Layer Cake: What are Layer 1 and Layer 2 Blockchains and Why Are They Important?
If you’ve been part of crypto for even a short while, you’ll have heard the terms Layer 1 (L1) and Layer 2 (L2). Layer 1 blockchains are sovereign consensus architectures like Bitcoin, Ethereum and Cosmos. Onomy Protocol, for example, is a Layer 1 blockchain based on Cosmos that runs with its own independent consensus and validators.
A Layer 2 blockchain is its own separate chain with its own consensus architecture, but linked to a Layer-1. It handles transaction load away from the main chain it is supporting and then feeds verifiable data through to that main chain for finalisation and integration of the recorded transactions.
Why Do We Need Layer 2 Blockchains?
Layer 2 blockchains emerged as a response to the scalability issue of the blockchain trilemma. A Layer 1 blockchain is limited in its ability to scale by two other factors, decentralisation and security. The trilemma posits that the more secure and decentralised a blockchain is, the slower and more difficult to scale it is.
Ancient, monolithic blockchains like Ethereum need scaling solutions if they ever hope to compete with current technology for typical financial use cases like payments. The TPS of Bitcoin, for example, is roughly 4 to 7, way below what would be required to handle the thousands of transactions a payment processor like Visa does every second, hence why BTC also technically has a L2, albeit different in design, referred to as the Lightning Network.
What Are Layer 1 Scaling Solutions?
There are ‘Layer 1’ scaling solutions, but they involve changing the fundamental principles of how a blockchain operates. Newer blockchains, Like Cosmos, Near, Avalanche or Onomy, are faster due to their different PoS consensus architecture, which allows for greater throughput.
The most famous Layer 1 scaling solution is currently the migration of Ethereum to Ethereum 2.0, which would change the consensus from Proof of Work to Proof of Stake. Another Layer 1 solution is sharding, which is a medium term goal on many blockchain’s roadmaps.
What Are Layer 2 Scaling Solutions?
Layer 2 solutions are ways to increase the throughput to a Layer 1 chain by handling transaction volume within their own, faster chains that are specifically built to handle the volume. They then use methods like zk rollups to send transactions on the main chain and have them validated. There are several different Layer 2 solutions using different methods.
A sidechain is a chain that is adjacent to a main chain that has independent consensus mechanisms. That consensus mechanism can be robust but nevertheless optimised for more speed and scalability, as final verification and security is still maintained on the main chain. Side chains have publicly recorded ledgers, and crucially — any breach or failure of side-chain architecture does not affect the main chain. Sidechains are the most difficult scaling solution as they require their own infrastructure.
Polkadot is a good example of the sidechain idea taken to the next level. Parachains work as consortiums of side chains that are networked and do their own validations in a scalable, secure way, but whose security is supplied by the main chain itself, in Polkadot’s case the relay chain. However, as the network grows, each parachain runs less nodes and is part of a larger consortium, and security increases in lockstep with the size of the network.
Avalanche’s subnets are another example of how sidechains can increase scalability. These subnets can validate one or blockchains in the avalanche network independently, but they themselves are part of Avalanche’s Primary Network, which ensures that each subnet is acting appropriately.
A state channel allows for two-way communication between a blockchain and an off-chain resource. It does not require validation by the Layer-1; instead, it is authenticated off chain and protected by a smart contract or multi-signature mechanism. When a transaction set is finalised, it’s recorded on the main chain. Bitcoin’s lightning network is an example of this.
In nested blockchains, parent chains delegate work to child blockchains that complete the work and send it back for validation. The main blockchain sets the parameters for the network and the consensus mechanisms, and the child chain does the work. The OMG network using Plasma is an example of a Layer 2 nested blockchain.
Onomy Protocol is a layer-1 Cosmos chain powering a multi-chain & intuitive DEX that combines AMM liquidity pools with an order book UI facilitating market, limit, and stop orders, alongside FX markets via its stablecoin minting system, and cross-chain asset storage through Onomy’s non-custodial DeFi access wallet.