Blockchain technology has come a long way since the birth of Bitcoin in 2008. From enabling digital payments in a high-speed, low-cost, and transparent manner, blockchain has evolved into a decentralized infrastructure supporting various applications, such as DeFi, GameFi, NFTs, metaverse, web3, and more.
However, mainstream adoption of blockchain technology for real-world use cases would require higher scalability and efficiency than current leading solutions. While Layer-1 blockchain networks like Ethereum and Bitcoin remain popular, their technology has limitations in offering adequate throughput for efficient mass adoption. For instance, the Bitcoin network can process around 7 transactions per second while the Layer-1 Ethereum network has a throughput of around 12 TPS, speeds that are well below Visa that can handle around 1,700 TPS.
Scalability is one of the three most important aspects of blockchain trilemma. One emerging technology that's rapidly gaining traction is Layer-2 networks.
Layer-2 networks have emerged as a crucial solution to address the scalability and efficiency issues that Layer-1 blockchains like Ethereum face. Also known as "layer-2 blockchain," these are second-layer protocols built on top of an existing blockchain (layer-1).
This article explores what Layer-2 networks are, how they work, and the best Layer-2 networks to watch in 2023.
What Is a Layer-2 Blockchain?
A Layer-2 blockchain is a set of scaling solutions designed to enhance the performance and scalability of existing Layer-1 blockchains, such as Ethereum. These solutions operate on top of the primary blockchain, aiming to reduce congestion, lower transaction fees, and increase throughput.
Layer-2 solutions alleviate congestion, enhance scalability, and reduce transaction fees, making them crucial for blockchain ecosystems' growth and usability. They are vital for addressing the scalability limitations of Layer-1 blockchains and encourage mass adoption of blockchain technology for real-world and commercial applications.
Here are the advantages of Layer-2 networks:
Layer-2 solutions address the critical issues of scalability and transaction speed. They unlock the full potential of decentralized applications (dApps) and decentralized finance (DeFi) platforms by making them faster and more cost-effective.
For traders and investors, Layer-2 networks significantly reduce transaction fees, making it more economical to participate in DeFi activities, such as yield farming and trading. This cost-effectiveness directly impacts profitability.
As blockchain technology inches closer to mainstream adoption, Layer-2 networks will play an even more critical role. They can become the bridge that makes blockchain technology accessible to a broader audience, ultimately driving its adoption in various industries beyond finance.
How Does a Layer-2 Network Work?
The central idea behind these networks is performing transactions off-chain and posting a final summary transaction on the main chain. This significantly reduces network congestion, cuts processing time, and lowers transaction costs.
Scaling Solutions: Layer-1 vs. Layer-2 vs. Layer-3
In the realm of blockchain platforms, there's an ongoing debate about Layer-1 vs. Layer-2 and even Layer-3 networks. Layer-1 is the main blockchain itself while Layer-2 is where transactions are processed before being verified on Layer-1.
Layer-1 represents the foundational blockchain itself, like Ethereum or Bitcoin, which is responsible for consensus mechanisms, security, and the execution of smart contracts directly on the main blockchain. Layer-2 solutions are designed to address the scalability limitations of Layer-1 blockchains. In Layer-2 networks, transactions are processed off-chain or through secondary networks, reducing congestion and costs on the main blockchain.
Layer-3 networks, on the other hand, are built on top of Layer-2 and may offer even more specialized functionalities. Another emerging solution for improving blockchain scalability is a Layer-3 network. Constructed on top of Layer-2 scaling solutions, they focus on specialized functionalities, often related to off-chain computation and interactions with dApps.
They aim to provide further efficiency and customization options for DApps by processing complex tasks off-chain. Unlike the foundational Layer-1 networks and the Layer-2 networks on top of them, Layer-3 blockchains primarily focus on further off-chain computation and application interactions.
Different Types of Layer-2 Scaling Solutions
Layer-2 solutions operate atop existing blockchains to enhance transaction throughput and efficiency. Here are the main types:
These solutions assume transactions are valid by default unless proven otherwise. They process transactions off-chain and then publish a single summary on-chain, reducing congestion and costs.
Zero Knowledge Rollups (zk-Rollups)
zk-Rollups bundle multiple transactions into a single proof, reducing the computational load on the blockchain. This approach maintains security and privacy.
Ethereum Plasma Chains
Plasma chains are sidechains connected to the Ethereum mainnet, allowing faster and cheaper transactions by offloading some processing. The Rollups are Layer-2 solutions implemented on the Ethereum network for scaling, while Plasma chains are a series of smart contracts that interact with the main blockchain.
Like ZK-Rollups, Validium moves transactions off-chain for validation, enhancing efficiency while ensuring security through cryptographic proofs. These transactions, once validated off-chain, are then committed on-chain.
Top Layer-2 Protocols to Watch
The following are among the largest Layer-2 blockchains facilitating the trend toward faster and more efficient blockchain transactions. Here are some of the top Layer-2 blockchain protocols to watch in 2023:
Arbitrum (ARB) focuses on improving Ethereum's scalability and cost-efficiency, and boasts a throughput of around 2,000-4,000 TPS. It utilizes Optimistic Rollups, similar to Optimism, to process transactions more efficiently.
By moving smart contract execution off-chain and maintaining security through the Ethereum mainnet, Arbitrum helps reduce congestion and lower transaction costs. As of September 2023, Arbitrum One has a TVL of over $5 billion and accounts for a market share of almost 55% among Ethereum Layer-2 scaling solutions.
Optimism (OP) is a Layer-2 solution primarily designed for Ethereum. It utilizes Optimistic Rollups, a technique that allows smart contracts to execute off-chain. This approach significantly improves scalability, reduces transaction fees, and enhances transaction speed, as Optimism can handle as many as 2,000-4,000 TPS.
Optimism achieves this by assuming transactions are valid by default unless proven otherwise on the Ethereum mainnet. By processing transactions off-chain and sending data to Layer-1, it achieves rapid and cost-effective transactions. Optimism is the second most popular Layer-2 network in the Ethereum ecosystem, enjoying a TVL of almost $2.5 billion and a market share of over 25%.
3. Bitcoin Lightning Network
The Lightning Network is a pioneering Layer-2 solution for Bitcoin. The Bitcoin Lightning Network can process as many as 1 million transactions per second, supporting rapid and low-cost Bitcoin transactions by creating off-chain payment channels.
These channels facilitate user transactions without requiring every transaction to be recorded on the Bitcoin blockchain. This approach significantly enhances the speed and cost-effectiveness of Bitcoin transfers. According to DefiLlama, the TVL on Bitcoin Lightning Network stands at just under $122 million as of September 2023.
Polygon (MATIC) is a Layer-2 solution compatible with Ethereum, and can handle as many as 65,000 transactions per second. It aims to provide a fast and cost-effective environment for Ethereum-based applications.
Polygon achieves this by utilizing various components, including PoS (Proof of Stake) chains, to process transactions more efficiently. Developers can deploy decentralized applications on Polygon to benefit from scalability and reduced gas fees. Polygon enjoys the second highest DeFi TVL among Layer-2 networks, of over $760 million as of September 2023, as per data on DefiLlama.
Coinbase's Layer-2 network, Base, enhances Ethereum's scalability and functionality. It serves as a safe, low-cost, and developer-friendly platform for building decentralized applications (DApps), addressing Ethereum's scalability issues by reducing mainnet congestion and increasing transaction throughput. Base’s maximum throughput hit a high of 15.88 TPS in mid-August 2023, and it enjoys a TVL of around $377 million as of September.
Base operates on the OP Stack and uses techniques like rollups for efficient transaction processing. Its throughput varies based on implementation and network conditions. Base's launch significantly alleviates Ethereum's congestion issues, enabling efficient DApp creation and interaction with lower transaction costs.
Starknet employs Zero Knowledge Rollups (ZK-Rollups) to enhance Ethereum's scalability and security. With the Quantum Leap upgrade of July 2023, the Starknet network achieved a maximum throughput of 90 TPS. Starknet has a TVL of around $156 million as of early September 2023, and accounts for a market share of 1.63% in the Ethereum L2 ecosystem.
It achieves this by bundling multiple transactions into a single cryptographic proof, reducing computational load and improving privacy. Starknet is a promising solution for those seeking improved Ethereum performance without compromising security.
Loopring (LRC) specializes in decentralized exchanges (DEXs) and trading. Loopring Layer-2 enjoys a throughput of around 2,000 TPS with near-instant finality. Loopring boasts a TVL of $102 million as of September 2023 and garners a 1.06% market share among Ethereum L2 networks.
This Layer-2 protocol on Ethereum enhances trading efficiency and reduces transaction costs. Loopring operates using ZK-Rollups, providing a secure and scalable solution for decentralized exchange operations.
ImmutableX (IMX) is tailored for NFTs (Non-Fungible Tokens). It offers a gas-free, eco-friendly Layer-2 solution for NFT trading and ownership. ImmutableX operates atop Ethereum, allowing users to mint, trade, and transfer NFTs without worrying about high gas fees.
The ImmutableX network can handle a throughput of as many as 9,000 TPS. ImmutableX enjoys a TVL of just under $93 million, and with a market share of 0.96%, ranks 8th in terms of popularity among Ethereum Layer-2 blockchains.
What Will Ethereum 2.0 Mean for the Future of Layer-2 Networks?
Ethereum 2.0 is a significant upgrade to the Ethereum blockchain. Its primary goals are to enhance speed, efficiency, and scalability. As of September 2023, the upcoming phase of the Ethereum 2.0 upgrade that will bring Danksharding capabilities to the blockchain, will increase Ethereum’s throughput to as high as 100,000 TPS.
Ethereum Danksharding, with a focus on Proto-Danksharding, is poised to positively impact Layer-2 networks by reducing costs, enhancing scalability, and improving the overall user experience. Here's how:
Enhanced Scalability: Danksharding aims to make transactions on Layer-2 networks as cost-effective as possible. Improving scalability will enable Layer-2 networks to process a larger volume of data efficiently. This means faster and cheaper transactions for users.
Reduced Costs for Layer-2 Networks: Proto-Danksharding aims to make transactions on Layer 2 networks as cheap as possible for users. This reduction in transaction costs is essential for improving the accessibility and affordability of Layer-2 solutions, making them more attractive to users and developers.
Enhanced Layer-2 Support: Proto-Danksharding enhances Ethereum's ability to support Layer-2 rollups and service rollup sequencers. This means Layer-2 solutions can work more seamlessly with the Ethereum network, providing users with faster and more cost-effective transactions.
Improved User Experience: Danksharding increases transactions per second, which greatly improves the user experience. Users will experience faster confirmation times, reduced network congestion, and lower gas fees, making Ethereum and Layer-2 solutions more user-friendly.
As Layer-2 solutions continue to play a vital role in Ethereum's growth, Danksharding's integration is expected to further boost the adoption and utility of these Layer-2 technologies in the Ethereum ecosystem. With the advent of Ethereum 2.0, the future of Layer-2 scaling solutions is promising. Ethereum 2.0 could significantly improve scalability, making Layer-2 solutions even more efficient.
Ethereum 2.0 doesn't render Layer-2 solutions obsolete; instead, it creates a symbiotic relationship where both Ethereum 2.0 and Layer-2 networks work together to offer a more efficient and scalable blockchain ecosystem. The complementary relationship between Ethereum 2.0 and Layer-2 networks is crucial for meeting the future demands of dApps and DeFi.
Layer-2 blockchain protocols are pivotal for improving blockchain ecosystems and making transactions faster, more cost-effective, and scalable. By solving the limitations of Layer-1 protocols, Layer-2 networks mark a transformative phase in blockchain evolution.
Understanding these networks is crucial for making informed decisions for crypto traders and investors. Layer-2 solutions can shape the future of the crypto industry, unlocking new opportunities and efficiencies. Remember, due diligence is vital when navigating the dynamic crypto landscape.