The world of cryptocurrency and DeFi applications is constantly growing more and more popular. This leads to a lot of structural changes as the platforms must be able to handle drastic scaling in a relatively short time.
This isn’t something easy to do in such a short time. Even if it was, it would be at the detriment to their security systems or decentralization. Something else had to be done. That is where Layer 2 solutions came in. By adding another layer, they were able to keep the security and most of the decentralization while also adding a way to increase the transactions to something more manageable.
Layer 2 solutions exist anywhere there is a main platform. Ethereum and Bitcoin are the two most popular. This means that they are also the two platforms with the most problems. While both have their scaling issues, Ethereum’s is much more well known. For a while, they reached such a backlog of transactions that gas fees were worth up to $500. Even on their lower days, it usually costs anywhere around $30 per transaction at the time of writing.
The need for layer 2 solutions came pretty quickly. At first, cryptocurrency was new, and not many people were into using them. However, pretty quickly, the desire to use a decentralized banking system proved appealing and the number of users has been increasing quickly. Now, the scalability issues are coming to light and something had to be done to fix the problems. However, there is a major issue when it comes to trying to fix the scalability of a blockchain.
Experts in the field of DeFi programs note that all apps and platforms have three elements that they can focus on when building a blockchain. These are decentralization, security, and scalability. However, it is impossible currently to have all three of these elements at the same time. Usually, two can be focused on at once, and the third is left behind.
Before, when there weren’t many users of cryptocurrency, focusing on decentralization and security made sense. Being able to process only 7 to 14 transactions per second wasn’t that big of an issue. However, now, with so many people using the blockchains at a time, that small of a number is laughable.
The popularity of cryptocurrency is increasing rapidly. It is expected that by the end of the next 4 years, 10% of global GDP will be using blockchain. This is a huge shift. To handle such a large amount of transactions, something else needs to be done.
Since giving up security or decentralization isn’t possible, another solution had to be found. Layer 1 solutions were tried first, such as Proof of Work (PoW) and Proof of Stake (PoS). However, not even that was enough to meet the increased demands.
This is when Layer 2 solutions started to grow.
Layer 2 solutions are designed to solve the problem that Ethereum and Bitcoin have with low transaction speed. By itself, the Ethereum mainnet is only able to handle roughly 14 transactions per second. With nearly a million users on the platform daily, this can, and has, created a large delay and increase in gas fees. In comparison, companies like Visa can handle up to 70,000 transactions per second.
They work by taking a lot of transactions off of Ethereum’s mainnet (Layer 1) and handling them in a separate area (Layer 2). This allows for lower fees and faster transactions.
Types Of Layer 2 Solutions
There are three main types of Layer 2 solutions.
Sidechains have been around a little longer than other Layer 2 solutions. They provide a way to make transactions faster and they can handle more at once than with Ethereum’s mainnet. However, they are also not very secure. They are unable to offer the security of the mainnet. Currently, one of the most well-known sidechains is Polygon. There is also Liquid Network, which is one that Bitcoin primarily uses on its platform.
Though they are often listed under Layer 2 solutions, they are more of a hybrid between Layer 1 and Layer 2. They offer better scaling solutions but do sacrifice a lot of their security to do so.
Channels are good for instant withdraws on the mainnet. They keep gas fees pretty low and allow for a lot of transactions to occur at once. However, it also takes a long time to set up a channel and there may be long exit times. The most popular channel currently available is Celer Network.
There are currently two types of channels, which are state channels and payment channels. They allow an incredibly large amount of transactions at once and have some of the lowest gas fees, which makes them great for multiple smaller payments. However, there has to be a constant observation of the network to make sure everything runs correctly and that the funds are secured properly.
These chains can be either on-chain or off-chain.
Rollups are what most people are looking to for the future of Layer 2 solutions. They offer quick transaction times, and the security of a mainnet. They take transactions off of the mainnet, and process them on a different layer, before returning a receipt over to the mainnet.
Rollups work by combining a large number of transactions (up to 2000 at a time) into one transaction that Ethereum has to process. There are two main kinds of rollups, ZK Rollup and Optimistic Rollups.
ZK Rollups can complete near-instant transfers, as well as stay secure and decentralized. However, it is not preferable for smaller applications, as it requires a lot of computing power without the users to run it.
Optimistic Rollups, on the other hand, have low gas fees, strong security, and increased throughput. However, there are still long withdrawal times, due to the way that it checks the authenticity of transactions.
There are three main properties of a Rollup:
- Transactions are done outside of Layer 1 to reduce the gas fees
- Proofs and receipts are recorded on Layer 1 to maintain security
- A rollup smart contract is on Layer 1 and enforces transaction execution, which requires the transaction data on Layer 1
There are other forms of Layer 2 solutions, but they aren’t used nearly as much. This includes Plasma chains. As the demand for Ethereum increases, so too does the different types of layering solutions.
Ethereum isn’t able to handle many transactions at once by itself. There is a plan to have Ethereum 2.0 released. However, that is likely to take a year or longer before it comes out. In the meantime, other solutions have to be found.
These solutions aren’t perfect, but they allow Ethereum to scale and serve all of the users on the platform so that they can keep up with their competitors and the high demand their users ask for.
Ethereum’s gas fees have been known to get up to nearly $500 per transaction. Having an option to reduce gas fees is very important to keep Ethereum running and well-used.
Instead of keeping these high prices, they decided to come up with other options. Layer 2 solutions are still fairly new, but offer up a lot of positive results already and show good hope for keeping gas prices low in the future.
The scalability trilemma is a term that was first used by the founder of Ethereum himself, Vitalik Buterin. He used this word to describe the issue that all blockchains and their projects have.
As the name suggests, the trilemma covers three different main elements of creating and maintaining a blockchain. These are scalability, security, and decentralization.
The theory states that you can only really focus on 2 out of the 3 sides of the triangle. Currently, major blockchains like Bitcoin and Ethereum have decided to focus on security and decentralization, which leads to issues when it comes to scalability.
This is a difficult question to answer. Currently, we have a strong dependency on Layer 2 solutions and don’t see that going away any time soon. However, Ethereum is planning on coming out with Ethereum 2.0, which will address several of the issues that Ethereum currently faces.
This includes their transaction speed. However, since there isn’t much of a way to get decentralization, security, and scalability, it remains to be seen how their system is planning to balance all three. Not to mention, Bitcoin has no plans for adjusting its transaction speeds in the future.
Therefore, it makes sense that Layer 2 solutions such as rollups and sidechains are here to stay for the foreseeable future.
Some issues are surrounding rollups and other Layer 2 solutions that need to be fixed if they are planning to stay long-term. One of the biggest issues is their lack of communication. Though Layer 2 solutions rely on the mainnet’s security to protect the transactions, there is one glaring flaw.
No two solutions communicate with each other. That means that transactions can be sent through multiple rollups at once and they wouldn’t be caught. This is a pretty big security risk. Though it hasn’t been exploited yet and may be something difficult to do, the fact still stands that it is a gaping issue that needs to be addressed before they are used more frequently.
Currently, a project known as Algorand is working hard to try and incorporate all three sides of the triangle into its program. Algorand uses a new proof for the consensus protocol known as Pure Proof of Stake (PPoS).
Theoretically, under this protocol, fees should be lower as there are minimal computations, it doesn’t matter the number of users on the platform at one time. As the number is constant, it should be easily scalable up to a large number. This allows the decentralization, security, and scalability to be pretty well balanced if done right.
If this does occur, other solutions may end up falling to the wayside. However, it will take a lot of extensive time and study to make sure that the program works well and is secure enough to be used by most people.
Layer 2 solutions, especially rollups, are a great way for large blockchains like Ethereum and Bitcoin to increase their total transactions per second without reducing security. At its best, a rollup can handle roughly 2000 transactions per second. This still isn’t nearly as much as some centralized platforms, but it is a lot of progress from 13 or 14 per second.
However, there is also a downside to using these rollups long-term. Since they work by relying on the main blockchain and reporting back to it, the whole process gets more and more centralized as it grows. This holds to the theory that currently, cryptocurrency is only able to handle two out of the three main elements.
At first, pushing scalability to the side wasn’t a bad idea. It allowed for the main features that make cryptocurrency appealing, such as security and decentralization. There also weren’t too many people using cryptocurrency at first, so scaling wasn’t such an issue. Now, however, cryptocurrency is gaining in popularity, and fast. It is even being accepted at a wide range of stores.
Scalability is now becoming a large issue.
It will be interesting to see if Ethereum can break from that with Ethereum 2.0 and manage to focus on all three elements. If they aren’t, then it is likely that they will just create another of many options to use when handling transactions on Ethereum. Unless Ethereum 2.0 can balance all three elements, Layer 2 scaling isn’t likely to go away in the near future.
If Algorand does manage to make an effective, balanced system, we might see a change in the future. However, for right now, it seems that Layer 2 solutions, flaws and all, are here to stay for a while longer.
John S. Logan has been working with cryptocurrency for nearly as long as it has been available on the market. With a professional background in the finance industry, he believes that blockchain technology, cryptocurrency, and decentralized finance play an important role in the future of the world.