Layer 2 Solutions Explained

Medium May 13, 2022 · 4 min read

Key Takeaways:
— Scalability is a defining issue for the future of crypto.

— Many early blockchains like the Ethereum and Bitcoin networks were not designed to handle the volume of traffic they now support.

— Layer 2 blockchains are subsidiary blockchains built on top of those underlying networks that enable faster, cheaper transactions.

— This opens the door for new blockchain applications, and increase the efficiency of the system as a whole.

Bigger, faster, better – are we talking about the latest blockbuster? No! We’re talking about humble old blockchain and its quest to keep up with the ever-increasing amount of activity on its network. Today, let’s take a look at layer 2 blockchains – and how they’re enabling existing blockchains to scale.

Blockchain has driven an incredible raft of innovation, all based on just one simple premise: the ability to move value around autonomously. But despite its evident utility, blockchain is facing some real-world limitations, and that’s down to one big problem: it’s not designed to scale. 

Transactions on older networks such as Ethereum or Bitcoin are notoriously slow and expensive for users, problems that accelerate as more people use those networks. This makes them impossible to use on a mainstream basis. So how can the utility of blockchain be brought to bear on a larger scale?

This is the big question currently driving innovation in the space. The result? A slew of new, more efficient networks, known as layer 2 solutions, are using creative approaches to tackle the problem. But what exactly are Layer 2 networks, how do they achieve what their predecessors couldn’t, and how are they currently being used? 

Let’s take a deep dive into the turbo-charged world of Layer 2 blockchains, and what they’re bringing to crypto and its users.

Scalability: A Dirty Word For Older Blockchains

Scalability is the ability of a system to handle increased load or traffic. In the context of blockchains, it is the ability to process more transactions per second (TPS) in order to meet the growing demands of users, something that layer 1 networks really struggle with.

What’s a layer 1 blockchain – and why is scaling such a problem?

The two most obvious examples of a Layer 1 network are Bitcoin and Ethereum. These blockchains are base networks – they handle every aspect of every transaction on-chain and without assistance from any other network. 

But this makes transactions on those blockchains extremely heavy and slow – every single new transaction needs to be validated by the network; then, before a new block is added to the chain, it requires to be checked against the entire history of the network. There are no shortcuts in layer 1 blockchains.

An Ever-Increasing Burden

A good analogy would be to imagine adding bricks to a pile – only, instead of adding each new brick to the top of the pile, you’re adding it to the bottom. Every new brick requires the whole pile of existing bricks to be lifted up before it can be added – but that pile is constantly growing and becoming heavier, and there is also more demand than ever for new bricks to be added. So each new add becomes a heavier, slower job. On one hand, the sheer computational power required to complete this process is what keeps the network – and your crypto – secure. But on the other hand, it renders the system totally impractical for day-to-day use.

Using this as an example will give you a pretty good understanding of what’s happening currently on busy layer 1 networks, why transactions are notoriously slow – and why your transaction fees are so high. 

How does this look in real life?

To give you some idea of how limiting this system can be, let’s look quickly at Bitcoin.

The Bitcoin blockchain can process a maximum of 7 transactions per second, which might seem pretty fast. But by comparison, the Visa network can process an enormous 24,000 transactions per second – this is why it is able to function as a global payments system. Looking at these two networks side by side, it is clear that Bitcoin (and similar layer 1 blockchains like Ethereum and Binance Smart Chain) is simply not capable of being used universally – it doesn’t have the capacity.

Blockchain isn’t practical for small payments

So in short, if you were hoping to go buy a quick coffee with your Bitcoin balance, don’t hold your breath – your coffee will be cold by the time you’ve managed to pay, and the fees will likely eclipse the coffee itself. Annoying, right?

This is where Layer 2 solutions are pushing things forward.

Layer 2 Solutions – Blockchain Lite

Layer 2 blockchains are so-called because they sit as a second layer on top of a base mainnet.

Layer 2 chains are designed to enable more transactions per second to be processed, and they achieve this by doing something novel – they move transactions off of the heavy mainnet. Different layer 2 solutions achieve this in slightly different ways, but the objective is always the same: streamlining the amount of information that needs to be validated by cumbersome underlying blockchain.

There are a multitude of layer 2 solutions currently being used with different blockchains, but for simplicity, let’s look at one of the most well-known, to better understand how it works.

Bitcoin Lightning Network

Bitcoin Lightning Network uses something called channels (which exist separately from Bitcoin’s mainnet) to create a peer-to-peer payment route between just two actors. So if you’re transacting with the same entity repeatedly, you can simply open a channel containing X amount of Bitcoin (sort of like topping up a store card) and transact freely with the recipient within that channel (until your crypto is spent). All of this happens off-chain – the only time any of that data will be communicated to the main Bitcoin blockchain, and go through the cumbersome process of being added, is when you close the channel. 

How does that look IRL? Say you go to the same supermarket every day, and want to pay your groceries in Bitcoin. You’d simply open a “channel” with that vendor using some Bitcoin, and from there you can make instant payments to the supermarket as you would with a debit card.

When you close the channel, all of your transactions will be communicated – as one piece of information, instead of many – to the Bitcoin mainnet. You can think of this sort of like bringing a whole busload of people to a  destination at once, rather than making multiply car journeys – less fuel, less time, less money spent.

And the bottom line? Using this system allows the throughput of Bitcoin transactions to increase from around 7 per second to roughly 1 million per second.

The Impact of Layer 2 Blockchains

Layer 2 solutions like Bitcoin Lightning Network offer a number of advantages for users and for the system itself.

Lower Cost and More Efficient for Users

For users, these blockchains are dramatically faster and cheaper to use. By keeping the nuts and bolts of low-value transactions off-chain, value transfers can be made quickly and with minimal network costs.

Broader Blockchain Utility

By facilitating transfers of value that are fast and efficient, layer 2 solutions open up broader possibilities for blockchain application. A great example can be seen in El Salvador, where Bitcoin is being used as legal tender – this would not have been possible without the speed and efficiency of the Lightning Network.

Relieves the Mainnet

Layer 2 solutions don’t just benefit their users, but also the crypto ecosystem as a whole. With large segments of the network activity handled off-chain, congested mainnets are relieved of much of their traffic. This means a faster, more efficient system for transactions still hosted on that network – and lower transaction fees for its users.

The limits of Layer 2 solutions are still being established, but the broad picture is clear: by using creative approaches to handling transaction data, they offer a practical way to manage smaller crypto value transactions, while harnessing the underlying security of the blockchain. 

Innovation leading the way to mass adoption

Layer 2 blockchains are just one example of the innovation currently taking place in blockchain, with the aim of bringing crypto to the widest possible audience in future. 

With developers constantly seeking solutions to the big issue of scalability, broader application for blockchain technology seems inevitable. So make sure you understand the different blockchains and their utility, so you can stay ahead of the curve – maybe even save yourself some transaction fees – and get the best of what crypto has to offer!

Knowledge is power.

Want to know more about Layer 2 blockchains and what they’re bringing to the crypto experience? Check out our School of Block episode right here!

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