What are Layer 1 and Layer 2? Understanding the Use Cases

Imagine a city’s main road that despite being well-built, becomes congested during peak hours due to the sheer volume of vehicles. To alleviate this issue, the city introduces secondary routes with more lanes that help manage traffic flow more efficiently and reduce the load on the main road. 

This is akin to Ethereum’s journey: originally it operated solely on its Layer 1 chain, but as its popularity grew, it encountered congestion and high fees. To address these issues, Ethereum began exploring and implementing Layer 2 solutions built on top of Layer 1, to enhance scalability and efficiency.

Stay with us as we delve into the fundamentals of this story, exploring what Layer 1 (L1) and Layer 2 (L2) are, how they operate, challenges faced by Layer 1, the different types of L2, and real-world use cases. We’ll conclude by discussing future trends.

What is Layer 1?

Layer 1 is the foundational layer of a blockchain network. Think of it as the base structure that all other blockchain activities build upon. It includes the main protocol that provides security, ensures transactions are verified and recorded, and maintains the decentralized nature of the network. 

These are some key points to understand Layer 1:

• L1 is the core infrastructure or base layer of a blockchain system, providing the basic framework and rules for the network. 
• L1’s are designed to be secure and tamper proof. They use cryptographic algorithms to ensure that transactions cannot be easily altered or manipulated. 
• L1 blockchains use a consensus mechanism, like Proof of Work (PoW) or Proof of Stake (PoS), to validate and secure transactions. This mechanism involves multiple network participants agreeing on the state of the blockchain.
• Bitcoin, Ethereum, and Cardano are popular examples of Layer 1 blockchains. They handle transaction processing, network security, and ensure the system operates smoothly.

Underlying working of Layer 1

Before we touchdown on L1, understanding Layer 0 is important as it is a foundational infrastructure that connects multiple blockchains and enables them to interoperate. It focuses on cross-chain communication and interoperability. Polkadot and Cosmos are examples of L0, which allow different blockchains to transfer data and value across networks.

L0 connects and supports multiple blockchains, while Layer 1 blockchains operate as the primary foundation of a blockchain network, handling all fundamental tasks necessary for the network to function. Here’s how L1 scaling solutions work:

• Increased Block Size

This approach involves updating the blockchain protocol to allow larger block sizes, meaning each block can hold more transactions. By increasing the block size, more transactions can be processed and verified at once, enhancing the overall throughput, meaning increased capacity of a blockchain network to process a specific number of transactions within a designated time frame. 

This can be better understood with the example of Bitcoin Cash. It increased it’s block size from 1 MB to 8 MB and later to 32 MB. This expansion theoretically allows Bitcoin Cash to process over 100 transactions per second, compared to Bitcoin’s approximate seven transactions per second.

• Updated Consensus Mechanism

Consensus mechanism is one of the fundamental technologies in blockchain and it is the key to a decentralized system. It eliminates the need for relying on a central authority. At the Layer 1 level, blockchain networks use consensus mechanisms to validate all transactions, maintaining the accuracy and security of the network. Different blockchains utilize different consensus models, such as Bitcoin’s Proof of Work (PoW) and Ethereum’s Proof of Stake (PoS). 

The main difference between PoW and PoS lies in how they achieve consensus and secure blockchain networks. Proof of Work relies on miners to solve complex mathematical puzzles using high energy and computational power. On the other hand, in Proof of Stake, validators are chosen to create new blocks based on the amount of cryptocurrency they hold and stake as collateral. To learn more about PoW and PoS, read here.

• Sharding

Sharding divides the blockchain network into smaller, more manageable segments called shards. Each shard is responsible for processing its own transactions and smart contracts, operating independently of the others. This allows multiple transactions to be processed in parallel, significantly increasing the network’s capacity.

Similar to database partitioning, sharding distributes the workload across multiple shards, preventing any single node from having to process every transaction on the network. This parallel processing approach enhances scalability by allowing the blockchain to handle a larger volume of transactions simultaneously.

Real-world L1 Use cases 

Layer 1 solutions have use cases for various applications and industries, including:

• Cryptocurrencies

Layer 1 blockchains form the base infrastructure for digital currencies, enabling secure, decentralized and transparent transactions. They manage the creation, transfer and validation of crypto. 

Examples: Bitcoin, operating on Layer 1 using PoW, and serves as a digital store of value and medium of exchange. Similarly, Ethereum using PoS, supports cryptocurrency transactions but handles complex smart contracts too, facilitating a wide range of dApps.

• Supply Chain Management

Layer 1 provides transparency and traceability in supply chains by recording every transaction and movement of goods on a tamper-proof ledger.

Example: IBM Food Trust uses L1 blockchain technology to trace the journey of food products from farm to table, allowing stakeholders to track and verify origin of products. This enhances visibility, reduces fraud and improves operational efficiency.

• Digital Identity Management

Layer 1 blockchain offers secure, decentralized storage for personal information, enabling individuals to manage their digital identities. This avoids tampering and protects against identity theft.

Example: SelfKey works on this concept, they provide a blockchain based self-sovereign identity system, allowing users to share their personal data securely, reducing risk of unauthorized access and fraud.

The scalability issue in L1 and Need for Layer 2s

The primary issue with Layer 1 blockchains like Bitcoin and Ethereum is scalability. As these networks gain popularity, they experience increased network traffic and congestion, necessitating more processing power to handle growing transaction volumes. 

Constraints such as Bitcoin’s 1 MB block size limit and 10-minute block time restrict throughput to around 7 transactions per second (TPS). During peak times, transactions queue up in the mempool, causing delays and increased confirmation times due to block propagation and potential forks.

Additionally, Layer 1 networks face scalability challenges due to the limitations of Proof of Work (PoW) and Proof of Stake (PoS) mechanisms. PoW requires significant computational resources, while PoS relies on financial stakes, both of which can create bottlenecks and slow down transaction times. As congestion persists, low-fee transactions may be delayed indefinitely, exacerbating scalability issues. Layer 2 solutions are designed to address these problems, offering improvements in efficiency and capacity for areas like DeFi, gaming, and payments.

Since blockchain’s inception, addressing scalability challenges has been crucial to support its growing use and adoption. Vitalik Buterin’s scalability trilemma highlights that improving blockchain scalability often comes at the expense of either security, decentralization, or both. Because a decentralized and secure network is fundamental to blockchain technology, finding the right balance between these elements is essential for effective scaling.

Layer 2 solutions tackle this challenge by offloading some of the workload, like transaction processing, data storage, and consensus, to systems outside the main blockchain. This approach helps reduce congestion and improves overall performance while maintaining the core principles of security and decentralization.

What is Layer 2?

Layer 2, or L2 refers to a secondary framework or protocol that is built on top of an existing Layer 1 blockchain. The primary purpose of the L2 solution is to enhance the scalability, speed, overall efficiency of transactions while reducing costs. By processing transactions off-chain, L2 solutions alleviate the burden on Layer 1 blockchains, allowing for faster and cheaper transactions without compromising the security provided by the underlying network. 

Examples of Layer 2 solutions include Polygon zkEVM, which operates on top of Ethereum, and the Lightning Network for Bitcoin.

Key aspects: Problems solved by L2

• Scalability solution: L1 often faces congestion due to the limited number of transactions carried out per second, leading to slow processing times. L2 handles transactions off-chain, significantly reducing congestion on blockchain, and increasing overall transaction speed.
• Lower costs:  During periods of high demand,  transaction fees can spike, because each transaction requires validation and recording on-chain, L2 solutions reduce the number of on-chain transactions, by only settling the results on the main blockchain and carrying out transactions off-chain, thereby lowering transaction fees.

• Enhanced functionality: Due to foundational architecture of L1, they may not support complex applications or new use cases fully. L2 enables new features and uses cases by adding functionality without altering underlying L1.

Underlying working: Types of L2 Scaling solutions

• Rollups are a Layer 2 scaling solution that bundle multiple transactions into a single transaction. By processing transactions off-chain and sending the data back to the Layer 1 blockchain for consensus, rollups significantly enhance transaction throughput.

• Optimism Rollup: Assume that all transactions are valid (“optimistically”) and bundle them into batches processed off-chain. These batches are then posted to the Ethereum Layer 1 blockchain, where they are verified using a fraud-proof mechanism. If someone suspects that a transaction is invalid, they can challenge it within a specific timeframe. If the challenge is correct, the faulty transaction is rejected, and the party that submitted it may be penalized. eg: OP Mainnet aka Optimism

• Zk-rollups: Similar to Optimistic Rollups, ZK-Rollups bundle multiple transactions and execute them off-chain. However, instead of assuming transactions are valid, they generate a cryptographic proof (known as a Zero-Knowledge Succinct Non-Interactive Argument of Knowledge, or ZK-SNARK) to prove that the transactions are valid. This proof is submitted to the Layer 1 blockchain, which verifies the proof without needing to check each individual transaction, ensuring all off-chain transactions are valid without revealing any transaction details. Eg: ZKsync Era

• State Channels operate off-chain, where multiple transactions between parties are conducted off the main blockchain. The final state of these transactions is recorded and broadcasted to the main network in bulk, reducing the need for each individual transaction to be processed on-chain. Eg: Raiden Network

Side Chains and Plasma are often associated with Layer 2 scaling, but they don’t perfectly fit the traditional L2 concept.

• Sidechains are independent blockchains, like Polygon POS, with their own validators and consensus mechanisms, processing transactions in parallel to the main chain.

 They increase capacity but aren’t strictly Layer 2 as they don’t rely on the main chain’s security. Instead, they connect to Layer 1 via bridges for scaling. Unlike typical Layer 2 solutions, sidechains handle their own security and can also add new functionality, such as enabling smart contracts for blockchains like Bitcoin, functioning separately from Layer 1 while interacting with it.

• Plasmas is a scaling solution proposed by Joseph Poon and Vitalik Buterin. As mentioned in the whitepaper, it involves creating multiple child chains, or “Plasma chains,” that can process transactions independently. 

The idea is to connect chains to the Ethereum mainnet, utilizing smart contracts and Merkle trees for security and consensus. OMG Network (formerly OmiseGO) implements Plasma to facilitate fast and low-cost transactions, particularly for financial services.

It’s classified as L2 because it helps scale the Ethereum network by offloading transactions.While Plasma enhances scalability by offloading transactions, it doesn’t fully fit the Layer 2 definition because it operates as a separate chain and doesn’t rely entirely on the security of the main Ethereum network.

Challenges in L2

Blockchain Forks:

Updating a blockchain to implement scaling solutions can lead to forks, splitting the network into two separate chains (e.g., Bitcoin vs. Bitcoin Cash), which can confuse users and impact the cryptocurrency’s value.

Harder to Verify:

Off-chain transactions processed by Layer 2 solutions lack the public transparency of on-chain transactions, making it more challenging to detect and prevent fraudulent activities (e.g., transactions on side chains are not directly visible on the main blockchain).

Centralization Risks:

Some Layer 2 solutions depend on a limited number of validators, which can concentrate control and reduce network decentralization (e.g., some state channels or rollup systems).

Interoperability:

Layer 2 solutions may not always be compatible with one another or with the main blockchain, complicating asset transfers and cross-network functionality (e.g., limited cross-compatibility between different rollup implementations on Ethereum).

Real-World L2 Use cases

Decentralized Finance (DeFi):

Layer 2 solutions like Optimistic Rollups and zk-Rollups enhance DeFi platforms by handling high transaction volumes and reducing costs. 

Examples include Uniswap and SushiSwap.

Gaming:

Layer 2 technologies enable faster and more secure transactions in gaming, minimizing latency and improving user experience.

Examples include Immutable X and Polygon zkEVM.

Payments:

Layer 2 solutions improve payment processing efficiency, offering faster transactions and lower fees.

Examples include Bitcoin’s Lightning Network and Ethereum’s Arbitrum.

Pros & Cons of Layer 1 Blockchain and Layer 2 Blockchain

Future of L2’s

As Layer 2 solutions continue to advance, we are witnessing significant innovations like native account abstraction on Starknet and emerging hybrid side chain models, like Polygon PoS, combine multiple technologies, leveraging the symbiosis of Plasma Chains, Proof of Stake (PoS), and Sidechains to optimize scalability: Plasma Chains handle bulk transactions off-chain, PoS provides an efficient consensus mechanism, and Sidechains enable parallel processing, together boosting network capacity and performance.

Future developments will closely follow the evolution of Layer 1 networks and new consensus mechanisms such as proof-of-stake, requiring L2 solutions to adapt and integrate seamlessly. The next few years are expected to bring a proliferation of specialized L2 solutions tailored to various applications, potentially positioning L2 networks as the primary layer for user interactions while L1 remains a secure settlement layer. 

Validity proofs such as zk-SNARKs and zk-STARKs are expected to make transactions faster, cheaper, and more private on L2 solutions, significantly improving scalability and privacy.

Layer 3 (L3) solutions are in their nascent stages but are already being explored. L3 is expected to provide more specialized services like privacy-focused transactions, host real world applications and execute tasks.

Conclusion

Payment channels, rollups, and Layer 2 solutions are essential for addressing blockchain scalability, supporting Web3 adoption, and enhancing user experience. As this technology is still developing, it remains unclear which solutions will ultimately be most effective. 

However, scaling is critical for increasing transaction capacity without compromising blockchain security. We at BlockApex are continuously working on innovative solutions within the blockchain, and Layer 2 ecosystems to make Web3 a reality.