What Are Cryptocurrency Layer 2 Scaling Solutions?
Crypto Basics

What Are Cryptocurrency Layer 2 Scaling Solutions?

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1 year ago

Layer 2 solutions are designed to increase the speed and efficiency of blockchains. Take a look at their different forms and how they work in this guide.

What Are Cryptocurrency Layer 2 Scaling Solutions?

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Blockchain technology offers tremendous benefits – decentralization, trustless interactions, high levels of security and immutable record-keeping. It has enabled a booming cryptocurrency ecosystem to develop and has underpinned consistent technological innovation. However, one of the main problems with many blockchain networks is their scalability. Scaling problems are an issue when the amount of data passing through the blockchain hits a limitation due to the insufficient capacities of the blockchain.
In an ideal case, a blockchain would be able to handle an infinite number of transactions per second, also referred to as throughput or with the acronym TPS. However, the Bitcoin main chain can only handle around 3-7 TPS. In comparison, Visa can process about 20,000 TPS using the centralized VisaNet electronics payment network. The difference lies in the level of decentralization and privacy that Bitcoin and other blockchains aim to provide. It takes a good deal of time and processing power to replace a simple centralized system. Each transaction must be accepted, mined, distributed, and validated by a global network of nodes.
To solve these problems, blockchain developers are working to improve the scope of what a blockchain can handle. That means allowing for a higher number of transactions per second and faster processing times. One method is to use layer 2 scaling solutions. This would make the common goal of the blockchain community a reality: to make cryptocurrencies and blockchain-based systems accessible to everyone in a convenient, secure and efficient manner.

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Why Are Scaling Solutions Necessary?

Scaling solutions can tackle the aforementioned problems by providing respite for the blockchain without needing to increase block sizes or introduce other measures that would tamper with the technology’s capacity for decentralization and high levels of security.

Layer 1 Scaling Solutions

Layer 1 blockchain solutions help to improve the base protocols (E.g. Bitcoin’s proof-of-work, or PoW) by changing how they operate as regards processing data. For example, the Ethereum network is now moving to a proof-of-stake (PoS) consensus algorithm. This new method of mining supports faster transaction speeds and more efficient energy use in the mining process.
Sharding is another layer 1 scaling solution that breaks down the job of authenticating and validating transactions into smaller pieces. It spreads the workload better across the peer-to-peer (P2P) network to bring in more computing power from more nodes. This all allows for blocks to be completed faster.
However, layer 1 solutions aren’t the only avenue available to scale blockchains. Layer 2 solutions to scaling establish an additional protocol that is built on top of blockchains like those of Ethereum and Bitcoin.

Layer 2 scaling solutions increase throughput without tampering with any of the original decentralization or security characteristics that are integral to the original blockchain.

What Is a Sidechain?

Sidechains are in fact something of a hybrid between layer 1 and layer 2 solutions to scaling. A sidechain is another blockchain that is linked to a main chain such as Bitcoin’s. They are linked with a two-way peg (2WP) that is a protocol that allows for the open transfer of cryptocurrency from the main chain to a layer two chain that requires a degree of third-party trust.
One example of a sidechain is the Liquid Network, attached to Bitcoin’s main chain. Like other layer 2 scaling solutions, it aims to tackle scalability problems by offloading some of the validation and transaction processing processes to another blockchain. This frees up the main chain to take on a greater number of transactions.

What Is a Parachain?

Parachains are short for “parallel chains.” As you can imagine, these chains run parallel to one another in a system of interconnected blockchains. They are all created within the same framework, which allows them to have the same security attributes, and they are all connected to the central relay chain. However, they can all also act independently to address their specific applications. This is the central idea behind Polkadot. Parachains allow for very fast transactions as the distribution is efficiently spread to handle workloads.

What Is Ethereum 2.0?

Ethereum 2.0 refers to the Ethereum network’s shift to a more sustainable PoS-based system that supports sharding and other scalability features. This set of improvements will increase the scalability of Ethereum and put it on par with other leading blockchains when it comes to throughput. Ethereum investors can stake their coins to earn rewards in return for their contribution to validation efforts.

What Is a Hashgraph?

Hashgraphs leave the realm of blockchain and are considered a different technology altogether. However, they are very similar insofar as they are also a distributed ledger technology (DLT). Moreover, unlike blockchain, hashgraph has been patented, and the only ledger out there that uses it is Hedera Hashgraph. Hedera touts itself as the third-generation of public ledger technology, following Bitcoin and Ethereum. It supports incredible scalability at 10,000 TPS, lower fees, less energy usage and lower processing times.

Types of Layer 2 Scaling Solutions

Layer 2 scaling solutions must inherit the underlying security of the main chain. Whereas sidechains may use other networks or validators to secure the chain, layer 2 differentiates itself by inheriting its security directly from the main chain. The main layer 2 solutions are zero-knowledge rollups and optimistic rollups.
Layer 2 scalability engines and solutions like Starkware, Optimism and Arbitrum provide scaling for blockchains so that a growing number of exchanges and platforms are able to use networks like Ethereum.

Zero-Knowledge Rollups

Zero-knowledge rollups – aka ZK-Rollups – are bundles of data that are collateralized by a smart contract on the main chain while they are transported off-chain for processing and computing. They are able to produce a block in around a minute, with the ability to process 2,000 TPS. Zero-knowledge means that all verifiers can know they have the same information without it actually being disclosed.

The ZK-rollups layer 2 scaling solution performs better than layer 1 due to the off-chain storage of data. Important data relevant to the smart contracts are requested less frequently than layer 1 blockchains. This saves large amount of processing power, and less of the blockchain capacity is used for transaction validation. Gas fees decrease as a result, making transactions faster and cheaper.

Optimistic Rollups

Optimistic rollups run on Ethereum’s base layer so that a huge number of smart contracts can be run without overburdening the network. They still benefit from the exact same levels of security as the Ethereum main chain. Data aggregators will compute merkle roots to achieve increased transaction speeds. However, they offer less throughput than Plasma and ZK Rollups.

The main difference compared to ZK-rollups is that layer 2 transactions take a longer time. Optimistic rollups have to rely on external validators to check the merkle roots before the state can be updated. However, the advantage is that optimistic rollups can support smart contracts in a similar way to the underlying smart contracts blockchain.

Plasma

Ethereum’s Plasma layer 2 solution uses child or secondary blockchains that will assist the main chain in verification. Plasma chains are similar to smart contracts or parachains from Polkadot. However, they are structured differently in a hierarchy to take transactions from the main chain to free up work and improve salability.

Bitcoin Layer 2 Scaling Solutions

Bitcoin Lightning Network

The Bitcoin Lightning Network is one of the best-known layer 2 solutions for Bitcoin. Like other layer 2 solutions, it takes transaction bundles from the main chain to be dealt with off-chain before transferring that information back. The Lightning Network also brings smart contracts to Bitcoin, which is a big improvement to the network overall.

Bitcoin lightning network promises the following benefits: instant payment, scalability, low cost and cross blockchains swaps.

As the name suggests, this layer 2 solution will introduce lightning-fast payments on the Bitcoin blockchain, as fast as milliseconds. The current Bitcoin average transaction time is about 10 minutes. However, it can vary largely if the network is congested.

The Bitcoin lightning network also claims that it is capable of processing millions to billions of TPS, which is many times higher than legacy payment providers like Visa.

By settling transactions off-chain as layer 2 solution, fees are greatly reduced, allowing for instant micropayments.

Finally, cross-chain atomic swaps can occur off-chain as long as the chains support the same cryptographic hash function. Bitcoin uses the SHA-256 cryptographic has function in its algorithm.
More information about the Bitcoin lightning network can be found here.

Ethereum Layer 2 Scaling Solutions

Starkware

Starkware is a Ethereum layer 2 scaling solution provider. It has three products: StarkNet, StarkEx and Cairo.

StarkNet is a permissionless decentralized ZK-rollup layer 2 solution for the Ethereum blockchain. Developers are now able to deploy their smart contracts permissionlessly on StarkNet's testnet. The main advantage is the ability for dApps to achieve unlimited scale, while still benefitting from Ethereum's composability and security. More information on StarkNet can be found here.
StarkEx is a layer 2 scalability engine that has been proven and deployed on mainnet since June 2020. It has been deployed in various use cases, and notable customers are DeversiFi, Immutable and dYdX. The main benefits of StarkEx is trustless scalability using ZK-STARK technology, ability to design self-custodial dApps, and robust and secure scaling solution for a wide range of uses. More information on StarkEx can be found here.

Cairo is Starkware's Turing-complete language behind both StarkNet and StarkEx. It allows for the scaling of dApps using STARKs.

Learn more in our deep dive into Starkware.

Optimism

Optimistic Ethereum is an Ethereum Virtual Machine (EVM) compatible optimistic rollup chain. The main benefits of deployed on Optimism is that it is fast, simple and secure. Users can move assets in and out of the network using Optimistic Ethereum Gateway, and projects looking to deploy can submit a form to get whitelisted by Optimism. Projects that meet their launch criteria will be approved within 2 weeks. On July 2021, Uniswap V3 announced its alpha launch on Optimistic Ethereum mainnet.

Learn more in our deep dive into Optimism.

Arbitrum

Arbitrum is a layer 2 solution designed to boost the speed and scalability of Ethereum smart contracts, while adding additional privacy features. The layer 2 platform allows developers to run unmodified EVM contracts and transactions on layer 2, without compromising on layer 1 security.

Arbitrum positions itself as the ideal scaling solution for DeFi apps, with the ability to use Arbitrum rollup to scale any Ethereum contract.

Offchain Labs, the company behind Arbitrum, rolled out Arbitrum One, their Ethereum mainnet beta on Aug. 31, 2021, and announced $120 in series B funding, valuing the firm at $1.2 billion.
Learn more in our deep dive on Arbitrum.

Polygon

Polygon is another layer-two solution for Ethereum, leveraging different technologies to enhance Ethereum’s scalability:

  • Polygon PoS: EVM-compatible sidechain.
  • Polygon Miden: a zk-rollup based on Starkware.
  • Polygon Hermez: an open-source zero-knowledge rollup.
  • Polygon Avail: a standalone layer-2 chain with a data availability focus.
  • Polygon Zero: a zk-rollup chain.
  • Polygon Nightfall: a privacy-focused rollup chain.
In July 2022, Polygon also announced the launch of Polygon zkEVM, a zero-knowledge version of the Ethereum Virtual Machine. Its aim is to reduce transaction costs and improve Ethereum’s scalability before the switch to proof-of-stake.
Learn more in our deep dive into Polygon.
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