Layer 1 vs Layer 2: Where’s the Next Block Party At?

Layer 2 blockchain protocols have posted stellar performance in 2021. So what is all the fuzz about and why do layer 2 solutions exist?

Crypto is like a noisy apartment block, with residents spilling out onto the hallways and stairwells each weekend in search of the next party. From the ground floor (Layer 1) upwards, each level has something to offer, complete with its own flava, scents, sights and sounds. Last year, all the best action was to be had on Ethereum, but this year residents are ascending higher in search of the hottest new block party…

1. Crashing the Blockchain Party

As each wave of crypto adoption takes hold, the increase in demand puts pressure on the scalability of blockchain protocols. This leads to bottlenecks that cause users to search for alternatives or solutions to mitigate these problems.

The earlier focus on Bitcoin scalability has shifted toward Ethereum with the rapid growth in defi applications and usage. As a result, comparisons have been made between layer 1 and layer 2 solutions, with users voting with their MetaMask RPCs.

Both Bitcoin and Ethereum can be considered layer 1 protocols, providing the settlement layer for all transactions on the network. Layer 2 solutions, such as the Lightning Network on Bitcoin, or Plasma on Ethereum, deliver a means of increasing transaction speeds and network scaling while retaining the security benefits of the base layer.

While the debate continues, the shift toward layer 2 solutions, particularly for the Ethereum ecosystem, is apparent. The question remains, though, whether this is a temporary or permanent phenomenon.

As each wave of crypto adoption takes hold, the increase in demand puts pressure on the scalability of blockchain protocols. This leads to bottlenecks that cause users to search for alternatives or solutions to mitigate these problems.

2. Making the Shift to Layer 2

The rise of defi has seen adoption clog the Ethereum network, causing bottlenecks and high transaction fees that render many decentralized applications unusable. While the proposed Ethereum 2.0 protocol change from Proof-of-Work to Proof-of-Stake may alleviate this at the base layer in time, the pressing need for a solution now is accelerating the shift to layer 2 technology.

While the proposed Ethereum 2.0 protocol change from Proof-of-Work to Proof-of-Stake may alleviate network congestion at the base layer in time, the pressing need for a solution now is accelerating the shift to layer 2 technology.

Several layer 2 solutions have been proposed for Ethereum, each with its own trade-offs. Plasma was an early solution enabling high-throughput payments but doesn’t support the smart contracts so vital to defi, nor do state or payment channel solutions similar to Bitcoin’s Lightning Network. Sidechains are another option, though slow to make progress.

Rollups have gained in popularity, aggregating transactions off-chain inside an Ethereum smart contract, reducing fees and increasing throughput, though Optimistic Rollups that support both simple payments and complex smart contracts are more immediately suitable for defi applications than ZK-Rollups. This is because most transaction costs on Ethereum are due to the complexity of smart contracts.

Polygon has been one of the best performing L2s this year in terms of traction. Initially focused on Plasma, Polygon is now building more of a scaling-solution aggregator, incorporating all layer 2 solutions and generating a significant increase in user adoption as a result.

Popular defi and NFT applications including SushiSwap, OpenSea, Curve Finance, and Decentraland have integrated with the layer 2 solution, taking advantage of Polygon’s fast, low-fee infrastructure. This has brought in significant liquidity, with the lending and borrowing platform Aave growing to nearly $1 billion in total value locked on Polygon and over 7,000 users within ten days of launching its L2 solution.

Moving forward, an increasing number of Ethereum dApps are likely to move to layer 2 network, escaping the high fees and bottlenecks in peak periods, while remaining in the largest and most composable defi ecosystem.

3. Alternative Solutions

So will this trend toward layer 2 solutions last? That depends. There are certainly alternative solutions available and on the horizon, so it comes down to user preference when considering the trade-offs.

Ethereum 2.0’s change to Proof-of-Stake will use sharding to provide scalability on layer 1. So instead of working on transactions sequentially, the network breaks them down into sets of shards that can be processed in parallel, dramatically increasing the speed and efficiency of the network. However, transitioning such a large established protocol that carries billions of dollars in value is not without risk and may take years to be fully securely deployed. Hardware requirements are also likely to increase over time if the size of the blockchain continues to outpace the technology, and at 32 ETH, running a validator node won’t be open to many, impacting decentralization.

Alternative layer 1 chains like Binance Smart Chain (BSC) and Solana have also grown in popularity, at least partly in response to the scalability issues encountered in the Ethereum ecosystem. While both networks have seen significant adoption as a result, the small set of BSC validator nodes and the complexity in running Solana validators means comparative centralization of the networks is the trade-off.

Ethereum-compatible layer 1 chains such as Polkadot, Cosmos, and Avalanche are another option, bringing interoperable bridges and scalability to Ethereum. However, they introduce additional security considerations associated with less established blockchains and can lose the composability of the Ethereum ecosystem upon which many defi applications rely.

Closing Thoughts

Ultimately it comes down to personal choice. Those who are more interested in the fastest and cheapest platforms above all else will select convenient options over more decentralized alternatives. Ethereum will continue to be used, and while the transition to 2.0 will bring the next generation of scalability improvements to the base layer, layer 2 solutions will serve the composable infrastructure well in the meantime and will likely continue to work alongside Ethereum 2.0 in the future.

Longer-term, the governance structure of the dApp in question will dictate the best environment to use sustainably, which could include multiple chains and layers for different use cases, hidden under the hood of a slick user interface.

Like the Internet itself, a layered structure, in which value accrues at every level throughout the blockchain stack, is probably here to stay.

About the author: Ruben Merre is a repeat tech entrepreneur, polyglot, life-long learner and founder and CEO of NGRAVE, the digital asset security company behind “ZERO”, the most secure cryptocurrency wallet in the world. Since 2018, Ruben and his team have partnered up with the top tier in nanotechnology, cryptography and hardware security, as well as thought leaders such as Jean-Jacques Quisquater, famous cryptography professor and second reference of the bitcoin paper. The result: a true end-to-end solution for managing digital assets, at maximum security (EAL7, highest security certification in the world), and an intuitive user interaction.