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What Are Layer-2 Scaling Solutions

The scalability trilemma remains one of the biggest issues of the blockchain. Here’s how Layer-2 scaling solutions can help.
Aug 12, 2022
Layer 2 Opt 1

Layer-2 scaling solutions are the technology that runs on top of a blockchain protocol that improves the speed and efficiency of the underlying blockchain. Here’s how it works in detail.

Key Takeaways

  • Layer-1 refers to a main blockchain, while Layer-2 refers to the network that sits on top of a main blockchain
  • Layer-2 solutions intend to solve the issue of scalability by processing transactions off the mainnet
  • The advantages of a Layer-2 solution include increased transactions per second (TPS), reduced gas fees, maintained security, and application-specific networks

What Are Layer-2 Scaling Solutions?

From using it as a transacting currency (ETH) to tapping into its immutability for record-keeping and cryptographically secured nature, Ethereum has been a catalyst for enormous growth in the blockchain industry since its introduction in 2013.

But, like many other blockchains, Ethereum has reached a point where it now faces the challenge of scalability. As of summer 2022, Ethereum processes an estimated 500,000 transactions per day, which translate to 30 transactions per second. In comparison, Visa’s payment system is capable of processing up to 150 million transactions per day and 65,000 transactions per second — magnitudes ahead of what Ethereum is capable of. 

In practice, reaching the limits of a blockchain results in network congestion (where it may take hours to process a transaction) and extremely high gas fees

Enter Layer-2, sometimes referred to as the Data Link Layer (DLL). This solution intends to solve the blockchain’s scalability issue by processing transactions on third-party networks instead of the Ethereum mainnet (Layer-1). In doing so, it not only lightens the workload on the mainnet, but also maintains the same security and decentralisation standards of the underlying blockchain.  

Layer-1 vs Layer-2 Blockchains

Layer-1 refers to the distributed database itself — the network that brings all of the blockchain’s nodes together into one system with its underlying consensus mechanisms. For example, Bitcoin’s Layer-1 is the Bitcoin network, and Ethereum’s Layer-1 is the Ethereum network. Both currently use a Proof of Work (PoW) consensus mechanism. 

Layer-2, however, is an overlaying network that sits on top of the blockchain. Lightning Network is the Layer-2 solution for Bitcoin. Plasma, Polygon, Optimism, and Arbitrum are just a few of the Layer-2 networks built on Ethereum.

Why Are They Important?

Currently, Ethereum is one of the most sophisticated blockchains in terms of network security and stability. The majority of individuals and companies opt to use this blockchain for transactions or to build projects. However, as the number of transactions increases, the network becomes increasingly congested. 

To tackle this, miners prioritise confirming transactions with higher gas prices. But these higher costs fall on the user, raising the minimum gas fee, which at times can exceed the value of a transaction itself. 

With Layer-2, the underlying network (mainnet) does not need to process such large amounts of data because it sends this data to different processing channels (third parties), recording only the final result on the Layer-1 blockchain. 

Advantages of Layer-2 Solutions

  • Increased transactions per second (TPS) can improve user experience and reduce network congestion on the mainnet
  • Transactions are consolidated into one package before recording onto the mainnet, reducing gas fees
  • Any updates to a Layer-2 solution do not alter the underlying blockchain, since Layer-2 is built on top of the blockchain, which helps ensure network security
  • Allows for application-specific Layer-2 networks that are specifically designed to optimise a certain feature

Disadvantages of Layer-2 Solutions

  • May remove liquidity from the primary blockchain
  • Potential security and privacy vulnerabilities; users should do their own research before using Layer-2 solutions
  • Could impede interconnectivity with other Ethereum-based applications (i.e., using an L-2)

What Types of Layer-2 Solutions Are Out There?

Layer-2 solutions mainly focus on directing the majority of transactions away from the mainnet. Within a short period, many Layer-2 projects have emerged to tackle this challenge. However, only a few have succeeded in resolving the most critical issues. Here are three examples of Layer-2 blockchain scaling solutions:

State Channels

A state channel is a two-way communication channel between participants. In other words, there is no need for a third party, such as a miner, to confirm the transactions; this improves transaction speed. 

The process starts by sealing off a portion of the blockchain via Multi-signature (multisig) to allow for a direct interaction without needing to submit anything to the miners. Once the transaction is confirmed, the final state of the channel is added to the blockchain. 

Examples: Bitcoin’s Lightning Network, Ethereum’s Raiden Network

Advantages

  • Manages complex interactions
  • Handles extremely high transaction throughput at a very low cost

Disadvantages

  • High cost for setup and settling channels
  • Funds are required to be locked up in open payment channels
  • Does not support open participation

Zero-Knowledge Rollups

Zero-knowledge rollups (ZK-Rollups) consolidate transactions that have been taken off the main blockchain and generate a cryptographic proof known as a SNARK (Succinct Non-Interactive Argument of Knowledge). This proof, also called a validity proof, is the only record required on the main blockchain; hence, reducing the gas fee that users would have incurred from processing the entire data. 

Examples: Immutable X, Polygon Hermez, Starkware

Advantages

  • Secure and decentralised
  • Near-instant transfers

Disadvantages

  • Hard to compute for smaller applications with less on-chain activity
  • Not all ZK-Rollups offer Ethereum Virtual Machine (EVM) compatibility
  • Transaction ordering can be influenced by a user

Optimistic Rollups

As opposed to ZK-Rollups, optimistic rollups rely on fraud proofs. Put simply, aggregators publish minimal information on Layer-1 and assume that the data is correct. 

If the transaction is indeed valid, the main blockchain is not required to do anything more. In the case of a fraudulent transaction, the optimistic rollup performs a fraud-proof and penalises the sender. 

Examples: Arbitrum, Boba, Cartesi, Fuel Network, Optimism

Advantages

  • Low gas fees
  • Increased throughput
  • Smart contract capability
  • Security 

Disadvantages

  • Long withdrawal times
  • Potential incentive misalignment between network participants
  • The underlying Layer-1 could censor transactions

What’s Next for Blockchain Scalability? 

Layer-2 blockchain projects and solutions on the Ethereum blockchain have become one of the most common answers to blockchain scalability issues. With a heavy focus on this technology, it promises a future with widespread adoption, accompanied by low transaction fees. 

The Layer-2 solutions introduced above are the industry’s initial attempt at solving scalability issues. In late 2022, Ethereum is slated to launch ‘The Merge’, encapsulating its next step in overcoming scalability issues. However, it is still unclear as to how this will change the landscape of blockchains and the impact it will have on Layer-2 scaling solutions.

Due Diligence and Do Your Own Research

All examples listed in this article are for informational purposes only. You should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained herein shall constitute a solicitation, recommendation, endorsement, or offer by Crypto.com to invest, buy, or sell any crypto assets. Returns on the buying and selling of crypto assets may be subject to tax, including capital gains tax, in your jurisdiction.

Past performance is not a guarantee or predictor of future performance. The value of crypto assets can increase or decrease, and you could lose all or a substantial amount of your purchase price. When assessing a crypto asset, it’s essential for you to do your research and due diligence to make the best possible judgement, as any purchases shall be your sole responsibility.

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Blockchain

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Layer 2 solutions

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