Blockchains
For those unfamiliar, blockchains provide a distributed, decentralised way of recording transactions and data in a permanent, verifiable way. However, as blockchains like Bitcoin and Ethereum have grown more popular, they’ve also become slower and more expensive to use due to network congestion. This is where layer two solutions come in – they aim to solve problems like scalability and usability while still maintaining the core benefits of decentralization and security that blockchains provide.
LAYER TWO BLOCKCHAINS DEEP DIVE?
At a high level, layer two blockchains (also sometimes called state channels, sidechains or rollups) can be thought of as additional networks or protocols built on top of core layer one blockchains that aim to boost capacity and efficiency. Transactions initially occur “off-chain” on layer two but can still leverage the security and trust of the underlying layer one blockchain. Let me break this down step-by-step:
- On layer one, a user deposits funds into a smart contract on the base blockchain like Ethereum. This “locks up” the funds and proves the user has the resource.
- Now the user can make transactions directly with other app users or dapps entirely on layer two, without having to broadcast to the entire layer one network and wait for miners each time.
- Periodically, the aggregated or “net” results of all layer two transactions that occurred in between are broadcast to the base layer one chain through the smart contract as a single “batch.”
- Users can withdraw their funds from layer two back to the base layer one chain at any time.
This process significantly boosts throughput by handling many transactions independently on layer two before periodically settling on layer one. It also reduces fees and wait times for users since they are not competing with all other transactions to be packaged into each new block. Instead, transfers occur quickly via layer two while still retaining the security of being anchored to the base blockchain through the initial deposit and net settlement.
Now that the general concept is explained, let’s compare some popular types of layer two solutions that are either currently deployed or in development:
TYPES OF LAYER TWO BLOCKCHAINS
Payment Channels – Used by platforms like the Lightning Network on Bitcoin, payment channels allow direct microtransactions between two parties without touching the base blockchain. Funds are locked in a multi-signature smart contract and transferred off-chain via digital signatures. Settlement is done periodically.
State Channels – Work like payment channels but allow application state to be updated off-chain on layer two protocols like Plasma and Raiden. This enables more complex interaction like playing games, multi-party transfers, and decentralised application usage via state updates.
Sidechains – Operate as fully separate parallel blockchains pegged to the main one via two-way asset and control transfers. The sidechain has its own blockchain consensus protocol and transactions can flow both ways at set intervals, as pioneered by the consortium behind Liquid.
Rollups – Aggregate many transactions into a single smart contract transaction on layer one. There are two types: 1) Optimistic rollups assume transactions are valid unless someone disputes, while 2) ZK-rollups use zero-knowledge proofs to validate a bundle is correct without revealing individual transfers. Examples include Optimism and ZKSync.
Each of these has trade offs around decentralisation, complexity, and how tightly they integrate with the underlying chain. Generally though, they allow vastly higher transaction throughput via parallel processing on layer two compared to serial validation on the base layer one blockchain alone.
According to third web.com “The most popular types of Layer 2 solutions are optimistic and zero-knowledge rollups. But there are also other types like sidechains and validiums that offer scalability similar to L2’s but don’t depend on the mainnet for security.”
Image Credit: thirdweb.com
BENEFITS OF LAYER TWO SCALING
With the core concepts and types of layer two blockchains explained, what advantages do they provide to users and the overall blockchain ecosystem? Here are some of the major benefits:
- Increased Scalability – By handling many transactions independently and periodically settling, layer two networks can process far more transactions per second than core blockchains alone. This vastly improves capacity.
- Lower Fees – Since transactions are bundled for settlement rather than all trying to fit individually into every block, fees associated with congestion and miner competition are reduced or even eliminated on layer two networks.
- Faster Speed – Transactions occur instantly on layer two as signatures or state updates rather than requiring competitive mining. This improves user experience for microtransactions or time-sensitive applications.
- Better Privacy – Some layer two solutions allow transaction amounts and addresses to be privately bundled before settlement, unlike on public block explorers of layer one chains.
- New Use Cases – The efficiency gains unlock entirely new decentralised applications that would otherwise be cost-prohibitive on base layer one networks alone due to fees or latency.
- Flexibility – Layer two protocols can be tailored and upgraded more easily than the core protocols of main blockchains, fostering more rapid innovation.
In summary, layer two scaling promises to address critical needs around scalability, usability and real-world deployment of blockchain technology, without compromising the core qualities of decentralisation and security provided at the foundational layer one level. That’s a compelling value proposition indeed.
POTENTIAL LIMITATIONS AND CHALLENGES
While layer two solutions hold immense promise to scale blockchain applications, it’s worth noting some limitations and challenges still being worked through:
- Interoperability – As different layer two networks proliferate, ensuring seamless transfer of assets between them may become complex requiring cross-chain bridges and standards.
- Complexity – Additional layers and state update reconciliation introduce new opportunities for bugs or issues compared to simple block validation alone on layer one networks.
- Centralization Risk – Mechanisms securing networks like fraud proofs represent attack vectors and risk of central points of failure depending on implementation. Decentralisation should not be fully traded for scalability gains.
- Adoption Costs – Widespread deployment relies on users and developers embracing new protocols and interfaces, which will take time as layer one systems matured first.
- Security Model Changes – Layer two conflict resolution differs from layer one mining incentives and challenges new approaches to securing consensus. Proper incentives must be maintained.
- Off-Chain Asset Management – Not all users may feel comfortable permanently storing funds or data in smart contracts versus tangible keys, though this paradigm is shifting as adoption broadens.
Overall, layer two scaling represents a major technological challenge but also significant opportunity if solutions can deliver both scalability and decentralisation together. The tradeoffs are being actively explored and improved upon via open-source development and innovation. Over time, layer two networks aim to address limitations and surpass legacy financial network capabilities.
FAQs
What problem is layer two trying to solve?
Layer two blockchains aim to solve the scalability, throughput and usability limitations of core layer one blockchains as their usage increases. They do this by enabling high volumes of transactions to occur independently and be periodically settled on layer one, boosting overall network capacity.
How do they improve scalability compared to layer one?
Layer two networks allow transactions to be grouped and processed much more efficiently than on layer one alone. This is done through techniques like state channels, payment channels and rollups that can confirm thousands of transfers with a single layer one transaction. This parallel processing model vastly improves scalability over serial block validation.
Is layer two less secure than layer one?
While layer two networks introduce additional complexity, they aren’t necessarily less secure when designed properly. Initial deposits anchor users’ funds within smart contracts on layer one as collateral, while settlement ensures all activity can ultimately be represented on the secure base chain. However, the mechanics of some solutions like fraud proofs do introduce new attack vectors to monitor.
How does privacy compare between layers?
Privacy of transfers can actually be better protected on some layer two networks compared to tracing every transaction publicly recorded on layer one. Solutions like zk-Rollups allow bundling of transfers without revealing each individual input/output, though privacy isn’t the primary focus in most cases.
What kinds of applications are layer two enabling?
New decentralised applications becoming possible through efficient layer two scaling include high-frequency financial applications, metaverse protocols, games, social media platforms, digital identity services, and more that require fast, low-cost transactions. This will drive further mainstream adoption of Web3 technologies.
When will layer two solutions be fully realised?
Layer two blockchains are still an area of active research and development rather than mature, standardised technologies. Over the next 2-5 years, many projects are working to harden security models, improve usability, boost maturity of codebases and deliver robust mainnets. Widespread integration into other applications and broader user awareness will likely take 5-10 years as layer one systems like Ethereum also scale further.
Conclusion
In conclusion, layer two blockchains represent one of the most promising scaling solutions being developed to help blockchains reach their full potential. By enabling massively higher transaction throughput through parallelized processing models, layer two protocols aim to solve the scalability and usability issues that are currently inhibiting mainstream adoption of Web3 applications.
Many different methods of implementing layer two systems are being explored through open collaboration in the blockchain community. While each approach has tradeoffs to balance, collectively they represent a major step forward in delivering on the original vision of blockchains to serve billions of people globally through an open, decentralised financial ecosystem.
Real-world testing of layer two networks is growing as the technology matures. Deployments over the next 5 years will provide more evidence around which solutions can reliably scale while maintaining security guarantees. For anyone interested in the long term success of blockchain technology, following advancements in layer two research is increasingly important.
With continued progress resolving challenges around interoperability, decentralization and complexity, layer two networks may finally fulfil the promise of blockchains to transform numerous industries by enabling uncensorable transactions at internet scale. Though challenges remain, projects in this area hold enormous potential value to drive further growth across the entire industry in the years ahead. It’s an exciting time for the development of these foundations for a trustless, distributed future.