Blockchain Layer 1 vs. Layer 2 Scaling Solutions: Explained

Blockchain technology increases trust, strengthens security, improves transparency, and expands the traceability of shared data in business networks—all while lowering costs and streamlining processes.

As a result of these benefits, blockchain network developments are unavoidable. It is crucial to remain competitive using innovations like cutting-edge scaling techniques, sharding, improved security protocols, and decentralization initiatives. This article intends to explore these developing changes. We will do it by showing how blockchain can spread and become more valuable over time.

Blockchain scalability is a critical component of cryptocurrencies, often discussed as "Blockchain Trilemma." Ethereum developer Vitalik Buterin first proposed this concept. It states that achieving decentralization, scalability, and security is impossible. Crypto projects must sacrifice one of three qualities to solve this trilemma.

Finding a solution that balances the three factors is essential for the long-term adoption of blockchain. So, various innovations and problem-solving initiatives are needed to tackle this issue.

We can divide blockchain network scaling solutions as blockchain Layer 1 vs. Layer 2. It is essential to note the difference because all use different mechanisms to reach their goals.

Simply put, we can classify Layer 1 solutions as

• Sharding is a distributed database-inspired system. It divides the state of the whole blockchain network.

• Changing the consensus mechanism from PoW to PoS to make the blockchain network more scalable, energy efficient and achieve higher throughput and decentralization.

• SegWit is a method that separates the signatures from the transaction data.

We can divide Layer 2 solutions into

• State channels have the goal of helping scalability by allowing transactions to occur outside of the main blockchain.

• Sidechains improve interoperability by allowing the transfer of assets between blockchains.

• Roll-ups collect transaction data and move it away from the main chain. Doing this allows transaction execution to occur off-chain while holding assets in on-chain smart contracts.

Layer 1 is the foundation of a network's operations and is also known as the base blockchain. These blockchain Layer 1 scaling solutions are also known as on-chain scaling. They work by enabling networks to handle transactions on their own blockchains.

Bitcoin and Ethereum are the two most famous examples of Layer 1 networks. Both networks use a decentralized consensus model to secure transactions. Also, many nodes verify transactions before they confirm them.

Yet, as the popularity of these networks grows, so does the demand for faster confirmation times and lower transaction fees.

Layer 1 solutions provide a variety of methods for a direct increase in the scalability of blockchain networks. Modifications to protocol rules, larger block sizes, and faster block creation are some approaches used in Layer 1 scaling. To put these solutions to work, the network's community may need to hard fork or soft fork the network, like with Bitcoin's SegWit update.

Another method for increasing network throughput is sharding. It divides a blockchain's operations into smaller sections. Those sections can process data in a concurrent rather than sequential way.

Examples of Layer 1 Solutions

Layer 1 solutions are upgrades to a main blockchain network architecture that do not need the addition of an overlay. These solutions enhance network efficiency by changing the underlying architecture or base protocol.

Many techniques help implement to achieve Layer 1 scaling. Some of them could be increasing the amount of data in each block or accelerating the block confirmation process.

Other blockchain updates include making improvements in the consensus protocol or implementing sharding.

Ethereum 2.0, Cardano’s Ouroboros PoS consensus mechanism, Bitcoin’s SegWit, Algorand’s pure PoS consensus, and Fantom’s aBFT (Asynchronous Byzantine Fault Tolerance) consensus mechanism are examples of Layer 1 scaling solutions.

How Do Layer 1 Blockchains Scale?

There are many ways to achieve greater effectiveness of various blockchains.

Sharding 

Sharding is a distributed database-inspired method. It is a prominent Layer 1 scalability approach that splits the state of the whole blockchain network into smaller amounts of data. We call these pieces shards.

Each node is assigned to an exact shard. Each shard allows the simultaneous processing of many transactions and boosts network performance. Shards interact with one another to share addresses, balances, and states. It is possible by cross-shard communication protocols. Zilliqa uses "sharding by transaction," where transactions are divided into smaller groups and processed in parallel by different shards.

Proof-of-Stake (PoS)

Proof of Stake is the most effective among consensus mechanisms. It uses less energy compared to Proof-of-Work, currently used by major blockchain networks such as Bitcoin. Ethereum's transition to Ethereum 2.0 involves adopting a PoS consensus mechanism, enhancing scalability, security, and energy efficiency.

This trait is essential for today's world, where many industries are looking for greener options for functioning.Rather than asking miners to solve cryptographic methods, Proof-of-Stake participants place collateral in the network to confirm new blocks.

Segregating Witness (SegWit)

SegWit, or Segregating Witness, is a method that separates the signatures from the transaction data and removes some parts of a transaction. As a result, it makes room for a block to process more transactions.

SegWit solved the Bitcoin network's block size restriction problem, in which blocks were limited to a maximum size of 1 MB. These blocks could hold only a limited amount of transactions, resulting in long processing times during peak network traffic.

The weight of the transactions is lowered by excluding the signatures and keeping them in a separate structure, allowing for a swifter data processing load and verification. Since the digital signature alone accounted for 65% of the space in a given transaction, the witness structure, which contains scripts and signatures, is now only one-fourth of its original size.

It is important to note that SegWit is backward compatible, which means that nodes that have added the protocol can interact with nodes that have not yet upgraded. It enables a smooth transition from existing protocols to the new protocol while minimizing network disruption.

Advantages of Layer 1 Scaling Solutions

Here are some advantages that Layer-1 scaling solutions offer: 

No Need For a Separate Chain

Layer 1 solutions have several advantages over Layer 2 solutions because they do not need a separate chain or related improvements that may interfere with the underlying construction. Instead, these solutions alter the protocol's rules to increase transaction capacity and speed and serve more users and data.

Changing Network's Underlying Protocol For Scalability 

Layer 1 blockchain solutions change a network's underlying protocol to improve scalability.

These technologies have various benefits, including greater transaction throughput, improved network efficiency, enhanced security, lower transaction fees, long-term scalability, and decentralization preservation.

Layer 1 Solutions May Reduce Network Transaction Fees 

These solutions may reduce transaction fees by lowering network congestion because users no longer have to fight for block space. Furthermore, rather than building on top of the underlying protocol, as in Layer 2 solutions, these solutions provide a long-term effect on scalability by making permanent changes.

Enforce Direct Changes to Consensus Protocol 

Finally, by adapting the consensus protocol changes more directly, Layer 1 solutions guarantee that the network remains decentralized and controlled by its users rather than a small group of entities. Layer 1 solutions' open environment enables simple integration of new tools and developments, making it a versatile and adaptable option for the blockchain ecosystem.

Limitations of Layer 1 Scaling Solutions

However, Layer 1 scaling solutions have some drawbacks or limitations, including: 

Potential Loss of Income For Miners

A well-known example of how validators might be unable to produce the expected profits is the transition from Proof of Work to Proof of Stake. This transition may cause miners to lose income due to a more efficient method, limiting their capacity to improve scalability.

Limitations of Individual Node Storage and Bandwidth 

Despite much research on blockchain Layer-1 solutions, scaling solutions need extra investigation. Individual node storage and bandwidth limitations pose significant performance and challenges in blockchain systems.

Potential Congestion Issues 

As the number of transactions per second (TPS) increases, more block data is spread throughout the network, leading to congestion issues.

Challenges of Cross-shard Transactions

The Sharding technique, which divides the blockchain into different shards and scales with the number of nodes, is a possible answer. Yet, improving the efficiency of cross-shard transactions is still a work in progress.

Besides, cross-shard transactions need more bandwidth and result in longer confirmation periods. A more effective method is required to decrease confirmation delay, and there is still more potential for development in this direction.

Any network, system, or technology that works on top of a blockchain (also known as Layer 1) to provide extra features and advancements is Layer 2. Layer 2 networks must ensure the underlying blockchain's security by confirming their transactions by the base layer network.

It contrasts with systems such as sidechains, which frequently have distinct consensus procedures and security assurances. Layer 2 networks offer a solution for blockchains that struggle with scalability, allowing faster and more efficient transactions while maintaining decentralization and security.

L2 scaling solutions are complex ways of ensuring the desired effect of blockchain adoption by being closer to resolving the trilemma.

Types of Layer 2 Scaling Solutions

Rollups 

Rollups improve blockchain scalability by executing transactions and smart contracts off-chain and validating them on-chain. It results in higher throughput and lower costs compared to traditional on-chain transactions. Rollups offer scalability solutions in three distinct ways: off-chain processing, batching transactions, and needing at least one honest validator.

Off-chain execution is a major element of rollups, in which layer-2 networks perform transactions on behalf of the base blockchain, whether with another user or a smart contract.

The workload of the underlying blockchain gets reduced because it simply needs to run proofs and store raw transaction data, resulting in cheaper transaction costs. Batching transactions involves combining several raw transaction data sets into a larger batch and uploading it to the blockchain.

Finally, rollups only need one honest validator to confirm base-layer blockchain transactions. It minimizes the number of validators required while increasing hardware requirements without compromising security.

State Channels

State channels are a Layer 2 solution that allows various parties to conduct multiple transactions off-chain without broadcasting each transaction to the entire network. This off-chain transaction channel improves a blockchain's scalability by lowering the number of transactions processed by the network and the associated expenses.

The Lightning Network functions on top of the Bitcoin blockchain and is an example of a state channel in action. The Lightning Network allows users to conduct multiple transactions off-chain, resulting in faster settlement times and lower transaction costs while simultaneously boosting the Bitcoin blockchain's scalability.

Sidechains 

Sidechains are independent blockchain networks linked via a two-way peg system or bridge. Sidechains have their own consensus methods suited to specific transactions, making them more efficient and cost-effective. They do not inherit the main chain's security features, and users must rely entirely on the security of the sidechain, including the nodes participating in its consensus procedure.

Sidechains provide a solution to main chain congestion, reducing prices for all users while boosting the scalability and usefulness of the ecosystem. Developers can also use sidechains to test new features and use cases unavailable on the main chain.

Polygon PoS, Skale, and Rootstock are among the popular sidechains. Ethereum 2.0 contains its own form of shard chains linked to the recently released Beacon Chain, which hopes to become the main PoS-based Ethereum chain in the future.

Examples of Layer 2 Solutions

Arbitrum, Lightning Network, Optimism, and Polygon are popular Layer 2 blockchains.

1. Arbitrum is an Ethereum-based Layer 2 solution that improves efficiency with Optimistic Rollups. It has better throughput and lower fees than Ethereum while benefiting from the main Ethereum blockchain's security and interoperability. Arbitrum's native currency, ARB, is utilized for governance, and the platform has transitioned to a decentralized autonomous organization (DAO) structure.

2. The Lightning Network is a Bitcoin Layer 2 solution that aims to make transactions faster and cheaper. The main Bitcoin network can move faster by outsourcing certain transaction requests to the Lightning Network. The Lightning Network aims to make Bitcoin more like peer-to-peer electronic cash, with lower fees and energy consumption than the main blockchain.

3. On top of Ethereum, Optimism is a Layer 2 blockchain. It contributes to the scaling of the Ethereum ecosystem through the use of optimistic rollups and benefits from the security of the Ethereum mainnet. Optimism is home to 97 protocols, including Synthetix, Uniswap, and Velodrome, and has over $500 million in total value locked.
   You may access Optimism by adding the chain to your MetaMask wallet and bridging coins such as ETH to the Layer 2 platform.

4. Finally, Polygon network intends to address Ethereum's challenges, such as high fees and low transaction throughput, by creating an "internet of blockchains" that will enable developers to launch their custom Ethereum-compatible blockchains quickly. The initiative envisions a society where blockchains exchange value and knowledge freely and easily, bridging technological and ideological boundaries. Polygon network was rebranded from Matic Network to reflect its enlarged purpose as the backbone for a network of massively scaling, collaborative blockchains.

Advantages of Layer 2 Scaling Solutions

We can investigate the positive sides of L2 scaling solutions through the example blockchains we provided.

1. Arbitrum leverages optimistic rollups to boost efficacy, resulting in higher throughput and reduced fees compared to Ethereum. It also uses its native currency, ARB, for governance and has switched to a DAO framework.

2. The transactions also become swifter - as a clear example, the Lightning Network seeks to make Bitcoin transactions faster and more affordable, allowing the cryptocurrency to function more like peer-to-peer digital money. Next, lower energy consumption is also the goal of the Lightning Network, which consumes less electricity than the main blockchain.

3. Optimism contributes to the scaling of the Ethereum ecosystem by using optimistic rollups, which ticks the box for improving scalability. To gain access to Optimism, add the chain to a Metamask wallet and bridge tokens to the Layer 2 platform, making it more accessible.

4. Polygon's goal is to create an "internet of blockchains" that will allow blockchains to freely exchange value and information, thereby bridging technological and ideological barriers.

Limitations of Layer 2 Scaling Solutions

Layer 2 solutions include restricted transactions, reduced interconnection, lower liquidity on the underlying blockchain, and increased onboarding friction.

Interconnectivity may be limited or lost entirely when transactions are constrained to a distinct Layer 2 protocol, as one Layer 2 dApp may have no method of connecting with another Layer 2 dApp on a different protocol or with a dApp on the principal Layer 1 blockchain.

Furthermore, creating a separate Layer 2 space can result in a more slim distribution of liquidity, as seen in the case of Ethereum, which relies on a robust and liquid market for all financial goods and tokens on its platform.

Besides, adding multiple Layer 2 solutions on top of the primary Layer 1 blockchain protocol can increase onboarding friction and time, as data and information transfer may require more accounts and bridges. It may also be more difficult for consumers to maintain track of their cash and ensure security across different Layer 2 protocols.

The primary question between blockchain layer 1 and layer 2 scaling solutions is how they behave and function. It is futile to compare them by how much they benefit the ecosystem since all have distinct qualities.

Layer 1 blockchains are self-contained networks that include every one of the essential layers, such as data availability, consensus, and execution. They are security-focused and offer a solid foundation for specific Layer 2 solutions. Layer 2 scaling solutions depend on Layer 1 blockchains and exist to support them.

Layer 1 blockchains achieve scalability by employing methods such as modifying the consensus algorithm and sharding. Layer 2 scaling solutions use state channels, nested blockchains, rollups, and sidechains to improve network performance, programmability, transaction requests, and fees.

Layer 1 networks act as the source of truth and are in charge of settling transactions. They also have a native token for accessing network resources and are frequently at the forefront of consensus mechanism innovation. Layer 2 solutions provide the same functionality as Layer 1 solutions but with extra benefits such as increased performance and lower prices. Each Layer 2 solution has its own method of mapping transactions back to the underlying Layer 1 network.

The Impact of Ethereum 2.0 on Layer 1 and Layer 2 Networks 

The upcoming Ethereum 2.0 upgrade marks a pivotal moment that could transform both Layer 1 and Layer 2 networks. Since The Merge, when Ethereum transitioned from a Proof of Work to a Proof of Stake consensus mechanism, the blockchain’s developers have strived to improve the network’s efficiency, scalability, and security. 

Ethereum 2.0 represents a substantial step forward in Ethereum's scalability and throughput, aiming to process up to 100,000 transactions per second, a significant increase from the current capacity of around 30 transactions per second. This upgrade addresses the congestion issues that have plagued Ethereum's network, allowing for a smoother and more efficient user experience. 

However, Ethereum 2.0 does not make Layer 2 solutions obsolete; instead, it reinforces the importance of Layer 2's role in enhancing Ethereum's scalability. Layer 2 solutions continue to offer unique advantages, such as enabling complex DeFi operations and interoperability between different blockchain protocols. 

While Ethereum 2.0 presents significant improvements, certain limitations are associated with Layer 1 scalability alone, underscoring the relevance of Layer 2 solutions. One notable limitation is composability, a crucial feature of DeFi that allows different protocols to interact seamlessly. Layer 2 solutions offer limited composability between chains, leading to a fragmented user experience. However, projects like Polygon aim to bridge this gap by providing an interoperable Layer 2 structure, although full implementation may take time.

Layer 2 scaling solutions have multiple real-world applications in various industries. Ethereum, one of the most prominent Layer 1 blockchains, offers a wide range of applications, including DeFi projects like MakerDAO, which employs complicated Ethereum smart contracts to create a Stablecoin (DAI) backed by Ether and fixed at $1.

Finance

Ethereum also offers smart contract-enabled loans and other financial applications, commerce and payment interactions, and data storage. Furthermore, its blockchain technology, which can securely transport data between millions of servers worldwide, can potentially revolutionize how we store and transfer data.

Another famous Layer 2 option that can alter several areas of digital transactions and financial applications is the Lightning Network. It provides faster, cheaper, and more scalable transactions, allowing for hitherto impossible use cases with Layer 1 blockchains. The Lightning Network can be used for various purposes, including micropayments, remittances, gaming, fast settlements, etc. In the micropayments arena, for example, Nostr, a decentralized social network, uses the Lightning Network to enable users to send and receive micropayments within its platform.

Strike, a smartphone app, uses the Lightning Network to provide rapid and low-cost cross-border money transactions. THNDR Games integrates Lightning's enthusiasm into its mobile games, providing thrilling and immersive experiences. OpenNode, a payment processing technology, allows retailers to accept Bitcoin payments via the Lightning Network, decreasing transaction fees and offering near-instant settlements.

NFTs

Furthermore, Ethereum is the foundation of the NFT market, allowing the monetization of works of art, music, and other media via non-fungible tokens.

Polygon is another Layer 2 solution that has considerably impacted the DeFi market. It has a total value locked in the DeFi area of about $1.3 billion as of June 2023 and is used by the largest DeFi platforms, such as Compound and Aave. Polygon also supports NFT trading and provides minimal transaction fees for buying and selling NFTs.

Gaming

Polygon founded the Polygon Studios section in July 2021, intending to transition games to Web 3.0 from Web 2.0. The division assists creators interested in building games on Polygon by providing marketing assistance, community support, and investments. The power of the Ethereum network paired with Polygon's Commit Chain scaling technology can alleviate worries about slow network latency and transaction rates in blockchain-based games.

Polygon can also improve the efficiency of trading in-game NFTs, as seen by several GameFi and NFT dApps using Polygon to enhance their user experience.

Blockchain protocol scaling solutions are now being researched and developed for the future. Developers are working on sharding, off-chain transactions, and layer 2 solutions to boost the system throughput rate and the scalability of blockchain networks. These solutions address blockchain networks' shortcomings, such as sluggish transaction speeds and excessive fees, to make them more accessible for mainstream applications.

One could use the best of both worlds in hybrid blockchain versions to achieve the best results. Many scaling strategies can make the chain more usable, quick, and approachable to new users.

The future of blockchain scaling solutions will significantly impact cryptocurrency mainstream adoption. Blockchain networks will become more usable for everyday blockchain transactions and other mainstream applications as they become more scalable.

It will boost cryptocurrency appeal and adoption, making them more accessible to a broader audience. Besides, as blockchain networks become more scalable, they will better meet the increasing demand for DeFi and other blockchain-based applications. Because blockchain services provide many solutions to real-world problems, their development and expansion are unavoidable in the current era.

In the end, the future of blockchain scaling solutions looks promising, with ongoing research and development aimed at improving the scalability of these new blockchain networks, e.g., LayerZero. The possibility of hybrid approaches, which combine diverse solutions for the greatest results, adds to the intriguing possibilities.

These initiatives' effect on mainstream cryptocurrency adoption cannot be emphasized, as more scalable blockchain networks will better manage the growing demand for decentralized finance and other blockchain-based applications.

We are heading towards a more usable, accessible, and safe digital environment due to these improvements. It's an exciting time to be a part of the blockchain sector, with endless possibilities in the future.