Why Layer 2 Solutions Will Take Over in 2022

The evolution of blockchain technology has been immense. We have witnessed the transition of blockchain solutions as efforts to improve on previous technologies intensify. Bitcoin, Ethereum, Litecoin, and a few others count as layer 1 blockchains and belong to the old generation of blockchain technologies, with one succeeding the other. Thus, in the wake of the rising interest in decentralized finance (DeFi) between 2020 and 2021, Ethereum became the go-to blockchain for DeFi products, birthing protocols like Bancor, Uniswap MakerDAO, amongst others.

The major factor that prompted the attention shift away from the Bitcoin blockchain is scalability. While the blockchain is decentralized and secure, given the large number of miners on the network, it traded off scalability, which brings to light Vitalik Buterin's blockchain trilemma concept. Buterin says no one blockchain can have all three features— decentralization, security, and scalability. In other words, there must be a trade-off.

Several blockchain innovations that succeeded the Bitcoin blockchain practiced opportunity cost on the features, selecting those aligned with their objectives. Meanwhile, Ethereum traded off decentralization for security and scalability. As developers sought to improve on early technologies, including Ethereum, they came up with a slew of innovations collectively known as layer two solutions.

Layer 2 Solutions: Lightning Network, ZK, and Optimistic Rollups

All layer 2 solutions have been designed as scalable alternatives to their parent blockchains. As such, they operate to carry some of the burdens borne by the latter, saving time and cost for every activity on the network.

• Lightning Network

Lightning Network is a layer 2 solution designed to address the issue of scalability on the Bitcoin blockchain, using multiple payment channels. According to estimates, the transaction throughput for the bitcoin blockchain can only accommodate seven transactions per second, meaning any number exceeding the transaction limit is likely to cause congestion on the network, delaying the time it takes to process each transaction and leading to higher gas costs. Delay in transactions may also cause a blockchain network to fork.

However, the Lightning Network relieves the main chain of the time and effort it takes to process each transaction. To achieve this, it moves transactions off-chain, processing them faster and cheaper, independent of the primary blockchain. However, the transactions are later updated on the main chain.

Rollups

Rollups operate the same way as the Lightning network. However, they are designed to scale on Ethereum and other EVM-compatible chains. Yet, they inherit the security infrastructure of the main network or layer 1, leaving no room for vulnerability. One example of a layer 2 solution for Ethereum is the ZK Rollups. In general, rollups reduce gas costs for users on the Ethereum network and facilitate open participation and faster transactions.

ZK–Rollups

are smart contracts that collate several transactions off-chain, creating a cryptographic proof, called a SNARK (Succinct Non-interactive Argument of Knowledge) which is submitted to the Layer 1— Ethereum mainnet. This cryptographic proof is also known as validity proof. Layer 1 (Ethereum) helps maintain the state of all transfers on the ZK smart contract, making it easier for a block to be validated since only the validity proof is required and not the entire transaction data.

ZK-rollups also reduce a transaction size to the barest minimum by representing an account on the Ethereum network with an index instead of an address. As such, the size of a transaction could be reduced from 32 bytes to 4 bytes, saving gas costs— because transactions are submitted to the mainnet as call data. Examples of ZK-rollups include Loopring, Starkware, Aztec 2.0, zkTube, Immutable X, etc.

Optimistic Rollups

Despite addressing the same challenge as the ZK-rollups, Optimistic rollups, as layer 2 solutions, adopt a different and unique mechanism. Optimistic Rollups run side by side with the main chain. However, Optimistic rollups assume that a transaction is valid by default, after which they propose the new state to the mainnet.

While assuming that a transaction is correct could save the computational power that mainnet miners would otherwise require to verify the transaction status. This could pose great risks, such as the tendency to submit a fraudulent transaction on layer 1. Optimistic rollups avoid this and other risks by introducing what is known as fraudproof.

With fraud proofs, a participant on the network can challenge the legitimacy of a transaction, which automatically instigates the rollup to compute the transaction and conduct a fraud-proof on it using theavailable state data. The fraudproof is taken a step further, such that participants are incentivized to prove a fraudulent transaction. Thus, each participant posts a bond, part of which gets reimbursed when fraud is proven. Where the fraud claim is not true, the bond is lost.

Ben Jones from Optimism simply explained the fraudproof mechanism as follows:

"Anyone who might be able to take any action that you would have to prove fraudulent to secure your funds requires that you post a bond. You basically take some ETH and lock it up, and you say "Hey, I promise to tell the truth"... If I don't tell the truth and fraud is proven, this money will be slashed. Not only does some of this money get slashed but some of it will pay for the gas that people spent doing the fraudproof."

The bane of the Optimistic rollups is the long wait period for transactions, especially when a transaction is challenged for fraud. Optimistic rollups include Arbitrum, Optimism, Boba, Cartesian, and Fuel Network.

P2E Gaming, NFTs, Metaverse: The Role of Layer 2 Solutions

Layer 2 solutions will lead the pace for blockchain adoption in 2022. In the last few months, innovations like blockchain gaming, the Metaverse, NFTs, including DeFi 2.0, have noticed high user interest from the mainstream and cryptocurrency frontiers. As the momentum continues to build for these innovations, scalability— which most layer 1 blockchains currently lack— will be a catalyst for adoption.

In the coming months, current transaction times will be unable to accommodate the number of active users and investors that will flood P2E games, NFT gaming, metaverse platforms (The Sandbox, Decentraland, Roblox) have been recently trending. This is where layer 2 solutions come in, as they would help eliminate entry barriers— low transaction throughput and high gas costs, democratizing access.

The attention of investors will also shift to tokens built around these solutions by 2022. For example, we have the LRC— a native token created for the Loopring ZK-rollup ecosystem. The LRC token is already listed on major centralized exchanges like Binance and Kucoin. Immutable X, a layer 2 solution built for Ethereum-based NFTs, equally has IMX as its native token.

Conclusion

For decades, scalability challenges have plagued layer 1 blockchains, thereby impeding the adoption of blockchain applications. The emergence of layer 2 solutions has inspired an uptick in adopting these solutions. Financial products like under-collateralized loans, self-paying loans, smart contract insurance, impermanent loss insurance will certainly rely on layer 2 technologies to enjoy more user interest.