Layer 2 Blockchains: Everything to Know

By  Beluga Research July 21, 2023

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Summary

  • A layer 2 blockchain solution is a second layer of functionality built on top of an existing blockchain
  • The second layer allows the blockchain to accomplish additional tasks
  • This does not compromise the security and decentralization of the initial blockchain
  • A layer 2 solution runs parallel to the main blockchain

Overview

A layer 2 blockchain solution is a second layer of functionality built on top of an existing blockchain. The second layer is necessary because the original blockchain can only process a limited number of transactions. Also, each block can only be added to the chain at a certain rate. These limitations result in slow transaction times and high fees. A layer 2 solution makes it possible for a blockchain to handle more transactions, yet remain secure and decentralized.

A Brief History

The concept of layer 2 solutions has been around since the early days of blockchain technology. In 2015, the Lightning Network was proposed as a solution to the scalability challenges faced by Bitcoin.

The Lightning Network is a layer 2 protocol that allows for fast and cheap transactions. It creates "payment channels" between users. The approach allows for a large number of transactions to be processed off-chain. There is not a need for each transaction to be recorded on the blockchain.

Since the introduction of the Lightning Network, numerous other layer 2 solutions have been developed for various blockchain platforms. These solutions include Plasma, Raiden and state channels. Each has its own approach to improving blockchain technology.

What are layer 2 solutions?

A layer 2 solution is a separate blockchain built on top of the main blockchain, which runs parallel to the main blockchain. It operates on top of the main blockchain, utilizing its security. Like the main blockchain, it offers a decentralized ledger and method of accomplishing transactions. A layer 2 solution offers functionality that reduces processing time and transaction fees. It ensures the blockchain is scalable, to handle more work.

There are different types of layer 2 blockchains, including sidechains and state channels. A sidechain is a separate blockchain that runs parallel to the main blockchain but has its own set of rules and consensus mechanisms. A state channel operates on the same rules and consensus mechanisms as the main blockchain. It does not record all the transactions on the main blockchain.

Instead, it moves some of the transactions off-chain. The transactions must be signed by the participants in order to record them on the blockchain. The participants usually sign the transactions after they execute all the necessary procedures to get them to occur.

Getting Started

  • Reduce the load on the base layer. Layer 2 solutions allow for faster and cheaper transactions. They enable off-chain transactions that are settled on the main chain. Instead of every transaction being processed and validated on the main chain, transactions are processed and validated on a secondary layer. Only the final result is settled on the main chain.
  • Offer scalability. With a layer 2 solution, a blockchain can accomplish more tasks, yet offer the same amount of security and decentralization.
  • Offer a higher level of functionality. A layer 2 solution allows a blockchain to do more, with the same basic infrastructure.
  • Reduce processing time and transaction fees. A layer 2 solution helps a blockchain run faster. It does not require a user to pay more in fees.
  • Use the same blockchain. A user does not need to establish a second blockchain to engage in and record transactions.

Unique Aspects

  • Ability to scale transactions. Layer 2 solutions can handle thousands of transactions per second. This is a lot when compared to the limited transaction throughput of some layer 1 blockchains. This increased scalability is achieved by moving the majority of transactions off-chain.
  • Flexibility. Layer 2 solutions can be designed to meet specific use cases and requirements, allowing for greater customization and flexibility. For example, some layer 2 solutions are optimized for micropayments. Others are designed to handle complex smart contract transactions.
  • Provide a better user experience by reducing transaction fees and wait times. Since layer 2 transactions are settled off-chain, they can be processed and confirmed almost instantly. They can be accomplished at a fraction of the cost of on-chain transactions. This makes layer 2 solutions more accessible to a wider range of users, including those priced out of using layer 1 blockchains.

Advantages

  • Scalability. A layer 2 blockchain can handle a significantly higher number of transactions per second than the underlying blockchain. This is achieved by offloading some of the transaction processing to the layer 2 blockchain. This action reduces load on the main blockchain.
  • Lower fees. By reducing load on the main blockchain, layer 2 blockchains can significantly reduce transaction fees. This makes it more affordable for users to transact on the network.
  • Faster transaction times. Transactions on a layer 2 blockchain can be confirmed much faster than on the main blockchain. The layer 2 blockchain processes transactions in parallel rather than sequentially.
  • Improved privacy. Layer 2 blockchains can improve privacy by enabling users to transact off-chain. This reduces the amount of data that needs to be stored on the main blockchain. That can make it more difficult for third parties to track user activity on the network.
  • Customizability. Layer 2 blockchains can be customized to suit the needs of different applications. This means developers can create specific layer 2 solutions that are tailored to their particular use case. They do not have to use a one-size-fits-all approach.

Disadvantages

  • Centralization. Some layer 2 solutions can be more centralized than the underlying blockchain. They require a certain level of trust between the parties involved in the off-chain transactions. This can potentially lead to a single point of failure. The centralization can make the network less secure.
  • Complexity. Layer 2 solutions can be complex and difficult to implement. They require a high degree of coordination between the parties involved in the off-chain transactions. It can be more difficult for new developers to get involved in the ecosystem.
  • Security. Layer 2 solutions can introduce new security vulnerabilities into the network. They are built on top of an existing blockchain. They may require new protocols and mechanisms to ensure the security of the off-chain transactions. If the mechanisms are not properly implemented, the blockchain could suffer security breaches and loss of funds.