A Primer on Layer 2 Scaling Solutions

Written by BTSE

December 1, 2023

A Primer on Layer 2 Scaling Solutions

There are more than 1,000 active blockchains in existence. Each has its own advantages and shortcomings. For example, Ethereum is highly decentralized and secure, but transaction confirmation can be slow and costly. On the other hand, Solana is secure and has fast confirmation times, but its capacities for scalability and decentralization have been questioned. Both of these are Layer 1 blockchains, which were built to establish new ways of processing data that are improvements over base protocols such as Bitcoin.

There is no perfect blockchain, but some solutions — Layer 2 protocols — take a step further by building new layers on top of Layer 1s. They’re meant to increase the efficiency and speed of decentralized networks, specifically by increasing the data throughput without affecting the original Layer 1 blockchain’s characteristics of decentralization or level of security. 

Examples of Layer 2 tokens include MATIC, IMX, ARB, OP, and LRC all of which can be acquired using BTSE’s digital asset exchange. There are many more Layer 2 solutions; for illustrative purposes, this article will focus on those built on Ethereum.

 

Types of Layer 2 Scaling Solutions

 

“Layer 2” is a term that refers to any scaling solution built on top of an existing blockchain system. There are many variations on this idea: Polygon, Avalanche, and Starknet are Layer 2 solutions built on Ethereum, while Aurora offers the speed and scalability of a Layer 2 network on top of NEAR Protocol, on which BTSE DEX operates. There are many differences among Layer 2 solutions.

Sidechains are among the most prominent Layer 2s. They are compatible with the Ethereum Virtual Machine (EVM), which means smart contracts deployed on these networks can also work on Ethereum with few changes. Sidechains are often used for large batch transactions because they use their own consensus mechanisms that are optimized for speed and scalability, although this means there may be compromises in terms of decentralization within the Layer 2 protocol. One of the most well-known sidechains is Polygon, which has gained recognition as one of the networks of choice for Web3 games.

Another Layer 2 category is parachains, which is short for “parallel chains.” As the name implies, these networks run in parallel within the same framework, interconnected to share security attributes and other characteristics. They can function independently from one another so that each chain can have a specific function, while all linking up with a central relay chain. An example of a parachain is Polkadot, which was designed as an alternative to Ethereum, with lower fees and better scalability.

Zero-knowledge rollups, or ZK-rollups, involve sending clusters of data collateralized by a smart contract off-chain, so that it can be processed. This leads to the capability of producing a block in under a minute and processing 2,000 transactions per second. The “zero-knowledge” in the name of ZK-rollups refers to an authentication method that allows all verifiers to know that each party has the same information without anyone disclosing it publicly, making this Layer 2 resilient against fraud. Additionally, ZK-rollups maintain high performance because of its off-chain data storage, saving processing power and lowering gas fees. Matter Labs and Starkware are projects that implement ZK-rollups.

Meanwhile, optimistic rollups were built with a different philosophy altogether: they rely on fraud proofs. If a transaction is not valid, optimistic rollups penalize the sender. They run on Ethereum’s base layer so that their transactions take less time than ZK-rollups while the same level of security is inherited. Examples include Arbitrum and, as the name suggests, Optimism.

 

The Significance of Layer 2 Scaling Solutions

 

Layer 2 solutions inherit the security characteristics of the underlying main chain. They also have higher transaction speeds and lower fees. Additionally, they can be built to optimize selected features, so Layer 2s can be specific to their corresponding applications. All of these qualities help shape a better user experience.

At the same time, the existence of successful Layer 2s could remove liquidity from the network on which they are built. And if there are vulnerabilities in the Layer 1 network, those same flaws would then be inherited by its Layer 2 protocols. These are important caveats to be aware of when using Layer 2 networks or investing in their tokens.

Aside from the Layer 2s mentioned above, there are other types too, such as the Bitcoin Lightning Network, which brought smart contracts to the Bitcoin protocol. 

To learn more about digital assets and their infrastructure, keep an eye on BTSE’s blog for more explainers.

 


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Note: BTSE Blog contents are intended solely to provide varying insights and perspectives. Unless otherwise noted, they do not represent the views of BTSE and should in no way be treated as investment advice. Markets are volatile, and trading brings rewards and risks. Trade with caution.

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