Why so many L2 Blockchains?

Ethereum, the second largest cryptocurrency by market capitalization, is set to undergo a major upgrade to its network that will introduce 1 million new layer 2 scaling solutions.

Layer 2 solutions aim to alleviate the network congestion and high transaction fees that have plagued Ethereum in recent years. The upgrade, known as Ethereum Improvement Proposal — EIP 1559, will also introduce a new fee structure, which will burn a portion of transaction fees, increasing the value of ether over time.

The latest fee structure is set to benefit ether holders in a significant way. A portion of the transaction fees will be burnt instead of being solely awarded to miners, which is expected to reduce the supply of ether in circulation. This, in turn, is predicted to drive up its value over time. And this new fee structure aims to make transaction fees more stable and predictable, ultimately improving the user experience and making Ethereum accessible to a wider range of users.

But why do we need so many L2's?

A Blockchain is built in layers, each serving a specific purpose. The base layer, known as Layer 1, is the foundation of the blockchain network. This is where transactions are processed and recorded on the distributed ledger.

While secure and decentralized, Layer 1 blockchains have limitations in scalability and transaction speeds due to the consensus mechanisms used to validate transactions. This is where Layer 2 solutions come in.

Layer 2 refers to secondary frameworks or protocols built on top of the base blockchain to improve transaction speeds and scalability. Rather than processing transactions directly on Layer 1, Layer 2 solutions handle transactions off-chain before bundling and settling them onto the main chain. This helps reduce congestion on the base layer.

Some examples of L2 solutions include state channels, sidechains, and rollups.

• State channels handle transactions between two parties off-chain by opening a payment channel.
• Sidechains are separate blockchains that run in parallel and link to the main chain.
• Rollups batch transactions off-chain and generate a cryptographic proof to validate transactions on L1.

Some blockchains like Cosmos, Polkadot and Cardano refer to themselves as Layer 0 (L0) because they are designed to serve as the foundation for building multiple interconnected blockchains in a network.

These Layer 0 blockchains are specifically optimized to allow different Layer 1 chains and Layer 2 solutions to interoperate and communicate with each other through the Layer 0 foundation.

They also allow developers to create customized L1’s for specific use cases that leverage the shared security and interoperability of the underlying Layer 0. And by coordinating message passing and transactions across chains, L0 networks can achieve greater overall transaction throughput across the blockchain ecosystem.

L0’s enable security to be derived from the overall network instead of each chain having to secure itself in silos. So "Sharing security", can offer stronger guarantees.

So L0’s are rather than just a singular chain, they act as the foundation for an Internet of blockchains.

Some examples

But going back to L2's…

Some of the main benefits of L2 solutions are:

• Improved throughput and transaction speeds compared to transacting directly on L1. This is key for dApps scalability.
• Lower transaction fees for users compared to paying gas fees on L1.
• Enhanced scalability as transaction processing is offloaded from the main chain.

Why there is a proliferation of multiple L2 blockchains rather than a single standardized approach?

I would say, different use cases — Each L2 technology like state channels, Plasma, rollups etc are optimized for certain types of transactions, assets or blockchain interactions. No single solution works best across the board.

For example, State Channels are best suited for fast micropayments, e-commerce transactions, and gaming use cases. Some of these platforms are Raiden Network for Ethereum and Counterfactual for NFT transfers.

Plasma — Optimized for more complex smart contracts and applications involving fund pooling. One example is Polygon Plasma, a scaling solution for the Ethereum network that aims to improve its speed and reduce transaction fees. It works by creating multiple sidechains, each capable of processing transactions independently from the main Ethereum blockchain.

Use cases can also include, Optimistic Rollups (ORs) and ZK-Rollups (ZKRs).

ORs can be good for decentralized exchanges and NFT-focused applications due to efficiency of bundling transfers. For instance, Synthetix and Loopring leverage Optimistic Rollups. ZKRs are ideal for privacy-focused transactions like anonymous payments and transfers. ZKSync 2.0 for Ethereum uses ZK-Rollups for low cost, private transactions.

Sidechains can be built for faster and more customized blockchains for enterprise use cases. RSK sidechain for example, implements Bitcoin-like functionality with smart contract capability, and Validium, suited for confidential DeFi applications and blockchain interoperability. Privacy protocol Railgun uses Validium for anonymity.

As you can see, each Layer 2 technique serves somewhat different purposes. By leveraging the appropriate one for their target use case, applications can optimize transaction throughput, cost and user experience.

With multiple L2 solutions co-existing, there is more room for experimentation, evolution and customization as per application needs, avoiding centralized failure points, where one dominant L2 solution fails due to technical issues or hacks, it would severely impact the whole ecosystem. With diverse solutions, the risk is reduced.

Applications may need to leverage multiple L2s in conjunction for different parts of their backend or transaction flows. Interoperability enables this kind of composability.

Different developer teams are creating Layer 2 designs concurrently without a centralized body mandating standards. This leads to more diversity.

Competition and funding dynamics — Each L2 competes for adoption amongst dApp developers. This drives innovation as solutions try to differentiate themselves in the market.

Still early days — Blockchain itself is still maturing. Over time, it is likely we will see more consolidation and standards emerge around Layer 2 as platforms, technologies and needs evolve.

The proliferation of Layer 2 solutions provides flexibility, reduces systemic risks, and enables customization for this rapidly innovating industry. But increased coordination and interoperability protocols can help bring more structure to this emerging landscape in the long run.

There are also challenges…

When implementing L2 blockchain, we must consider some challenges:

• Increased complexity in design and security considerations.
• Potential security tradeoffs and centralization risks depending on L2 design.
• Fragmentation across multiple L2 solutions instead of a unified ecosystem.
• Technical barriers in getting users to adopt new processes for handling transactions.

Layer 2 solutions will be critical for enabling blockchain networks to scale for larger transaction volumes and users. But thought needs to be given to integrating Layer 2 in a secure and decentralized manner. The right Layer 2 solutions can unlock significant capabilities and use cases for blockchains over the long term.

So can we say that L1 is the consensus and the L2 the transactions?

It's probably a good way to think about it, but let me provide some extra details:

The Layer 1 is where the core consensus mechanism operates to validate transactions and add new blocks to the blockchain. It establishes trust and security for the network. However, Layer 1 also processes transactions that get embedded into the blockchain. The issue is that transacting directly on Layer 1 can be slow and costly due to limitations like block sizes and the need to pay high gas fees.

This is where Layer 2 comes in — it enables much faster and cheaper transactions by handling them off the main blockchain initially.

So L2 solutions essentially batch many transactions together and leverage the security of Layer 1 for final settlement, while avoiding its inherent limitations around speed and fees. In that sense, both layers process transactions, but L2's are optimized for transaction throughput, user experience and lower costs.

An analogy is Layer 1 being like the federal reserve’s bank settlement system, while Layer 2s are analogous to Visa/Mastercard payment networks that interface with consumers and merchants.

TLDR: Layer 1 handles consensus, security and some base-level transactions, while Layer 2 specializes in transaction scalability. But they work hand-in-hand to provide overall utility of the blockchain.

So, Do we need more L2s or not?

Very straightforward, my answer is NO. We don't necessarily need so many L2 solutions proliferating in the blockchain space long-term, while diversity and flexibility can be beneficial in these early stages, too many siloed or fragmented Layer 2 protocols may ultimately hinder mainstream adoption down the road.

Ideally, over time there would be more coordination and standardization as the industry matures and leading practices emerge. This could result in a handful of dominant cross-compatible Layer 2 frameworks tailored for certain functions like payments, decentralized exchanges, NFT applications etc.

Interoperability standards and modular design would allow these solutions to work together seamlessly. This could provide a good balance of customization, reduced risk, and unified user experience.

All Layer 2 experiments may be necessary initially but not optimal long-term. Some consolidation and integration of standards can help unlock the true potential of Layer 2 to scale blockchain technology with both flexibility and cohesion across applications.