transactions and reducing the cost of minting and trading NFTs.
Decentralized finance (DeFi): Layer 2 solutions enhance the scalability and usability of DeFi applications, allowing for faster and cheaper transactions in lending, borrowing, and yield farming protocols.
