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Blockchain technology has grown rapidly since Satoshi Nakamoto brought Bitcoin to the world’s attention. Since then, in the race to fulfill every requirement of decentralized products like DeFi and Dex, blockchains, especially layer 1 blockchains, have had to adapt and scale as much as possible. An increase in scalability also means risks to the chain’s integrity and security, which means that the developers must make the blockchain scalable while also maintaining the network’s security. Note, blockchain was introduced focusing only on decentralization and security that led to its self-imposed scalability limits like smaller block sizes and low block production rates.
Layer 1 protocols are simple additions to the existing base layer of a blockchain. Some prominent examples are Ethereum and Bitcoin, where the layer 1 protocols have been experimenting with its protocols to adapt and scale primarily by increasing the data storing capacity of each block (block size) along with the block rate to improve throughput/transaction speed. Limiting throughput eventually results in network congestion. In order to decongest, the networks would need individual nodes to be equipped with high hardware and software requirements. At that point, only limited people can afford to run a node. When network congestion results in higher costs to operate a node coupled with the high demand for limited block space, nodes prioritize transactions in order of highest fees paid instead of processing transactions in the order they were received inevitably driving up the average transaction fees for users.
More modern L1 blockchain networks (especially those that are live since 2021) are now working on their protocols to be both scalable, fast and lower the transaction fees for users. Blockchains like Shardeum are using mechanisms like sharding to significantly improve the scalability and maintain low fees even as the usage grows. Sharding, in particular, involves breaking up the L1 chain into smaller chains called shards, each capable of independently processing transactions and smart contracts. These shards can operate in parallel, increasing the throughput of the blockchain network instantly. Importantly many of the latest blockchains are not only working towards improving scalability and low costs but also maintain high security and decentralization – the two attributes blockchain networks are known for.
Increased scalability and speed paves way for greater adoption even though L1 platforms will need some more time to solve the blockchain trilemma – where it can maintain high security, decentralization and scalability – all at the same time. But once Ethereum took the Bitcoin’s innovation to a whole new league by introducing smart contracts and enabling blockchain technology to be used by multiple industries such as finance, art, governance since 2016, the need for layer 2 scalable solutions arose overnight. Public blockchains, who were only fulfilling the job of decentralized payment processors and peer-to-peer transfer of value thus far, suddenly saw the volume of user transactions grow rapidly which they weren’t prepared for at all.
And considering L1 blockchains are permissionless, layer 2 solutions and other types of services started building over them immediately as a stop-gap measure. A good example of a layer 2 blockchain solution is rollup. We will go through some of them in the segment below. In a nutshell, these layer 2 networks improves scalability and other inherent shortcomings of public blockchains (like privacy) by processing transactions off-chain, reducing congestion and costs, while preserving security through the mainchain. Here are some of the examples.
Rollups are layer 2 solutions that aim to improve the scalability by aggregating multiple transactions into a single transaction. There are two types of rollups: optimistic rollups and zk-rollups. In optimistic rollups, transactions are initially processed off-chain by ‘assuming’ all of them are valid and then later verified on-chain for any invalid ones. In zk-rollups, transactions are verified off-chain using zero-knowledge proofs (by proving the transactions are valid without revealing specific details, similar to you proving you are over 18 without revealing your exact date of birth) before being committed to the blockchain. Rollups allow for increased transaction throughput and reduced gas fees by minimizing the amount of data that must be stored and processed on the main blockchain while maintaining security through the verification process.
Sidechains are separate blockchains connected to the main blockchain, allowing for transactions to occur off-chain. Sidechains operate independently but can transfer assets and data back and forth with the main blockchain. This helps alleviate congestion on the main blockchain and allows faster and cheaper transactions. Sidechains can have their own consensus mechanisms, rules, and token economies, enabling experimentation and innovation within its blockchain ecosystem.
State channels are Layer 2 solutions allowing off-chain transactions, albeit, between two parties. State channels are essentially private off-chain channels consensus where parties can transact without broadcasting every transaction to the main blockchain. Only the final state of the channel is recorded on the blockchain. State channels enable instant transactions, low transaction fees, and high scalability, as transactions are only processed off-chain between the parties involved. State channels are especially suitable for frequent and small transactions between known parties, such as gaming or micropayments.
The importance of blockchain layers arises from the simple fact that blockchain technology needs to keep up with the world while it expands its utilities and adoption at a massive scale. Blockchain’s multi-layered structure underpins its transformative potential. Together, they can address the inherent shortcomings of layer 1 blockchains such as scalability and privacy to a certain extent, at least till a L1 platform solves the scalability trilemma at the root or base protocol layer. And together, they have been to handle the decentralized market fairly by supporting decentralized applications (dapps) and smart contracts, translating the tech’s power into real-world utilities like decentralized finance (DeFi). Collectively, these layers intertwine, balancing robust security with innovation, showcasing blockchain’s vast applicability across industries.
Consider this – the Visa network processes transactions at a speed of more than 24,000 transactions per second. In contrast, blockchains like Bitcoin and Ethereum can process a maximum of 15 TPS. Even the recent blockchains process an average of 400 TPS (max) in practice. As mentioned previously, this is down to public blockchain’s indispensable requirement to prioritize security and decentralization (note Bitcoin was innovated in the aftermath of 2008 financial crisis where the history repeated when legacy centralized entities abused their power and people’s resources to cause widespread market downturn).
Note, the throughput of a blockchain network, or any network for that matter, directly impacts its scalability. If the speed or throughput of processing transactions is low, it means the blockchain can handle fewer transactions per second (TPS). This limitation becomes evident especially when there’s a surge in user activity, leading to congestion, delayed transactions, and higher fees. Therefore, to achieve broader adoption and handle large-scale applications, enhancing the speed and throughput is crucial to improve blockchain scalability.
Learning about the limitations of these two layers directs the blockchain technology towards future improvements. In fact, there are more on-chain and off-chain layers atop the base layer. Technology finesse is a step by step process. Experts, though, widely believe that solving the blockchain trilemma at the root level will be the most ideal. Applications and solutions developed on top of Layer 1 are intrinsically tied to its foundational architecture and principles. This means that their core features, functionalities, and advantages are often a direct result of the Layer 1 blockchain’s capabilities. They, further serve as the bedrock, establishing standardized protocols that allow diverse applications and even other chains to communicate and share data seamlessly.
While Layer 1 chains are predominantly permissionless, granting the freedom for anyone to create tailored solutions and applications without needing external consent, it’s pivotal to recognize the diverse scenarios coexisting within our societal framework. Blockchains inherently advocate inclusivity. Entities like defense agencies or private corporations often deal with delicate transactions and operations. Such organizations can benefit from the capabilities of L1, utilizing advanced tools like zero-knowledge proofs to maintain discretion.
Although current L1s have areas for improvement, numerous private entities have harnessed blockchain through distinct private and consortium L1 chains, which prioritize adaptability over absolute decentralization. As they modify this technology to fit specific requirements, the emergence of a highly scalable, cost-effective public L1 chain would further empower these entities to innovate and refine their offerings seamlessly. You could imagine a layer 3 or layer 4 evolving that will work on improving the interoperability, easier application development frameworks, breakthrough off-chain storage systems compared to existing systems today.
Layer 1 blockchains are the main blockchains that serve as the foundation of a blockchain network. They handle the core functionalities of a blockchain, such as transaction processing, consensus, and smart contract execution. Examples of layer 1 blockchains include Bitcoin, Ethereum, and Shardeum. Layer 2 blockchains, on the other hand, are built on top of layer 1 blockchains and provide add-on features and functionality. Layer 2 solutions are designed to moderately alleviate the limitations of layer 1 blockchains in terms of transaction throughput, transaction fees, and processing times. They can include technologies such as state channels, rollups, and sidechains. Example of such networks include Polygon, Arbitrum, Lightning Network.
An example of a layer 1 blockchain is Ethereum, a widely used blockchain platform for decentralized applications (dapps) and smart contracts. Ethereum is a layer 1 blockchain because it operates as the primary blockchain that processes transactions, executes smart contracts, and maintains its own consensus mechanism. Ethereum has its native cryptocurrency, Ether (ETH), which fuels transactions and smart contracts on the platform.
An example of a layer 2 blockchain is the Lightning Network, a layer 2 solution built on the Bitcoin blockchain. The Lightning Network is designed to enable faster and cheaper bitcoin transactions by creating off-chain payment channels between users. Transactions can be conducted relatively quickly and with lower fees than on-chain bitcoin transactions. The Lightning Network operates as a layer 2 solution because it relies on the Bitcoin blockchain as the base layer for security and final settlement while processing most transactions off-chain within the Lightning Network’s payment channels.
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