What Are Layer 2s?
Layer 2s are off-chain vertical scaling solutions that run on top of Layer 1s like Ethereum to improve scalability and reduce transaction costs, while maintaining the security guarantee of the Layer 1. Types of Layer 2s include optimistic and zero-knowledge rollups, state channels, sidechains, and nested blockchains.
Layer 1s are accountable for security, data availability and decentralization as Layer 2s handle transaction scaling.
Layer 2 crypto projects have been gaining traction and usage because of Ethereum's high gas fees and slow processing speeds.
Layer 2s are one of the key narratives in 2023, with L2 chain Arbitrum surpassing $2 billion in TVL.
Layer 1 blockchains (L1) or first-generation blockchains, such as Bitcoin and Ethereum, have long experienced a blockchain trilemma – scalability, decentralization, and security. This compels them to sacrifice one of these features to function effectively. For example, Bitcoin and Ethereum trade scalability for security and decentralization. Though they store data in a secure and distributed ledger, these networks experience low transaction speeds as network users have been increasing steadily.
Bitcoin boasts a transaction per second (TPS) speed of approximately 7, while Ethereum has a TPS of around 15. These speeds are awfully slow compared to other settlement services such as Visa, which boasts a TPS of about 45,000. And this is where Layer 2 (L2) protocols come in.
This article will help you understand why developers built L2 protocols on top of L1 and the role and rise of L2 protocols to become a leading narrative in 2023. In addition, the article deeply delves into some examples of L2 chains and the top four L2 crypto coins by market cap.
What Does Layer 2 Mean in Crypto?
Layer 2s are a set of off-chain solutions (distinct chains) running on top of L1s to combat the bottlenecks of scaling and transaction costs. Let's use the analogy of a restaurant kitchen to drive this point home:
When every order is made by one worker from the onset to offset before it's verified and answered, the process becomes time-consuming and resource-intensive in the long run.
However, L2s are like preparation stations – there is a station for chopping food, cooking, taking orders, serving, and assembling and cleaning dishes. These stations help the management staff focus and perform every activity precisely. At the end of every order, an individual matches the assembled dishes to order and confirms them before serving the customer.
Payment companies like Visa leverage a similar method. Instead of discretely controlling thousands of daily micro-transactions from a vendor like Starbucks (which would fill up a few hours’ worth of work in seconds), Visa arranges them into groups settled by the banking system at periodic intervals. The banks then pile and sort transactions via internal equivalents of settlement layers. In that regard, Visa acts as an L2 protocol and the extensive network of banks and central banks that store transaction records and create the game's rules as L1.
Essentially, L1s are accountable for security, data availability and decentralization as L2s handle transaction scaling.
The Importance of Layer 2 Protocols
Though Ethereum is known for its robust security and decentralization, the resultant market popularity over the years has hit the current capacity of 1.1 million daily transactions. Besides, since it can only handle about 15 TPS, periods of high network surges often result in data congestion. Consequently, this causes gas fees to increase, slowing the performance of dApps.
To solve these problems, L2 protocols out-spread Ethereum as a distinct chain above the L1 blockchain. They interconnect and unload the heavy burden of transactions from the mainnet via smart contracts, which incorporate and benefit from Ethereum's stable decentralized security mechanism.
Layer 1 vs. Layer 2 in Crypto
Layer 1 refers to the foundation level of a blockchain architecture – the primary structure of a blockchain. Examples of L1 chains include Bitcoin, Ethereum, and BNB Smart Chain. On the other hand, L2 are chains built on top of other networks. For example, Polygon (MATIC) is an L2 protocol built on the Ethereum blockchain, as seen in the diagram below.
The significant differences between L1 and L2 networks lies in their role and focus on the blockchain:
Types of Layer 2 Solutions in Crypto and How They Work
The application and use of blockchain technology are growing, and L2 protocols must rise to the occasion to improve on their L1 counterparts. Understanding the common L2 chains can provide more insights into how they can be a major milestone in blockchain evolution. Here are some common L2 protocols:
The design of a nested blockchain comprises a primary chain and some secondary chains. The design ensures that a network can seamlessly function jointly with other networks. The primary chain is accountable for assigning tasks, regulating the working parameters, and resolving disputes when necessary. The secondary chains execute transactions of the primary chain and send feedback and approvals to the main chain.
As the term implies, a sidechain is a side network linked to a primary blockchain through a two-way peg. You can think of it as a forest where the trees act as side chains, while the forest is the main chain. The main goal of sidechains is handling a high number of transactions. As such, they support the L1 blockchains by verifying transactions, freeing the main chain from the network congestion issue. However, you must trust the sidechains to operate appropriately as they can control assets on the main chain.
State channels enable parties to interact directly on the blockchain by providing an option of executing transactions without considering the main chains. Moreover, validators can take less time verifying transactions, improving the processing speeds of L1 chains. State channels don't rely on transaction validation on the L1 networks but instead use smart contracts to perform the same roles. When a transaction is finished successfully, the channels ensure secure storage on the main chain.
Rollups are L2 chains that facilitate computations outside the main blockchain. The transfer of transaction details takes place after a certain interval, hence offering the necessary backup for maintaining records. Besides, rollups can manage transactions with minimal interference to the main chain. Therefore, they can ensure transactions are processed faster and at minimal costs. Optimistic and zero-knowledge are the common types of rollups.
These are L2 protocols intended to expand the throughput of L1s. They minimize computation on L1s by processing transactions off-chain, significantly improving processing speeds. Besides, they obtain their security from L1s by rolling transaction outcomes on-chain.
Zero Knowledge Rollups (ZK-Rollups)
ZK-rollups are similar to optimistic rollups in that they combine L2 transactions performed off-chain and publish them as a batch on L1s. But instead of assuming transactions are genuine until confirmed otherwise, ZK-rollups leverage validity proofs to rapidly verify whether transactions are authentic or not.
List of Top Layer 2 Crypto Projects by Market Cap
L2 crypto projects have been gaining traction and usage because of Ethereum's high gas fees and slow processing speeds. This section looks at the top four Layer 2s by their market cap.
Polygon (MATIC) - $6.49B Market Cap
Polygon, formerly Matic, is an L2 scaling solution that allows developers to create scalable and user-friendly dApps with minimal transaction costs and without sacrificing security. It has a TVL of just under $850 million, with over 450 protocols running on its chain. It boasts a TPS of up to 7,000 compared to Ethereum's 15 TPS. Besides, Polygon is already used by major crypto brands like Sushiswap, Chain Games, and Quickswap, and non-crypto brands like Instagram, Stripe, Adidas Originals, and Prada. Currently, MATIC has a market cap of around $6.5 billion and a maximum supply of 10 billion. You can trade MATIC on various exchanges, including Binance, Coinbase, Digifinex, and FTX.US.
Mantle (MNT) – $1.68B Market Cap
Mantle is a modular EVM-compatible Layer 2 blockchain that uses optimistic rollups, where transactions executed on Mantle are bundled up before being submitted to the Ethereum mainnet. It also leverages EigenLayer's EigenDA for data availability instead of the Ethereum mainnet, further lowering transaction costs.
Another key development of Mantle is its use of multi-party computation (MPC), where MPC nodes can independently assess and validate the sequencer's state root. As more nodes sign the block, confidence in the block validity will increase, and this offers a solution to reduce the current optimistic rollup challenge period of 7 days.
MNT is rebranded from the BitDAO (BIT) token after BitDAO merged with Mantle. MNT is now the native token of Mantle and fuels the tax, utility and governance system of Mantle Network ad its ecosystem, where fees for every transaction is paid in MNT.
Arbitrum (ARB) - $1.49B Market Cap
After Polygon, Arbitrum has the highest total value locked (TVL) across the Layer 2 ecosystems. Arbitrum is an optimistic rollup scaling solution, combining multiple transactions into one smart contract message for bulk processing on Ethereum. As of time of writing, Arbitrum has over 400 protocols, with a TVL of $2.02 billion. Arbitrum launched its native token, ARB, which serves as the governance token for the Layer 2 chain, while all transaction fees are settled using ETH. This means that in order to use Arbitrum, you must bridge your assets from the Ethereum mainnet to Arbitrum, which can be done using the Arbitrum bridge.
More recently, Arbitrum announced its Arbitrum Orbit program, where new Layer 2 networks can be built using Arbitrum's tech stack, although creating a new chain off Arbitrum's code requires explicit sign-off from the Arbitrum DAO.
Optimism (OP) - $1.19B Market Cap
Optimism is also an optimistic rollup scaling solution, hence its name. It provides users with cheaper transactions and a smoother user experience, and is also one of the top five Ethereum Layer 2 solutions by TVL, with over $872 million locked in. Like Arbitrum, all transactions fees are charged in ETH, so you'll need to transfer some ETH over to Optimism before you can start using the chain. Optimism has already launched its token, OP, which is used for goernance, and 14% of the tokens are reserved for future airdrops.
Like Arbitrum's Arbitrum Orbit, Optimism has also released its OP Stack, where protocols can create app-specific Layer 2 blockchains based on their needs. Through this, Optimism envisions the Optimism Superchain, which is a unified network of chains built using the OP stack, where no bridging or network switching is required since they are built from the same standardized technology stack. One notable project builting on the OP Stack is Coinbase's Base.
Up and Coming Layer 2 Protocols
Beyond the four L2 platforms outlined above, here are some other interesting Layer 2 projects:
zkSync Era is a Layer 2 blockchain built on Ethereum that leverages zero-knowledge rollups to deliver faster and cheaper transactions while maintiaining a high level of security. As mentioned above, zero-knowledge ensures transaction privacy by masking the details of a transaction without dampening its validty. Since its launch, the Layer 2's TVL has been steadily climbing, reaching a high of $196.55M, although that might be partly due to the anticipation around a potential zkSync Era airdrop.
Linea is developer-ready Ethereum-equivalent zkEVM network developed by Consensys, the company behind MetaMask. As an Ethereum-equivalent network, it is perfectly compatible with Ethereum, enabling the smooth deployment of existing applications on Linea.
The Linea ecosystem supports a wide range of applications, including DeFi projects like iZUMi Finance, NFT projects like NFTs2Me, and utility applications like HAPI, where users on Linea can track their transactions via HAPILAB’s terminal.
Shibarium is a Layer 2 scaling solution, and is part of the Shiba Inu (SHIB) ecosystem. While it's not launched yet, the Shiba Inu team has shared some details around what it will look like. BONE will be the native token used to pay for gas transactions, and rewards will also be distributed in BONE. Also, ShibaSwap will be integrated into the Shibarium mainnet for easier access to tools and functions, while allowing users to access staking and liquidity pools efficiently.
What are Layer 3 Protocols?
Layer 3 (L3) protocols refer to blockchain-based applications, like dApps and distributed storage, which present cross-chain functionalities. These protocols strive to attain blockchain interoperability without relying on custodians or third parties, while maintaining the simplicity of processes in the underlying layers.
Scalability is the stumbling block of L1 blockchains, limiting them from exploring their full potential. And this is where L2 protocols come in. They have evolved to combat this issue head-on and ensure the future of blockchain technology is scalable. In the future, L3 interoperability projects are expected to connect different blockchains and L2 services, removing the fragmentation issue faced by the cryptocurrency industry today.
Josiah is a tech evangelist passionate about helping the world understand Blockchain, Crypto, NFT, DeFi, Tokenization, Fintech, and Web3 concepts. His hobbies are listening to music and playing football. Follow the author on Twitter @TechWriting001