What Are Layer 2 Blockchains? A Complete Guide

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Layer 2 blockchains are built on top of these Layer 1 networks, functioning as secondary frameworks to enhance transaction capacity and speed.

In the rapidly evolving landscape of blockchain technology, Layer 2 blockchains have emerged as a pivotal innovation. These solutions are designed to address the scalability and efficiency challenges faced by their Layer 1 counterparts.

This article delves into the intricacies of Layer 2 blockchains, one of the top crypto narratives to watch out for in 2024, and offers insights into how they are revolutionizing the blockchain world.

A Complete Guide On Layer 2 Blockchains

  1. Understanding Layer 2 Blockchain
  2. The Need for Layer 2 in Blockchain Scalability
  3. Comprehensive Guide to Layer 2 Solutions
  4. Top Layer 2 Blockchains
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1. Understanding Layer 2 Blockchain

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Layer 1 blockchains, such as Bitcoin and Ethereum, are the foundational networks where transactions are finalized. However, they often face limitations in scalability and transaction speed.

Layer 2 networks are off-chain solutions built on top of a base blockchain (Layer 1), enhancing its capabilities, especially in scalability and transaction speed. These networks inherit the security of the underlying blockchain, ensuring that transaction data is verified by the base layer, not separate nodes. This is a key distinction from systems like sidechains, which have different security models due to their independent validators.

Layer 2 solutions address scalability issues in blockchains that prioritize decentralization and security, enabling faster transactions and potentially lower fees. They offer a balanced approach to scaling blockchain networks, maintaining core principles of security and decentralization while improving performance.

2. The Need for Layer 2 in Blockchain Scalability

Blockchain scalability trilemma

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The blockchain scalability trilemma, a concept introduced by Ethereum Co-founder Vitalik Buterin, highlights a fundamental challenge in blockchain technology. Since its inception in 2008, blockchain has faced limitations that hinder its ability to scale effectively while maintaining both security and decentralization. This dilemma suggests that a blockchain can achieve only two of these three critical aspects simultaneously, not all three.

Thousands of researchers and developers have been working tirelessly to address these scalability issues, which have historically led to high fees and slow execution times. These challenges significantly reduce the efficiency of blockchains, especially as adoption grows. The core functions of blockchains today – execution, data availability, and consensus – are at the heart of these scalability issues.

  1. Execution: This involves transaction processing and throughput, essentially the number of computations, including transactions, that a blockchain can process per second.
  2. Data Availability: This refers to the storage requirements for nodes and validators, encompassing transactions, state, and other data. It’s typically measured in standard storage units like megabytes or gigabytes.
  3. Consensus: This is about achieving broad agreement among nodes and validators on the network’s state and the ordering of transactions. It’s measured in terms of decentralization and time-to-finality, which is the duration it takes for all nodes to agree on a particular state change.

Layer 2 solutions have emerged as a promising technology built on the premise that these scalability limitations exist because blockchains are overloaded with responsibilities. By offloading some of these tasks, Layer 2s aim to enhance scalability without compromising on security or decentralization, addressing the core challenges posed by the blockchain scalability trilemma.

Ethereum’s Cases

Ethereum is the most established foundational blockchain. As it has been around for many years, there’s been a steady increase in the number of developers and projects, including Dapps, within its ecosystem, with no signs of slowing down. This growth has led to a surge in user numbers, especially during market highs.

However, Ethereum’s limited capacity of about 15 transactions per second (TPS) often leads to network congestion and slow performance. Coupled with high gas fees, these issues pose significant challenges to Ethereum’s widespread adoption.

Certain events have led Ethereum’s core developers to realize the need for changes and upgrades to the network, such as:

  • The CryptoKitties game exploded in popularity in 2017 and even caused Ethereum’s network to be congested at that time.
  • The DeFi Summer of 2020 saw network fees skyrocket.
  • The GameFi craze started with Axie Infinity.
  • The NFT boom, where the fee surge led to some collections incurring thousands of dollars in transaction fees to mint just a single NFT.

Two clear strategies have emerged to help the Ethereum ecosystem address these challenges:

  1. Ethereum 2.0 with Proof Of Stake and DankSharding: These core elements are crucial for the network’s evolution.
  2. Layer 2 Solutions: These off-chain solutions process and execute transactions outside the main chain, eventually integrating them back into Layer 1, in this case, Ethereum. Layer 2 effectively addresses issues related to transaction speed and fees while maintaining the security of the original chain.

Both of these solutions are being developed simultaneously. Recently, Ethereum officially upgraded from Proof Of Work to Proof Of Stake, and Layer 2 projects have also made significant strides, particularly with Rollup solutions.

4. Comprehensive Guide to Layer 2 Solutions

There are four prominent Layer 2 solutions for Ethereum, which include:

  1. State Channel
  2. Plasma
  3. Validium
  4. Rollup, which further divides into two solutions:
    • Optimistic Rollup
    • Zero-Knowledge Rollup, abbreviated as Zk Rollup

State Channel

A State Channel is a private channel, essentially a smart contract, opened by two or more individuals. Everyone in this channel can interact (buy, sell, transfer money, trade, etc.) quickly, easily, and at a low cost. The channel only sends two pieces of information to Layer 1:

  1. Transactions for opening and closing the channel.
  2. The final balance of all members in the channel.

Pros:

  • Extremely fast transaction speeds.
  • Very low costs.
  • User-friendly and easy to interact with.

Cons:

  • Suitable only for small-scale use among a group of people, lacking the ability to scale globally.
  • Does not support smart contracts.

Plasma

Also known as a “child chain,” Plasma is a separate blockchain that derives its security from Ethereum.

Plasma is similar to Optimistic Rollup in that it uses Fraud Proof, but the key difference is in the information sent back to the main chain. While Optimistic Rollup sends complete transaction details to the main chain, Plasma only sends a portion of this information. As a result, Plasma sacrifices some network security in favor of better scalability (speed and transaction costs) compared to Optimistic Rollup solutions.

Validium

Validium bears similarities to ZK Rollup, as both use ZK Proof. However, the difference lies in the transaction information sent to the main chain. Like Plasma, Validium only sends part of the transaction details to the main chain. This approach means Validium sacrifices some network security to achieve better scalability (in terms of speed and transaction costs) than ZK Rollup solutions.

Rollups

Rollups work by executing transactions off-chain, and then bundling hundreds of these transactions into a single block. This block, complete with a transaction proof, is then sent back to Layer 1. On Layer 1, validators confirm the block and store it on the main network. This way, Layer 2 solutions maintain Ethereum’s decentralized and secure nature.

There are two main types of Rollup solutions:

  1. Optimistic Rollup: Examples include platforms like Optimism, Arbitrum, Boba Network, and Metis DAO.
  2. ZK Rollup: This includes StarkNet, ZkSync, Polygon, among others.

The primary difference between Optimistic and ZK Rollups is in their approach to transaction proof. ZK Rollups bundle Layer 2 transactions and send them to the main chain with a Validity Proof, ensuring the transactions in the block are legitimate. This process streamlines validation on the main chain.

Optimistic Rollups use a Fraud Proof method. It’s akin to a man entering a bar and being told by the bouncer to prove he’s over 18. The man says, “I’ll stay here for 7 days. If no one challenges my age during that time, assume I’m of age.”

Optimism Rollup-Blockchain Layer 2
Optimism Rollup Layer 2 Model.

In contrast, ZK Rollups use a Validity Proof (zero-knowledge proof). Using the same example as above, it’s like a man entering a bar and being asked for age proof. He responds, “I’ll prove I’m over 18 but won’t show any personal ID.” ZK Rollups use zero-knowledge technology for this purpose.

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Zk Rollup Layer 2 Model

Both Optimistic and ZK Rollups have their strengths and weaknesses. While Optimistic Rollups may lag behind ZK Rollups in terms of scalability and Layer 1 withdrawal times, they are technically simpler and EVM-compatible, leading to earlier ecosystem development. ZK Rollups, offering superior performance, require more development time due to their technical complexity.

5. Top Layer 2 Blockchains

Ethereum, known for its smart contract capabilities, faces scalability challenges. Layer 2 solutions like Arbitrum, Optimism and Starknet have gained prominence. Now, let’s discover the top layer 2 blockchains that will dominate the market in 2024.

Arbitrum

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Arbitrum Blockchain-Layer 2 Ecosystem.

Arbitrum is an Optimistic Rollup platform developed by Offchain Labs, a team with extensive experience in the crypto market. The project has successfully raised hundreds of millions of dollars from renowned investment funds worldwide, including Lightspeed Venture Partners, Ribbit Capital, Alameda Research, Pantera Capital, Redpoint, Compound VCs, and others. In its most recent funding round, Arbitrum was valued at $1.2 billion.

Currently, Arbitrum is a leading project in the Layer 2 sector, excelling in various aspects such as a robust ecosystem and Total Value Locked (TVL), ranking just behind established names like Ethereum and BNB Chain, and even surpassing others like Polygon and Solana in terms of users and transactions. To achieve this, Arbitrum has introduced several upgrades like Nitro and Stylus, along with other products such as Nova and Orbit.

Optimism

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OP Stacks Ecosystem.

Optimism is another Optimistic Rollup layer 2 solution, developed by the OP Labs team. It successfully raised a substantial amount of $178.5 million from investors like Paradigm, A16Z, Wintermute, and IDEO CoLab Ventures. In March 2022, Optimism was valued at $1.2 billion.

Currently, Optimism is focused on building and developing the Superchain ecosystem, primarily using OP Stack technology. The Superchain ecosystem is rapidly expanding, featuring prominent names such as Base, opBNB, Zora, Mode Network, Frax Finance, Lyra Finance, Polygon, Celop, Fantom, DeBank, and others.

StarkNet

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Starknet Ecosystem Map.

StarkNet is a zkRollup solution developed by StarkWare, a company valued at $8 billion, making it the highest-valued among all current Layer 2 solutions. In addition to StarkNet, StarkWare has also developed another Layer 2 solution, StarkEx, which is centered around Validium technology. StarkEx powers several prominent products like Immutable X, dYdX, Sorare, and more.

StarkNet adopts a non-EVM approach, focusing on its own Cairo language. Currently, the StarkNet ecosystem is one of the Layer 2 solutions with the most native projects, compared to others like Base, Optimism, zkSync, and Linea.

Base

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Base blockchain layer 2, developed by Coinbase.

Base is a Layer 2 solution leveraging Optimistic Rollup technology, developed on Optimism’s OP Stack. It’s crafted by the team at Coinbase, a major player in the crypto exchange world and a listed entity on the US stock market. Coinbase’s involvement is a solid vote of confidence for Base’s future success. Its launch has been a blast, featuring unique and standout projects in its ecosystem, such as Friend.tech, a social networking platform, and Aerodrome, a ve(3.3) model AMM developed by Velodrome.

Linea

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Linea blockchain layer 2.

Linea, a zkRollup solution, is being developed by one of the most seasoned teams in the Ethereum space, Consensys. This is the company behind pivotal Ethereum ecosystem components like Infura and Metamask, which have been crucial in the past, present, and future of Ethereum. Just as Coinbase stands as a testament to Base’s potential success, the achievements of Consensys serve as a solid endorsement for Linea’s promising future.

Conclusions

Layer 2 solutions are crucial in driving wider blockchain adoption. Addressing scalability and cost issues makes blockchain technology more accessible and practical for everyday use. This is particularly evident in sectors like DeFi and NFTs, where transaction speed and costs are critical. More application narratives are derived from blockchain scalability, such as Liquid Staking, LSDfi and now Restaking.

While Layer 2 solutions offer numerous benefits, they also present challenges. Security is a primary concern, as some solutions may compromise decentralization for efficiency. Additionally, the success of Layer 2 solutions heavily relies on user and developer adoption, which is still in its nascent stages.

Layer 2 blockchains represent a significant step forward in addressing the limitations of traditional blockchain networks. By enhancing scalability, speed, and cost-effectiveness, they are poised to play a crucial role in the future of blockchain technology. As the ecosystem continues to evolve, Layer 2 solutions will undoubtedly be at the forefront of this transformation.

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Disclaimer: This article serves informational purposes only and does not constitute financial advice. Conduct your own research before making investmendecisions.