Published Feb 17, 2022
By Qredo Team
Layer 2 Blockchains – Taking Crypto to the Next Level
Qredo combines its own Layer 2 blockchain with decentralized multi-party computation (MPC) to provide a radical new infrastructure for digital asset investors.
But what exactly is a Layer 2 blockchain – and why are we predicting their rapid growth in the year ahead?
In this introductory piece, written for people learning about crypto, we unpack what a Layer 2 is, and why they’re so important to the future of blockchain.
The prices of mainstream cryptocurrencies such as BTC and ETH surged to all time highs in 2021, and non-fungible tokens sparked a flurry of innovation and investment — granting the sector more acceptance outside its core historical audience.
But the swift increase in users and transactions brought problems of its own, with the sudden influx of new users and a spike in activity putting strain on the networks' abilities to process and confirm transactions.
The blockchains most familiar and popular with institutions and retail traders, such as Ethereum, deliver on their promise of security and decentralization, with millions of stakeholders involved in the upkeep, mining and trading of assets on the network.
With that, though, comes a cost; namely that, as more and more transactions are sent to the network for verification, the price of sending and receiving that information rises, as the time taken to confirm transactions increases as well.
The blockchain scaling problem
This issue is known as the blockchain scaling problem, or the scalability trilemma: To maintain the secure and decentralized fundamentals of the ledger, it becomes more difficult and costly to process the transactions.
For example, on Ethereum, one of the most popular blockchains used to mint and trade NFTs, gas fees — the cost of making a transaction — have in some instances risen to as high as $1,000 apiece, as the network became overloaded with users seeking to trade and use its computing power.
To address this issue, the industry has developed ‘Layer 2’ solutions, designed as a complementary interface which interacts with the underlying — or ‘Layer 1’ — blockchains to help alleviate some of the issues related to rapid scaling.
But what are Layer 2 solutions and how can they help the crypto market address the scalability problem?
What are Layer 2 Blockchains?
The blockchains most familiar to a wide audience are ‘Layer 1’ protocols, such as Bitcoin, Ethereum, Litecoin or Cardano.
These represent the base layer of the blockchain world, the fundamental infrastructure which allows for cryptoassets to be minted, traded and stored in individual wallets in a decentralized ecosystem.
‘Layer 2’ blockchains are conceived as an extra layer of the network which works on top of platforms like these, but which address the scalability and cost issues commonly found on Layer 1 chains.
There are several types of Layer 2 solution:
● Nested blockchains
A complete second chain which functions as another layer of the existing network while helping to deal with a set portion of transactions from users.
● State Channels
Essentially a two-way channel for communication between two users which summarizes their shared transaction history internally, available only to proscribed participants. The transaction history is then uploaded to the Layer 1 chain once the channel is shut, meaning that only one transaction is sent to the main blockchain, helping to alleviate costs and time taken to confirm trades.
● Sidechains
As the name suggests, a sidechain functions alongside the main blockchain but uses its own consensus mechanism to confirm transactions. A sidechain is connected to the Layer 1 platform with a bridge, and can be used between trusted parties to facilitate repeat trades .
● Plasma and Optimistic Rollups
Both of these solutions operate by moving transactions off the main Layer 1 blockchain onto another form of sidechain, where a trusted party is given authority to ensure the information stored on the network is true. The main difference is that Plasma rollups are used for individual tokens or assets, while Optimistic rollouts operate with smart contracts.
● Zero-Knowledge Rollups
ZK-Rollups address one of the main drawbacks of its Plasma and Optimistic counterparts by doing away with the need for oversight and using zero-knowledge proofs to store and publish information on the main chain.
Why does crypto need Layer 2 blockchains?
Prior to the rapid development of the crypto market in 2021, there were few usable Layer 2 blockchain solutions available.
As demand has grown and the strain on the networks and users have increased, more attention has turned to Layer 2 platforms to help develop the ecosystem and make it easier, cheaper and more secure to transact without high costs and waiting times.
Although geared towards speed and scalability, Layer 2's may also have their own unique selling points. On Bitcoin, for example, Lightning Network is aimed at enabling coffee-sized transactions, while Rootstock seeks to provide sophisticated smart contract functionality.
Others, such as Qredo, enable decentralized custody and settlement across multiple different blockchains.
The best blockchain scaling solution
Several purported solutions have surfaced over the years such as larger block sizes on the Bitcoin Cash chain to help address this issue, but as the market has expanded it is clear that an alternative is required.
With the number of users and transactions set to continue to rise, it is clear that the cryptocurrency industry urgently needs functional Layer 2 solutions which can interact with the fundamental blockchain architecture and provide a more workable user experience at scale.
Several of the most popular use cases for blockchain currently, such as NFTs or gaming, are simply unable to perform effectively with current transaction times and costs.
Using a Layer 2 solution helps to immediately address some of the most challenging issues holding the sector back from growing to serve the millions of users which are interacting with crypto on a daily basis.
Everyone, from high-frequency traders, to gamers and artists will benefit from further adoption of Layer 2 solutions in the years to come.