What are Layer 1 and Layer 2 solutions?

There are two main trends presented in the cryptocurrency community that solve the scalability problem:

• Layer 1 solutions;
• Layer 2 solutions.

Layer 1 solutions

The goal of Layer 1 solutions is to bring changes to the architecture of the blockchain itself. Layer 1 solutions include changing the principles of transaction processing, splitting the network, or changing the consensus protocol.

Examples of Layer 1 solutions are Ethereum's move from PoW to a more energy-efficient PoS algorithm and the Bitcoin Cash project's attempt to increase the block size to include more transactions. Both solutions have received a lot of criticism from the community and, in practice so far, indicate more of a failure of the idea.

Layer 1 can also include horizontal data separation, which is called sharding. The term comes from the English word "shard," which means shard. The blockchain is divided into separate parts and assigned to specific nodes. In such a scheme, it is easier for network nodes to control individual parts than the entire blockchain.

Each shard contains a unique set of smart contracts and account balances. This transition from a scheme where nodes compute all transactions simultaneously to a system where nodes perform only part of the overall computation allows the blockchain to process different tasks in parallel.

But sharding has its challenges, most notably communication between segments and security. Because the blockchain is divided into shards, communication between these parts is lost, and users of different shards will need unique mechanisms for interaction. Taking control of a separate segment is also more accessible, requiring less processing power.

For this reason, sharding is still months away from being tested on large blockchains to prove its validity and validate its reliability.

In addition to the obvious problems, there are technical difficulties in implementing any such concept. Any such test involves a network hardfork, which most nodes must support. Otherwise, the network will split and take some resources away from the leading working network.

Therefore, developers also create auxiliary tools on top of the leading blockchains. Collectively, they are called Layer 2 solutions.

Layer 2 solutions

Layer 2 Solutions are infrastructure solutions in networks built on top of the underlying blockchains. L2 solutions are add-ons on top of the underlying blockchain that involve shifting some tasks from the underlying blockchain to another. The result is sharding but less invasive, i.e., not as dangerous for the underlying blockchain. Such solutions can handle large volumes of transactions and reduce the load on the underlying network.

There are several areas of development within Layer2, each designed for specific purposes:

• sidechains,
• state channels,
• optimistic and ZK rollups.

State Channels

For this L2 solution, participants open a so-called "channel" between them and send tokens through it according to a simplified scheme of mutual settlements. In practice, it looks like a joint wallet with the right to sign on both sides. Such "channels" are combined into a network that independently finds the shortest path from intermediaries between nodes, even if the participants have no direct agreement on exchange.

When a channel becomes unnecessary, it can be closed, and only then will a record of the wallets' status appear in the main blockchain.

The most prominent example of Layer 2 is the Lightning Network for Bitcoin. You can read more about the technology in our article: Can Bitcoin transactions be accelerated and made cheaper?

Sidechains

The sidechain is the creation of a separate blockchain linked to the underlying smart contracts but with a separate technical base, including security.

The most famous example is an Ethereum sidechain launched in 2017 called Matic Network. However, since then, the project has grown into an independent ecosystem with tens of thousands of decentralized projects, and its name has been changed to Polygon. In practice, no one calls it a simple sidechain anymore, although the interconnectivity between blockchains remains in operation.

Rollups

These are also separate networks that process transactions outside the leading blockchain, aggregate them, and send the information to the underlying network.

The critical difference between sidechains and rollups is that rollups provide evidence that allows the leading network to verify the correctness of the data without verifying the transactions themselves. Verification, in this case, is delegated to a separate network. The most famous examples are Arbitrum and Optimism.

They are divided into two categories by the mechanism of operation:

1. Optimistic. They knowingly assume all transactions are correct and transfer them to the main blockchain without additional calculations. And only if someone makes a claim does rollup do a double-check. This makes transactions much cheaper and faster but gives rise to much well-founded criticism.
2. ZK-rollups. These networks verify the correctness of transactions, just like the underlying blockchain, using complex cryptographic functions and transmitting the verification results to the underlying network and groups of transactions. The abbreviation ZK is "zero knowledge," i.e., "zero knowledge." In this scheme, the core network can confirm the correctness of the data without knowing anything about its content.

Summary

Existing blockchains are technically flawed, making mass adoption difficult and hindering the development of cryptocurrency infrastructure.

L1- and L2-solutions give developers and users more flexibility, new features, and functionality.

For example, Polygon, Arbitrum, and Optimism are cheap alternatives to Ethereum that support all the same large DeFi applications:

• Uniswap,
• Aave,
• Curve,
• Balancer,
• Sushi, etc.

Layer 2 networks allow commissions on the Ethereum network to be reduced from about $5-15 per transaction to below $0.10. At the same time, the speed of transaction processing will increase manifold. All this allows for more active trading on decentralized exchanges, buying NFTs, earning on farming and landings, etc.

Also, Layer 2 solutions do not directly impact the underlying blockchain. L2 can be quickly disconnected from the underlying blockchain without risk to users if necessary. Although switching to L2 may entail additional risks.

L2s do not help to solve the problem fundamentally — they only "smooth out" the project's flaws. Therefore, it is necessary to keep looking for L1 solutions as well.

Both layers of solutions play an essential role in technology development and help overcome the historical limitations of the first generations of blockchains. They contribute to improving the performance and efficiency of networks, making cryptocurrencies more convenient and attractive for a wide range of users.