Summary
The popularity of cryptocurrencies and blockchains is growing rapidly, as are the number of users and transactions. Although it is easy to see how innovative blockchains are, scalability – the ability of the system to grow while simultaneously accommodating increasing demand – has always been a challenge. Public blockchain networks that are highly decentralized and secure often have difficulty achieving high throughput.
This is often described as the three-dimensional dilemma of blockchains, which states that it is realistically impossible for any decentralized system to simultaneously achieve equally high levels of decentralization, security, and scalability. In reality, blockchain networks can only achieve two of these three factors.
But, fortunately, thousands of enthusiasts and experts are working on solutions for scaling. Some of these solutions are designed to modify the structure of the main blockchain (Layer 1), while others target Layer 2 protocols that run on top of the core network.
the introduction
With the large number of blockchains and cryptocurrencies available, you may not know whether you are using a Layer 1 or Layer 2 chain. There are benefits to hiding the complexity of the blockchain, but it is worth understanding the system you are investing in or using. Through this article, you will understand the differences between layer 1 and layer 2 blockchains and the many different scaling solutions.
What are Layer 1 and Layer 2 blockchains?
Layer 1 refers to the basic level of the blockchain structure; It is the basic structure of the blockchain network. Bitcoin, Ethereum, and the BNB chain are examples of layer-one blockchains. The second layer refers to the networks that exist on top of other blockchain chains. Hence, if Bitcoin is the first layer, the Lightning Network above it is an example of the second layer.
Scalability improvements for blockchain networks can be classified into Layer 1 solutions and Layer 2 solutions. Layer 1 solutions directly change the rules and mechanisms of the original blockchain. Layer 2 solutions use a parallel external network to facilitate transactions away from the main chain.
Why is blockchain scalability important?
Imagine building a new highway between a major city and its fast-growing suburb. With the increased traffic on this highway and the frequent occurrence of traffic congestion – especially during peak hours – the average time to get from point A to point B can increase dramatically. This is not surprising given that the road infrastructure has limited capacity and demand is constantly increasing.
What can the authorities do to help more people move along this route more quickly? One solution is to improve the highway itself by adding more lanes on each side of it. But this is not a permanent practical solution; Because it is expensive and can cause a great deal of inconvenience to those who actually use the road. An alternative is to resort to innovative solutions and consider multiple approaches that are not related to changes in basic infrastructure, such as establishing additional service roads or launching a light rail line along the highway.
In the world of blockchain technology, the main highway is the first layer (the main network), while the additional service routes are the second layer solutions (the secondary network that improves the overall capacity).
Bitcoin, Ethereum, and Polkadot are layer-one blockchains. This means that they are base-layer blockchains that process and record transactions for their ecosystem, and include a native digital currency – typically used to pay fees and provide a broader service. Polygon is an example of a layer 2 scaling solution for the Ethereum network. The Polygon network regularly dedicates checkpoints to the Ethereum mainnet to update its status.
Throughput capacity is an essential component of any blockchain. It is a measure of speed and efficiency that shows how many transactions can be processed and recorded within a specific time frame. As the number of users and the number of concurrent transactions increases, the layer-one blockchain can become slow and expensive to use. This applies specifically to layer-one blockchains that use a proof-of-work mechanism, as opposed to those that use a proof of stake.
Current first class problems
Bitcoin and Ethereum are good examples of layer-one networks that have scaling issues. They both secure the network through a distributed consensus model. This means that all transactions are verified by multiple nodes before being audited. All so-called mining nodes compete to solve a complex computer puzzle, and miners who succeed in solving it receive rewards in the network's native digital currency.
In other words, all transactions require independent authentication from multiple nodes before they can be confirmed. This is an effective way to include and record valid and verified data in the blockchain, while at the same time reducing the risk of attack from ill-intentioned people. But once the network becomes as popular as Ethereum or Bitcoin, the demand for throughput becomes a growing problem. During periods of high network stress, users will experience slower confirmation times and higher transaction fees.
How do Layer 1 expansion solutions work?
There are many solutions available for layer 1 blockchains that can increase the throughput and overall capacity of the network. In the case of blockchains that use Proof of Work, converting to Proof of Stake can be an option to increase transactions per second (TPS) while simultaneously reducing processing fees. However, there are mixed opinions in the cryptocurrency community regarding the benefits and long-term implications of Proof of Stake.
Expansion solutions on Layer 1 networks are typically provided by the project development team. Depending on the solution, the community will have to perform either a chain fork or a protocol upgrade. Some small changes are backward compatible, such as the SegWit update.
Larger changes, such as increasing the Bitcoin block size to 8MB, require a chain fork. This creates two copies of the blockchain, one with an update and one without. Another option to increase network throughput is segmentation. Hashing divides blockchain operations into multiple small partitions that can process data simultaneously rather than sequentially.
How do layer 2 expansion solutions work?
As mentioned, Layer 2 solutions rely on secondary networks that operate in parallel with or independently of the main chain.
Assemblies
Zero-knowledge pools (the most common type) collect Layer 2 transactions off-chain and send them as a single transaction on the main chain. These systems use authenticity proofs to verify the validity of transactions. Assets are held on the original chain with a smart peg contract, which confirms that the pool is working as it should. This provides mainnet security with the benefits of less resource-intensive aggregation.
Side chains
Sidechains are independent blockchain networks that have their own groups of validators. This means that the smart contract on the main chain does not confirm the authenticity of the sidechain network. Therefore, you should make sure that the sidechain is working properly because it can control assets on the original network.
Status channels
A status channel is a two-way communication environment between trading parties. Parties lock down part of the underlying blockchain and connect it to an off-chain transaction channel. This is usually done via multi-signature or a pre-agreed smart contract. The parties then execute a transaction or set of transactions off-chain without sending the transaction data directly to the underlying financial distributed ledger (i.e. the main chain). Once all transactions in the group are completed, the final “state” of the channel is broadcast on the blockchain to verify its validity. This mechanism allows to improve the speed of transactions and increases the overall capacity of the network. Solutions such as Bitcoin's Lightning Network and Ethereum's Raiden operate based on state channels.
Overlapping blockchains
This solution is based on a set of secondary chains located on top of the main blockchain. Overlapping blockchains operate based on rules and standards established by the main chain. The main chain is not involved in executing transactions, but rather its role is limited to resolving disputes when necessary. The daily work is delegated to subchains, which return processed transactions to the main chain when they are completed outside of it. The Plasma project of the OmiseGo network is an example of a layer 2 cross-chain solution.
Disadvantages of first and second layer expansion solutions
Both Layer 1 and Layer 2 solutions have their own distinct advantages and disadvantages. Working with Layer 1 can provide the most effective solution for large-scale protocol improvements. But this also means that validators must be convinced to accept changes through a network split.
An example of a situation where validators may not want to do this is when you change from proof of work to proof of stake. Miners will lose income as a result of this shift to a more efficient system, discouraging them from improving scalability.
Layer 2 provides a faster way to improve scalability. But depending on the method used, you can lose a significant amount of the security of the original blockchain. Users trust networks like Ethereum and Bitcoin for their adaptability and proven track record for security. With some aspects of the first layer removed, you are often forced to rely on the second layer team and network for efficiency and security.
What comes after the first layer and the second layer?
An important question is whether we will need Layer 2 solutions if Layer 1 becomes more scalable. Existing blockchains are seeing improvements, while new networks are designed to have really good scalability. However, large systems will take a long time to improve their scalability, and this is not guaranteed. The likely option is for the first layers to rely on security, while the second layer networks allow their services to be tailored to specific use cases.
In the near future, there is a good possibility that large chains like Ethereum will remain dominant due to their large user and developer community. But the large, decentralized pool of validators and good reputation of these chains creates a base for targeted layer 2 solutions.
Concluding thoughts
Since the advent of cryptocurrencies, the search for improved scalability has given rise to a dual approach in layer-one improvements and layer-two solutions. If you have a diversified cryptocurrency investment portfolio, chances are you already have exposure to Layer 1 and Layer 2 networks. You now understand the differences between the two, as well as the different expansion approaches they offer.