TL;DR

The popularity of crypto and blockchain is growing rapidly, as is the number of users and transactions. Blockchain is indeed a revolutionary thing. However, scalability, that is, the system's capacity to grow while accommodating increasing demand, is always a challenge. Highly decentralized and secure public blockchain networks often struggle to achieve high throughput.

This is often described as the Blockchain Trilemma which states that it is impossible for a decentralized system to achieve decentralization, security and high scalability equally. In reality, a blockchain network can only have two of these three factors.

However, fortunately thousands of enthusiasts and experts are working on scaling solutions. Some of these solutions are designed to change the primary blockchain architecture (Layer 1), while others focus on Layer 2 protocols that operate on top of the underlying network.

Introduction

With the large number of blockchains and cryptocurrencies available, you may not be able to tell whether you are using a Layer 1 or Layer 2 chain. It is important to understand the system you are using or investing in. In this article, you will understand the differences between Layer 1 and Layer 2 blockchains as well as various scalability solutions.

What is Layer 1 vs. Layer 1 blockchain? Layer 2?

The term Layer 1 refers to the basic level of a blockchain architecture. This layer is the main structure of a blockchain network. Bitcoin, Ethereum, and BNB Chain are examples of Layer 1 blockchains. Layer 2 are networks built on top of other blockchains. So, if Bitcoin is Layer 1, then the Lightning Network that operates on top of it is an example of Layer 2.

Increasing the scalability of blockchain networks can be categorized into Layer 1 and Layer 2 solutions. Layer 1 solutions will change the rules and mechanisms of the original blockchain directly. Layer 2 solutions will use external parallel networks to facilitate transactions outside the mainchain.

Why is blockchain scalability important?

Imagine there is a new highway being built between a large city and its rapidly growing suburbs. As the amount of traffic using the highway increases and congestion becomes commonplace, especially during rush hour, the average time from A to B can increase significantly. This is of course because the road infrastructure has limited capacity, while demand continues to increase.

So, what measures can authorities take to help more commuters travel via this route more quickly? One solution is to improve the highway by adding lanes on each side. However, this is not always practical, as this solution is expensive and will cause problems for people who already use the highway. An alternative solution is to think creatively and consider approaches that are unrelated to making changes to the core infrastructure, such as building additional access roads or even launching a light rail line along the highway.

In the realm of blockchain technology, the main highway is Layer 1 (main network), while the additional access roads are Layer 2 solutions (secondary networks to increase overall capacity).

Bitcoin, Ethereum, and Polkadot are considered Layer 1 blockchains. These blockchains are the base layer that processes and records transactions for their respective ecosystems with native cryptocurrencies typically used to pay fees and provide broader utility. Polygon is one example of a Layer 2 scaling solution for Ethereum. The Polygon Network regularly checkpoints the Ethereum mainnet to update its status.

Throughput capability is an important element of a blockchain. This is a measure of speed and efficiency that shows the number of transactions that can be processed and recorded within a certain time period. As the number of users rises and the number of simultaneous transactions increases, Layer 1 blockchains will become slow and expensive to use. This applies especially to Layer 1 blockchains that use Proof of Work mechanisms rather than Proof of Stake.

Current Layer 1 issues

Bitcoin and Ethereum are great examples of Layer 1 networks with scaling problems. Both secure the network through a distributed consensus model. This means that all transactions are verified by multiple nodes before being validated. All these mining nodes compete to solve complex computational puzzles. Successful miners will receive rewards in the form of the network's native cryptocurrency.

In other words, all transactions require independent verification from multiple nodes before being confirmed. This is an effective way to input and record correct, verified data to the blockchain while mitigating the risk of attacks by malicious actors. However, once a network becomes as popular as Ethereum or Bitcoin, throughput demands become an increasing problem. During times of network congestion, users will experience slower confirmation times and higher transaction fees.

How does the Layer 1 scaling solution work?

There are several options available for Layer 1 blockchains that can increase overall network throughput and capacity. If the blockchain uses Proof of Work, transitioning to Proof of Stake could be an option to increase transactions per second (TPS) while reducing processing costs. However, there are varying views within the crypto community regarding the benefits and long-term impact of Proof of Stake.

Scaling solutions on Layer 1 networks are usually introduced by the project development team. Depending on the solution, the community will have to hard or soft fork the network. Some minor changes are backward compatible, such as Bitcoin's SegWit update.

Larger changes, such as increasing Bitcoin's block size to 8 MB, require a hard fork. This results in two versions of the blockchain, namely one with updates and one without updates. Another option to increase network throughput is sharding. This action divides blockchain operations into smaller parts that can process data simultaneously rather than sequentially.

How does the Layer 2 scaling solution work?

As discussed, Layer 2 solutions rely on secondary networks that function in parallel or independently from the primary chain.

Rollup

Zero-knowledge rollup (the most common type) bundles Layer 2 transactions off-chain, then sends them as a single transaction on the main chain. This system uses proof of validity to check the integrity of transactions. Assets are stored on the original chain with a bridging smart contract, and then the smart contract confirms that the rollup is working as intended. In this way, native network security benefits from rollups that are not resource-intensive.

Sidechain

Sidechain is an independent blockchain network with its own set of validators. This means that smart contract bridging on the main chain does not verify the validity of the sidechain network. Therefore, you must trust that the sidechain is operating correctly, because it can control the assets on the original chain.

State channel

State channel is a two-way communication environment between transacting parties. The parties close a portion of the underlying blockchain and connect it to an off-chain transaction channel. This is usually done through an agreed smart contract or multiple signatures. Then, the parties execute the transaction or batch of transactions off-chain without immediately sending the transaction data to the underlying distributed ledger (i.e., the main chain). Once all transactions in the chain are complete, the final “state” of the channel is broadcast to the blockchain for validation. This mechanism allows for higher transaction speeds and increased overall network capacity. Solutions like the Bitcoin Lightning Network and Ethereum's Raiden operate based on state channels.

Nested blockchain

This solution relies on a series of secondary chains that sit on top of the primary “parent” blockchain. Nested blockchains operate based on rules and parameters set by the parent chain. The main chain does not participate in executing transactions and its role is limited to resolving disputes if necessary. Daily work is delegated to “child” chains that return processed transactions to the main chain after they are completed outside the main chain. OmiseGO's Plasma project is an example of a Layer 2 nested blockchain solution.

Limitations of Layer 1 and Layer 2 scaling solutions

Layer 1 and Layer 2 solutions have unique advantages and disadvantages. Working with Layer 1 can provide the most effective solution for large-scale protocol upgrades. However, this also means that validators must be encouraged to accept changes via a hard fork.

One example of when validators may not want to do this is the change from Proof of Work to Proof of Stake. Miners will lose revenue with this switch to more efficient systems, creating a disincentive to improve scalability.

Layer 2 provides a faster way to increase scalability. However, depending on the method used, you can lose much of the security of the original blockchain. Users trust networks like Ethereum and Bitcoin because of their resilience and security track record. By eliminating aspects of Layer 1, you often have to rely on Layer 2 teams and networks for efficiency and security.

What's next after Layer 1 and Layer 2?

One important question is whether we will need a Layer 2 solution as Layer 1 becomes more scalable. Existing blockchains have been upgraded and new networks have been created with good scalability. However, it will take a long time for the main system to increase its scalability and this is not guaranteed. The most likely option is that Layer 1 should focus on security and allow Layer 2 networks to tailor their services to specific uses.

In the near future, there is a possibility that large chains like Ethereum will still dominate due to their large communities of users and developers. However, the large network of decentralized validators and trusted reputation make for a strong foundation for targeted Layer 2 solutions.

Closing

Since crypto began, the search for increased scalability has resulted in a two-pronged approach with Layer 1 improvements and Layer 2 solutions. If you have a diverse crypto portfolio, you probably already have exposure to Layer 1 and Layer 2 networks. Now, you understand the difference between both along with the various scaling approaches they offer.