Layer 3 Solutions on Bitcoin & Blockchain — AAX Academy
As the crypto industry is experiencing surging demand from users, scalability has become an even more important issue.
Since top blockchains like Bitcoin and Ethereum feature limited throughput, improving their scalability is vital to handling the increased network load as congestion often leads to excessively high transaction fees and processing times.
And it goes without saying that this discourages many from using decentralized applications (dApps) and other on-chain solutions. Instead, these users (and many developers as well) move to competing blockchains that feature better scalability by often sacrificing a degree of decentralization or security.
To avoid the above scenario, blockchains with lower throughput aim to solve their issues by improving their scalability via layer-two (L2) solutions.
In the case of Bitcoin, this is the Lightning Network, while there are numerous projects on Ethereum that build L2 services to relieve some stress from the main chain as developers are getting ready to roll out the long-awaited ETH 2.0 upgrade.
For these reasons, scalability solutions built on the second layer of a blockchain have been at the center of the discussion in the crypto community in the past few months.
However, while many projects are just about to launch their L2 solutions on the main chain and integrate them with popular services, others are already developing their products on layer-three (L3) to solve another burning issue of blockchain networks: interoperability.
In this article, we will introduce you to the layered architecture of blockchain networks while exploring the essentials of L3 solutions.
The Case for Multi-Layer Blockchains
If you have been in the crypto space for a time, then you have probably heard about the blockchain trilemma (also called the scalability trilemma).
Simply put, due to the nature of distributed ledger technology (DLT), existing blockchains can only achieve two of the three qualities below:
For that reason, DLT projects have to sacrifice one thing to excel in the other two. This means that:
- Traditional blockchains like Bitcoin and Ethereum feature rock-solid security and true decentralization by relying on network participants to operate full nodes to validate every transaction. However, this leads to limited scalability and throughput.
- Highly scalable blockchains like Binance Smart Chain and Solana reach a consensus via a limited number of nodes to achieve high scalability and excellent security, which comes with increased centralization.
- Some DLT solutions utilize ecosystems in which multiple interconnected chains (on the first layer) run in parallel to operate dApps. While this comes with high scalability and decentralization, this setup often has caveats in terms of security.
The good news is that the scalability trilemma only poses an issue when DLT projects want to have all three qualities on the first layer (the main chain or L1).
This means that, while Bitcoin can’t achieve high scalability without sacrificing some of its security or decentralization on L1, it can increase its throughput by implementing a layer-two solution like the Lightning Network that offers near-instant and cheap BTC transactions for users by moving them off the main chain.
Most importantly, layers built on top of a blockchain generally rely on the main chain to finalize transactions. For that reason, while they offer additional benefits for the DLT solution’s ecosystem (enhanced scalability in the case of L2), layer-two and layer-three services still provide the same (or very similar) security and decentralization as L1 transactions.
As a result, the multi-layer structure of blockchains provides an efficient solution to the scalability trilemma, allowing DLT networks to become scalable, decentralized, and secure without sacrificing any of the three critical qualities.
The Blockchain Interoperability Problem
Now that you know the essentials about the layered architecture of blockchains and how L2 solves scalability-related issues let’s take a look at why we need the third layer.
The blockchain trilemma is not the only fundamental problem that impacts crypto market participants. Interoperability, which refers to the ability to see, access, and exchange information between separate computer systems, is left unsolved by L2 services.
In terms of crypto, interoperability (or cross-chain functionality) means that two blockchains with separate ecosystems (think of Bitcoin and Ethereum) can communicate and interact without any centralized intermediaries.
Natively, it’s impossible to move BTC to Ethereum and utilize the cryptocurrency across multiple decentralized finance (DeFi) apps or vice versa. While projects like Wrapped Bitcoin (WBTC) have built bridges between BTC and Ethereum on the first layer so users can utilize the digital asset with dApps in the smart contract blockchain’s ecosystem, they generally feature trusted intermediaries or some form of centralization (e.g., centralized custodians).
Despite such efforts, dApps reside in their own distinct ecosystems — for example, the lending protocol Aave on Ethereum, the PancakeSwap automated market maker (AMM) on Binance Smart Chain, and the Serum decentralized exchange (DEX) on Solana — and are nearly impossible to access if you hold your assets on another chain without using a centralized third party.
And, while the scalability issues of traditional chains are being solved by L2 solutions, they are expected to fragment the crypto space further (thus, make the interoperability problem even greater).
For example, while the AMMs Uniswap and SushiSwap both reside on Ethereum, they are working to implement separate L2 solutions (Optimism and Polygon, respectively). As a result, to move an ERC-20 token from Uniswap’s L2 to SushiSwap L2, a user would have to transfer his coin from Optimism to Ethereum’s main chain and then to Polygon.
As you can see, such an inefficient process comes with higher costs and much longer processing times, which can sometimes take multiple days due to the time some L2 scalability protocols need to finalize transactions.
Considering all this, the lack of interoperability between different blockchains and layer-two solutions has led to a highly fragmented experience, which can significantly hinder the mass adoption of cryptocurrencies and DLT technology.
For that reason, the need for layer-three solutions is greater than ever.
Layer-Three (L3) Solutions: the Key to Achieve Blockchain Interoperability
Layer-three solutions aim to supercharge distinct blockchains with the cross-chain functionality they need to communicate and interact with each other to achieve true interoperability.
It’s important to emphasize that L3 projects seek to accomplish this in a decentralized way without any centralized custodians, intermediaries, or other third parties. For that reason, they have to take a distinct approach to fulfill their goals.
While multiple projects are focusing on providing interoperability between blockchain ecosystems on the third layer, what they have in common is that they seek to create something similar to the internet’s layered structure.
As you can see in the image above that illustrates the Open Systems Interconnection (OSI) model, the internet’s first layer consists of physical devices like coax and fiber cables that provide the backbone for users to connect to the web.
In terms of DLT technology, this is the main chain that hosts the distributed ledger and where consensus between network participants occurs. In general, the first layer provides the security, transparency, traceability, decentralization, and the other benefits of blockchain tech to users along with basic functionalities like peer-to-peer (P2P) coin transfers.
Simply put, the internet’s link-layer and blockchain networks’ scalability layer both have the goal to achieve efficient (data or financial) transactions between directly connected parties (e.g., via the WiFi for the web and Optimism’s L2 service).
Like L1 chains, layer-two solutions feature various qualities that make them distinct from each other. At the same time, services on L2 are usually tied to specific (or multiple but very similar) blockchains (e.g., Optimism is developed primarily for Ethereum while the Lightning Network is specifically created for Bitcoin).
Since there is a close connection between L2 and L1 solutions, it makes great sense to implement interoperability protocols on a separate (third) layer. And this takes us to L3 services.
While L1 and L2 solutions have numerous differences — using various technologies, features, and functionalities to serve users within their ecosystems — layer-three interoperability protocols seek to make all the things that take place in the underlying layers as simple as possible.
By abstracting away these differences, distinct networks and ecosystems can connect, communicate, and interact via an L3 protocol.
In the internet’s case, the Internet Protocol (IP) is responsible for achieving this. While the different devices, applications, and services on the layers below utilize distinct networking technologies, IP can establish communication between them by routing packets of data across various networks.
Layer-three interoperability protocols are meant to work similarly in the blockchain world. However, in addition to data, L3 solutions seek to packetize value and route these value packets across DLT networks.
As a result, they can effectively connect L1 and L2 chains as well as the applications and services within without trusting any third parties.
Interestingly, multiple L3 projects are developing interoperability protocols to connect different blockchains and L2 services.
- Interledger Protocol (ILP): Originally launched as a Ripple project, the Interledger Protocol is an L3 solution that implements the standards of interconnectivity on the web into the world of blockchains. Serving the same purpose as the Internet Protocol (IP), ILP packetizes value and establishes value transfers across multiple L2 and L1 chains.
- IBC Protocol: Introduced with the’ Stargate upgrade, the IBC Protocol resides on the third layer of the Cosmos stack as a reliable and secure module that provides interconnectivity between connected blockchains. Dubbed as the “TCP/IP for blockchains,” IBC handles data transportation, authentication, and ordering across numerous chains, such as the Cosmos Hub, IRISnet, Akash, and Crypto.com’s DLT network.
- Quant: Focused primarily on enterprise blockchain networks, Quant connects both public and private chains via its Overledger DLT gateway service and unique solutions, such as multi-DLT smart contracts and multi-ledger tokens. Its partners include businesses like Hyperledger, Nvidia, and Oracle.
- ICON: Featuring partnerships with the likes of Samsung and Seoul’s government, ICON is an interoperability protocol that aggregates all blockchain data into one layer to connect numerous chains under one unified web of interconnected networks.
The Road to Creating the Internet of Value
L3 protocols have great potential and are expected to drastically change how blockchains work in the digital asset industry.
When L3 protocols get implemented across various blockchain networks and L2 scalability solutions, it will eliminate the fragmentation problem of the cryptocurrency industry and unify all the different products and services in a similar way to how the internet works today.
True interoperability will not only lead to a boost in the adoption of blockchain technology and cryptocurrencies but will also allow the industry to go beyond finance.
Potentially, it will lead us to the much-awaited Internet of Value (IoV). This concept envisions an internet where value can be transferred just as easily, cost-effectively, and reliably as data on the web.
And, in addition to money, IoV will allow users to exchange any valuable asset, such as stocks, bonds, commodities, music, intellectual property, art, and scientific breakthroughs.
While the Internet of Value is definitely years away, it will be exciting to see how layer-three protocols will supercharge otherwise isolated blockchain networks with cross-chain functionality to take the industry to the next level.Originally published at https://academy.aaxspace.com on August 23, 2021.