Layer-2 scaling solutions are innovative technologies that act as an extension of the main blockchain (Layer 1), taking the burden of everyday transactions off its shoulders.
For example, between 2017 to 2018, the peak of a bull run on the Ethereum blockchain, the average transaction fee reached $5.70. Since January 18th, 2021, Ethereum’s average transaction fee has consistently exceeded $5.70 daily. For most of the year, the median transaction fee has been higher than $10.
This highlights the need for solutions that reduce transaction costs associated with blockchain usage. With increased adoption of cryptocurrency comes a growing pain point: scalability.
Blockchains, the technology underpinning cryptocurrencies, can struggle to handle the massive amount of transactions happening every day. This leads to slow transaction times and skyrocketing fees, hindering the user experience and hindering the potential of crypto applications.
By processing transactions off-chain and only recording the final results on the main chain, Layer-2 solutions offer a novel method to solve this challenge.
Key Takeaways
- Layer-2 scaling solutions help solve problems of cryptocurrencies like slow transaction speeds and high fees.
- Optimistic Rollups are a kind of Layer-2 solutions which offer fast speeds and support smart contracts, while ZK-Rollups provide even faster transactions and privacy but have limitations with complex smart contracts.
- State Channels are ideal for specific, recurring transactions between two parties with the fastest speeds and high privacy but limited scalability.
- Layer-2 solutions improve the user experience by offering faster transactions and lower fees. However, they can introduce complexities for users and have security dependence on the main chain.
What are Layer-2 Scaling Solutions?
Layer-2 scaling solutions process transactions off-chain, meaning they don’t directly burden the main blockchain. This significantly improves transaction speed, reduces costs and makes crypto transactions more efficient and affordable.
Think of layer-2 scaling solutions like ways to ease a busy highway jammed with cars, all trying to reach the same destination. This gridlock is analogous to what happens on some blockchains when transaction volume surges.
Based on Santiment data on January 25th, Ethereum experienced a significant increase in its transaction volume. The surge suggests a substantial exchange of Ether between market participants using exchange platforms, indicating heightened activity and interest in the cryptocurrency.
Blockchains, the distributed ledgers that power cryptocurrencies, have limitations in the number of transactions they can process per second. This inherent scalability issue leads to slow transaction times and sky-high fees and can hinder the user experience.
Here’s where Layer-2 scaling solutions come in. They act as an ingenious extension of the main blockchain (often referred to as Layer 1). Think of them as additional lanes built alongside the highway, specifically designed to handle a large volume of everyday traffic.
Scalability Limitations That Necessitate Layer-2 Solutions
While blockchains offer a revolutionary way to store and transfer value securely, their current design struggles to handle the demands of a rapidly growing ecosystem. Here’s a closer look at the key scalability limitations that necessitate Layer-2 solutions:
Limited Transaction Throughput
Blockchains process transactions in blocks, and each block can only hold a specific amount of data. This creates a bottleneck, limiting the number of transactions that can be processed per second (TPS).
For example, Bitcoin can only handle around 7 transactions per second, while Ethereum, the popular platform for smart contracts, can manage a slightly higher but still limited number (around 15 TPS). This pales in comparison to traditional payment processors like Visa, which can handle thousands of transactions per second.
High Transaction Fees
Due to limited space in each block, competition for inclusion becomes fierce. Users willing to pay higher fees get their transactions prioritized, leading to a surge in overall transaction fees. This can be particularly problematic for smaller transactions, making them economically impractical.
Network Congestion
When transaction volume exceeds the blockchain’s processing capacity, the network becomes congested. This leads to slow transaction times, frustrating users who have to wait for their transactions to be confirmed.
How Layer-2 Scaling Solutions Work
The core concept behind Layer-2 scaling solutions is simple yet powerful: offloading transactions from the congested main blockchain (Layer 1) to a secondary layer.
This allows the main chain to focus on security and final settlement, while the Layer-2 solution handles the heavy lifting of processing a high volume of transactions efficiently. Imagine delegating repetitive tasks to free up your time for more important things, Layer-2 solutions operate on a similar principle.
Here are some of the ways Layer-2 solutions achieve this offloading:
Bundling Transactions
Instead of processing each transaction individually, Layer-2 solutions bundle them together into a single batch.
This significantly reduces the data load on the main chain, as only the final bundle needs to be recorded there. Think of it like carpooling – instead of each car taking up space on the road, multiple passengers travel together in a single vehicle.
State Channels
This approach allows two parties to conduct multiple transactions directly with each other off-chain.
Only the final outcome or agreed-upon state change is then recorded on the main chain. This is like having a private conversation and then just informing others of the final decision.
Rollups
These solutions involve processing transactions off-chain but keeping cryptographic proofs of their validity. These proofs are then submitted to the main chain for verification and final settlement.
Types of Layer-2 Scaling Solutions
There are different types of layer-2 scaling solutions, each with its own advantages and trade-offs.
Optimistic Rollups
These assume transactions are valid by default. However, a mechanism exists for anyone to dispute a transaction if they believe it’s fraudulent. In such cases, the disputed transaction is then brought back to the main chain for verification.
Optimistic Rollups operate on the principle of “innocent until proven guilty.” Transactions are bundled together off-chain and processed by a sequencer on the Layer-2 network. The sequencer broadcasts a compressed record of the transaction batch along with a cryptographic fraud proof to the main chain.
Advantages
Here are three advantages of Optimistic Rollups:
- Fast Transactions: By processing transactions off-chain, Optimistic Rollups achieve significantly faster transaction speeds compared to the main blockchain.
- Low Fees: Bundling transactions reduces the data load on the main chain, leading to lower transaction fees for users.
- Supports Smart Contracts: Unlike some other Layer-2 solutions, Optimistic Rollups can handle smart contracts, enabling a wider range of applications.
Disadvantages
Here are two disadvantages of Optimistic Rollups:
- Fraud Proofs: The fraud proof mechanism can introduce a slight delay in finalizing transactions, as there’s a window for disputes.
- Security Relies on Main Chain: Ultimately, the security of Optimistic Rollups depends on the security of the underlying main blockchain.
Zero-Knowledge Rollups (ZK-Rollups)
These employ advanced cryptography to create concise proofs that transactions are valid without revealing all the transaction data. This allows for even faster and cheaper transactions compared to Optimistic Rollups.
Also, ZK-Rollups take a more privacy-focused approach. Transactions are processed off-chain, similar to Optimistic Rollups. However, ZK-Rollups generate cryptographic proofs (without revealing the actual transaction data) that demonstrate the validity of the entire transaction batch.
Advantages
Here are three advantages of ZK-Rollups:
- Ultra-Fast Transactions: ZK-Rollups offer even faster transaction speeds compared to Optimistic Rollups due to their lighter proofs.
- Very Low Fees: Similar to Optimistic Rollups, ZK-Rollups benefit from reduced data load on the main chain, leading to minimal transaction fees.
- Enhanced Privacy: ZK-Rollups keep transaction details hidden, offering greater privacy compared to Optimistic Rollups.
Disadvantages
Here are two disadvantages of ZK-Rollups:
- Complex Computations: Generating ZK-proofs requires more complex computations, which can be computationally expensive for the sequencer.
- Limited Smart Contract Functionality: Currently, ZK-Rollups have limitations in supporting complex smart contracts. However, this is an area of active development.
State Channels
State Channels offer a unique approach to offloading transactions, ideal for specific use cases. Two parties establish a direct communication channel off-chain. They can conduct multiple transactions directly with each other within this channel.
Only the final agreed-upon state (outcome) is then recorded on the main chain.
Advantages
Here are two advantages of State Channels:
- Fastest Transactions: State Channels offer the potential for the fastest transaction speeds among Layer-2 solutions due to their completely off-chain nature.
- Highly Private: Transactions within the channel are completely private, offering a strong privacy advantage.
Disadvantages
Here are two advantages of State Channels:
- Limited Scalability: State Channels are best suited for specific, recurring transactions between two parties. They don’t scale well for broader network participation.
- Complex Setup: Setting up and managing State Channels can be technically complex for users.
Sidechains vs Layer-2 Solutions
While not technically classified as Layer-2 solutions, sidechains are an important concept in blockchain scalability.
Sidechains are independent blockchains that run alongside the main chain. Assets can be transferred (or “pegged”) between the main chain and the sidechain through a two-way bridge.
Sidechains differ from Layer-2 solutions in how they inherit security. Layer-2 solutions leverage the security of the main chain, while sidechains have their own independent security mechanisms. So, although they are not strictly Layer-2, sidechains offer a valuable alternative for achieving scalability and exploring interoperability between blockchains.
Advantages
Here are two advantages of Sidechains:
- High Scalability: Sidechains can handle a much higher volume of transactions compared to the main chain due to their independent design.
- Interoperability: Sidechains can potentially enable communication and asset transfer between different blockchains, promoting a more interconnected ecosystem.
Disadvantages
Here are two advantages of Sidechains:
- Reduced Security: Security on a sidechain is not directly tied to the main chain, potentially making it more vulnerable to attacks.
- Complexity: Managing the bridge between the main chain and the sidechain introduces additional complexity.
Examples of Layer-2 Solutions
The world of Layer-2 solutions is brimming with innovation, with different solutions catering to specific blockchains. Here are some of the popular Layer-2 players:
Ethereum
Ethereum, the leading platform for smart contracts, has seen a surge in Layer-2 adoption due to its scalability limitations. Here are some prominent contenders:
- Optimism: A well-established Layer-2 solution offering fast transaction speeds and low fees for Ethereum users.
- Arbitrum: Another popular choice known for its high throughput and compatibility with existing Ethereum tools.
- Polygon: This platform offers a suite of Layer-2 scaling solutions, including Polygon PoS (sidechain) and Polygon zkEVM (a ZK-rollup solution under development).
Bitcoin
While Bitcoin primarily focuses on security, the Lightning Network is a Layer-2 solution enabling faster and cheaper microtransactions for everyday use on the Bitcoin network.
Use Cases of Layer-2 Solutions
Layer-2 solutions are already making a significant impact across various sectors of the crypto ecosystem:
Decentralized Applications (dApps)
Faster and cheaper transactions through Layer-2 solutions open doors for a wider range of dApps to flourish. Users can interact with gaming platforms, social media dApps, and other innovative applications without encountering high transaction fees.
DeFi (Decentralized Finance)
DeFi protocols rely heavily on fast and affordable transactions. Layer-2 solutions enable users to participate in borrowing, lending and other DeFi activities without exorbitant gas fees, boosting accessibility and growth within the DeFi space.
NFT (Non-Fungible Token) Transactions
On December 3, 2021, the most costly NFT transaction took place on the marketplace Nifty Gateway. The Merge, a digital art collection by PAK, was sold for a staggering $91,806,516, making it the highest-priced NFT ever sold. This remarkable sale transpired within a short span of 48 hours following its release.
Buying, selling and trading NFTs can be expensive due to high gas fees on the main chain. Layer-2 solutions can significantly reduce these costs, making NFTs more accessible to a broader audience and fostering a more vibrant NFT ecosystem.
Benefits of Layer-2 Scaling Solutions
By offloading transactions from the main blockchain, Layer-2 solutions help ease the cryptocurrency ecosystem. Here are some key benefits they bring:
Faster Transactions
This is the core advantage of Layer-2 solutions. By processing transactions off-chain, they significantly increase the overall transaction throughput compared to the main blockchain.
Users experience faster confirmation times, leading to a smoother and more efficient experience. Imagine rush hour traffic suddenly disappearing – Layer-2 solutions create a similar sense of relief on congested blockchains.
Reduced Transaction Fees
The limited space on the main chain drives up transaction fees when demand is high. Layer-2 solutions alleviate this pressure by processing transactions off-chain. This reduces the data load on the main chain, resulting in significantly lower transaction fees for users.
It is like having multiple toll booths open during peak hours – Layer-2 solutions help avoid the congestion that leads to high fees.
Improved User Experience
Faster transactions and lower fees directly translate to a more enjoyable user experience.
Users no longer have to wait for extended periods for their transactions to be confirmed, and they can participate in the crypto ecosystem without facing exorbitant fees. This leads to wider adoption and increased engagement with crypto applications.
Drawbacks of Layer-2 Scaling Solutions
In November 2023, the cybersecurity company known as ChainLight made public the discovery of a vulnerability within the implementation of zkSync Era’s mainnet. Had this bug been exploited, a potential loss of 1.9 billion dollars could have occurred.
This shows that the introduction of ZK-proofs brings about security challenges that developers must address.
While Layer-2 solutions offer substantial benefits, here are some potential drawbacks:
Increased Complexity
Integrating with Layer-2 solutions can add complexity for users and developers compared to using the main chain directly. Understanding different Layer-2 options, their functionalities and potential security implications requires additional knowledge.
Security Dependence
The security of some Layer-2 solutions, particularly Optimistic Rollups, ultimately relies on the security of the underlying main chain. If the main chain is compromised, it could impact the security of the Layer-2 solution.
Limited Interoperability
Currently, different Layer-2 solutions often operate in silos, making it challenging to seamlessly move assets and interact between them. This can hinder the development of a truly interconnected blockchain ecosystem.
Centralization Risks
Some Layer-2 solutions, especially those with a single sequencer responsible for processing transactions, could introduce centralization risks. This goes against the decentralized nature of many blockchains.
Evolving Technology
Layer-2 technology is still under development, and some solutions are more mature than others. Continuously evaluating the security and functionality of these evolving technologies is crucial.
The Future of Layer-2 Scaling Solutions
Layer-2 solutions are not a finished product, but rather a rapidly evolving field with immense potential to shape the future of blockchain technology. Here’s what to expect:
Improved Security
Developers are constantly working on strengthening security mechanisms, exploring new cryptographic techniques and mitigating potential vulnerabilities to ensure the safekeeping of user funds and assets.
Enhanced Scalability
With a focus on handling even higher transaction volumes, future Layer-2 solutions will push the boundaries of scalability, paving the way for mass adoption of blockchain technology.
Interoperability
Efforts are underway to create bridges between different Layer-2 solutions and blockchains, enabling seamless asset transfer and communication across the entire ecosystem.
User Experience
Simplifying onboarding processes and making Layer-2 solutions more user-friendly will be crucial for broader adoption. Developers are working on intuitive interfaces and tools to streamline the user experience.
Unlocking DeFi and NFTs
By reducing costs, Layer-2 solutions will unlock the full potential of DeFi and NFTs, opening doors for innovative financial services and the creation of more vibrant digital assets.
Conclusion
Layer-2 scaling solutions constitute a transformative step towards a more scalable and user-friendly blockchain ecosystem. They address the critical challenge of scalability and pave the way for faster, cheaper and more accessible crypto transactions.
Acting as an extension of the main blockchain, Layer-2 solutions unlock the true potential of blockchain technology.
They can enable a future where crypto adoption flourishes, innovative applications thrive and blockchain seamlessly integrates into various aspects of our lives.
