Ethereum Layer 2 Blockchain Technology — A Step Forward to Scale

Ethereum Layer 2 Blockchain Technology — A Step Forward to Scale

Blockchains are no longer a buzzword. With the growing popularity of amazing applications like Cryptocurrency, Decentralized Finance (DeFi), and Non-fungible tokens (NFTs), blockchains, particularly Ethereum, are on the road to increased adoption.

Blockchains rest on three pillars- decentralization, security, and scalability. While all blockchains are decentralized and secure, their degree of scalability varies. This is often referred to as the Blockchain Trilemma, where meeting all the three requirements looks far-fetched, with blockchains mostly compromising on scalability. Scalability primarily refers to the transaction throughput or the number of transactions per second (TPS). It is a measure of the blockchain’s efficiency and performance; it certainly cannot be ignored.

Why is scalability important? Well, blockchains still are in a tussle with the centralized systems. And no one knows how long it might take for blockchain-based payment systems to gain worldwide adoption!

To win the combat, blockchains must outperform the traditional centralized platforms, which implies they need to have incredible speeds! Unfortunately, even today, after achieving a good level of adoption worldwide, Bitcoin is criticized for its 7 TPS compared to Visa’s 1000+ TPS.

What is Layer 2 Blockchain? Why is it important?

Let’s understand how technology solves the concern of scalability of blockchain systems. Layer 1 blockchain refers to the base or foundational blockchains such as Bitcoin and Ethereum. Another blockchain known as Layer 2 is built on top of the first layer to address the challenge of scalability.

Essentially, Layer 2 is a supplementary chain built above the main chain to reduce its load. This layer processes the transactions and enhances scalability. For example, Bitcoin uses the Lightning network to make off-chain payments.

Likewise, Ethereum Layer 2, which rests on top of Ethereum Mainnet, tackles its problem of increasing the transaction throughput. Ethereum is already operating at its maximum capacity of over 1 million TPS. Besides, the demand is growing every day, requiring a much higher speed and efficiency.

In addition, as demand rises, the gas fee and transaction fee increase, resulting in users being priced out, who cannot afford them. This is why Layer 2 comes into the picture. Layer 2 removes considerable load from Layer 1 by converting the requests into bundles and processing them while taking the data from Layer 1. Finally, it posts the results onto Layer 1, thereby retaining its true identity. As Layer 2 bundles the transactions and processes them, the costs are reduced, minimizing the transaction fee per user. As a result, it improves the Ethereum platform’s affordability to include more users.

How is it different from Layer 1?

Layer 2 differs from Layer 1 fundamentally. To elucidate, Layer 1 includes the original blockchain, the block producers, the node operators, the consensus mechanism, and the history of all transactions. So, what does then Layer 2 have?

Well, the job of Layer 2 is to reduce the transaction load by bundling the transactions, processing them off the chain, and later posting the finalized proofs to Layer 1. All this does not cause any change in Layer 1’s operations. In a nutshell, while Layer 1 maintains the transactions with its attributes of decentralization and security, Layer 2 takes care of transaction processing and addressing the scalability issues.

As the transaction load is removed from the base layer, i.e., Layer 1, it gets less congested and more scalable. Together, the layers work in tandem to resolve the issue of Blockchain Trilemma.

In simple parlance, Layer 2 acts like additional highways designed into the main highway, Layer 1, to divert traffic and reduce congestion.

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Benefits of Ethereum Layer 2

Ethereum Layer 2 offers a bunch of benefits. These include:

Reduce Transaction Fee: As the transactional burden on Layer 1 is reduced, multiple off-chain payments get combined, reducing transaction fees and making Ethereum affordable.

Maintain Security: While Layer 2 helps in increasing the scalability, the transactions are settled on Layer 1, that is, Ethereum Mainnet only, without compromising on security.

Expands applications: As the emergence of Layer 2 technology improves scalability and speed and reduces fees, more projects would flow in to explore the features of Ethereum.

Drawbacks of Ethereum Layer 2

Although Ethereum’s Layer 2 offers excellent scalability solutions, it suffers from certain limitations, too.

Remove Liquidity from the base blockchain: The primary advantage of financial markets is high liquidity which enables more transactions to take place in a timely fashion. Unfortunately, Ethereum employs decentralized apps (dApps) whose liquidity could get unevenly spread when there are separate layers in the blockchain.

Thus, Layer 2 poses the threat of considerably impacting Ethereum Mainnet’s liquidity which will adversely affect the blockchain’s sustenance.

Extra time and problems in tracking: As multiple layers are built on top of the base Ethereum platform, the dApps would need more interfaces for data transfer. That, in turn, requires additional accounts to be created. As a result, it would render it difficult to users to keep track of their fund transfers.

Interoperability issues: Ethereum was essentially designed to keep interoperability in view. However, with multiple layers, this could be hampered as the dApp of one Layer 2 may not interact with that of another Layer 2 or even Layer 1.

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Types of Layer 2 Solutions

Ethereum’s Layer 2 scaling solutions come in a wide range of choices. Let’s explore some of these here.

Rollups

Rollups are presently the most sought-after scaling solution for Ethereum Layer 2. This is because they can help significantly reduce the gas fee for the users. So, how do they work?

As the name suggests, rollups bundle several transactions into one single transaction on Layer 1. As a result, the transactions are processed outside Layer 1 while posted to Layer 1. This ensures faster transaction throughput, simultaneously leveraging security. Moreover, as the transactions are grouped into several bundles on Layer 1, it distributes the transaction costs across all users in the rollups, reducing the per-user fee.

Next, based on how the transaction data is posted onto Layer 1, the rollups are classified into two types:

Optimistic Rollups

Optimistic rollups run parallel to Ethereum main chain. Therefore, they do not run on Ethereum’s base layer; rather, they work on top of it. As a result, they can execute smart contracts efficiently. The main strength of optimistic rollups is that they do not perform any computations by default and thus increase scalability by 10–100 times. However, one key limitation is that they experience longer withdrawal periods.

Zero-Knowledge Rollups

Zero-Knowledge rollups or ZK rollups operate by reducing the computational load on Layer 1 by creating a cryptographic or validity proof each time the state of Layer 1 changes. They offer a few advantages. For example, the movement of money from Layer 2 to Layer 1 does not involve delays as they already performed verification using the validity proof. In addition, as the data remains on Layer 1, it is decentralized and secure.

In addition to Rollups, there’s one more type of Layer 2 scaling solution.

Plasma

Plasma uses techniques like intelligent contracts and Merkle trees to conduct scaling operations. It creates numerous child chains which act as mirrors of the Ethereum main chain and facilitate verification. Plasma systems reduce transaction costs and increase blockchain throughput by dumping most of the transactions into the child chains.

Ethereum Layer 2 Scaling Solutions and Projects

While the solutions discussed in the above paragraphs pertain to Layer 2 in general, the below content talks about similar scaling solutions with reference to the Ethereum blockchain.

Starkware: This is a Layer 2 scaling solution specific to Ethereum and comes as three products — StarkNet, StarkEx, and Cairo.

StarkNet uses the ZK rollup for Ethereum and enhances dApps to achieve high scalability. StarkEx engine has been deployed on Mainnet since 2020 and supports projects such as Immutable, DerversiFi, and more. And Cairo is the Turing-complete language for these products that allows scaling of dApps.

Arbitrum: Arbitrum is a Layer 2 solution that offers extra privacy features and is particularly used to scale DeFi apps on Ethereum.

Optimism: Optimism or Optimistic Ethereum is an Ethereum Virtual Machine (EVM) based on the Optimistic Rollups protocol. It is very simple and secure, and participants can use its gateway to enter and exit the network.

Let’s now take a look at Ethereum’s Layer 2 renowned projects. These include –

Polygon (MATIC): Polygon (formerly MATIC) is a Layer 2 scaling solution operating on Ethereum, and projects like Sushiswap and Quickswap are based on it. It offers high scalability and executes 2¹⁶ transactions per block.

Loopring (LRC): Loopring is another similar scaling solution on Ethereum, offering features for payments and transfers and decentralized exchanges (DEX). With its native token LRC, the Loopring service enables users to transfer ETH instantly and at a relatively cheaper cost.

OMG Foundation (OMG): OMG Foundation (formerly OMG Network), joined hands with Enya to build Boba Network, an Ethereum Layer 2 scaling solution that enables programmers to scale Dapps. Boba Network, based on Optimistic Rollups led to the rise in the prices of OMG tokens.

Bottom line

The layer 2 concept of blockchains addresses the challenge of scalability in the realm of blockchains, where the other parameters — decentralization and security, are in place. Ethereum’s demand is increasing dramatically, which creates the need for its throughput to escalate. Along these lines, Ethereum came up with various Layer 2 scaling solutions, including Rollups and Plasma. These have been used across projects, and their significance will grow as the Ethereum blockchain matures.

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Building Financial-Grade Digital Assets. The World’s First Regulated JPY-Pegged Stablecoin Issuer.

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