Layer-1 and Layer-2 Blockchain – The Difference

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Introduction

Blockchain technology has grown rapidly since Satoshi Nakamoto brought Bitcoin to the world’s attention. Since then, in the race to fulfill every requirement of decentralized products like DeFi and Dex, blockchains, especially layer 1 blockchains, have had to adapt and scale as much as possible. An increase in scalability also means risks to the chain’s integrity and security, which means that the developers must make the blockchain scalable while also maintaining the network’s security. Note, blockchain was introduced focusing only on decentralization and security that led to its self-imposed scalability limits like smaller block sizes and low block production rates.

What is Blockchain Layer 1?

Layer 1 protocols are simple additions to the existing base layer of a blockchain. Some prominent examples are Ethereum and Bitcoin, where the layer 1 protocols have been experimenting with its protocols to adapt and scale primarily by increasing the data storing capacity of each block (block size) along with the block rate to improve throughput/transaction speed. Limiting throughput eventually results in network congestion. In order to decongest, the networks would need individual nodes to be equipped with high hardware and software requirements. At that point, only limited people can afford to run a node. When network congestion results in higher costs to operate a node coupled with the high demand for limited block space, nodes prioritize transactions in order of highest fees paid instead of processing transactions in the order they were received inevitably driving up the average transaction fees for users.

More modern L1 blockchain networks (especially those that are live since 2021) are now working on their protocols to be both scalable, fast and lower the transaction fees for users. Blockchains like Shardeum are using mechanisms like sharding to significantly improve the scalability and maintain low fees even as the usage grows. Sharding, in particular, involves breaking up the L1 chain into smaller chains called shards, each capable of independently processing transactions and smart contracts. These shards can operate in parallel, increasing the throughput of the blockchain network instantly. Importantly many of the latest blockchains are not only working towards improving scalability and low costs but also maintain high security and decentralization – the two attributes blockchain networks are known for.

What is Blockchain Layer 2?

Increased scalability and speed paves way for greater adoption even though L1 platforms will need some more time to solve the blockchain trilemma – where it can maintain high security, decentralization and scalability – all at the same time. But once Ethereum took the Bitcoin’s innovation to a whole new league by introducing smart contracts and enabling blockchain technology to be used by multiple industries such as finance, art, governance since 2016, the need for layer 2 scalable solutions arose overnight. Public blockchains, who were only fulfilling the job of decentralized payment processors and peer-to-peer transfer of value thus far, suddenly saw the volume of user transactions grow rapidly which they weren’t prepared for at all.

How Do Layer 1 Scaling Solutions Work?

The two commonly accepted solutions (albeit not without tradeoffs) on layer 1 are improvements to the consensus protocol and sharding. 

1. Consensus Protocol Improvements

Adjusting consensus protocol that includes how transactions are ordered and processed, could lead to higher scalability. Proof of Stake, for instance, may be seen as less secure than Proof of Work. At the same time, it is widely accepted that Proof of Stake is secure enough for public blockchains while being more environment friendly so much so that this sentiment is reflected in Ethereum’s recent merge, where the network shifted from a PoW consensus to a PoS mechanism. However what is crucial here is – the acceptance of the community behind a project when it comes to a very complex and serious task of adjusting existing consensus mechanism or even migrating to a new one.

2. Sharding 

Another solution that’s gained a lot of traction in recent days is sharding. Sharding enables the network to be partitioned into smaller pieces, allowing for a more parallel transaction processing. This in turn helps to scale the network during high demand while retaining low gas fees and fast finality. 

Networks like Shardeum use Proof of Quorum consensus algorithm, along with Proof of stake to ensure the highest levels of scalability without having to sacrifice security and decentralization. 

3. Modifying Block Size and Rate

While this approach is less common in public blockchains, which prioritize security and decentralization, the practice of adjusting block size and block production rate is notably popular among private chains. In networks like Bitcoin and Ethereum, the block size is deliberately kept smaller and the block production rate longer compared to private blockchains. This design strategy helps maintain network security and reduces the risk of centralization. Although larger block sizes can increase network throughput by accommodating more transactions per block, this typically comes at the expense of decentralization.

Private blockchains, often designed to serve specific organizational needs, prioritize efficiency and scalability over decentralization. By adjusting their block sizes and production rates, these networks can optimize for higher transaction throughput and faster confirmation times, catering to business processes that require quick and reliable transaction handling. This flexibility allows private chains to be tailored to the unique demands of both enterprise and retail environments, where performance metrics such as speed and capacity are critical. Most stablecoin projects operating today are examples of private blockchains.

How Do Layer 2 Scaling Solutions Work? 

As mentioned earlier, Layer 2 solutions use another layer of blockchain on top of the current layer to ensure that the load is taken off the mainnet. Blockchain networks like Polygon allow for smart contracts of the network to be validated in the Ethereum network, with the final results being pushed out to the mainnet over time to ensure the same levels of security, and decentralization with increased scalability. 

1. Rollups 

Rollups basically bundle up several transactions on the layer-2 blockchains and submit them to the mainnet. Validity proofs are utilized to ensure the integrity of the transactions, not to mention the fact that the assets continue to exist on the mainnet. 

2. Sidechains 

These are independent blockchains with their own validators. Even though the mainnet plays no role in validating the transactions, this is still one of the most secure layer-2 chains, due to the chains containing its own validators. 

3. State Channels 

State channels are typically two-way communication environments between the two parties. The parties then seal off a part of the blockchain and connect it to a new, off-chain transaction channel. Usually done via an agreed-upon smart contract, the parties execute the transactions off-chain, and only the final state of the transaction is submitted to the main chain. Popular examples of this method include bitcoin Lightning Network and Ethereum’s Raiden operate based on state channels.

4. Nested Blockchains 

Nested blockchains are multiple secondary blockchains that exist on top of the main chain. The rules and regulations are entirely dependent on the parent chain. However, the main chain is not involved in the participation of the transactions, and the routine transactions are delegated to the nested blockchains. 

Importance of Blockchain Layers

The importance of blockchain layers arises from the simple fact that blockchain technology needs to keep up with the world while it expands its utilities and adoption at a massive scale. Blockchain’s multi-layered structure underpins its transformative potential. Together, they can address the inherent shortcomings of layer 1 blockchains such as scalability and privacy to a certain extent, at least till a L1 platform solves the scalability trilemma at the root or base protocol layer. And together, they have been to handle the decentralized market fairly by supporting decentralized applications (dapps) and smart contracts, translating the tech’s power into real-world utilities like decentralized finance (DeFi). Collectively, these layers intertwine, balancing robust security with innovation, showcasing blockchain’s vast applicability across industries.

What is the Blockchain Scalability Problem?

Consider this – the Visa network processes transactions at a speed of more than 24,000 transactions per second. In contrast, blockchains like Bitcoin and Ethereum can process a maximum of 15 TPS. Even the recent blockchains process an average of 400 TPS (max) in practice. As mentioned previously, this is down to public blockchain’s indispensable requirement to prioritize security and decentralization (note Bitcoin was innovated in the aftermath of 2008 financial crisis where the history repeated when legacy centralized entities abused their power and people’s resources to cause widespread market downturn).

Note, the throughput of a blockchain network, or any network for that matter, directly impacts its scalability. If the speed or throughput of processing transactions is low, it means the blockchain can handle fewer transactions per second (TPS). This limitation becomes evident especially when there’s a surge in user activity, leading to congestion, delayed transactions, and higher fees. Therefore, to achieve broader adoption and handle large-scale applications, enhancing the speed and throughput is crucial to improve blockchain scalability.

What’s next after Layer 1 and Layer 2 blockchains?

Learning about the limitations of these two layers directs the blockchain technology towards future improvements. In fact, there are more on-chain and off-chain layers atop the base layer. Technology finesse is a step by step process. Experts, though, widely believe that solving the blockchain trilemma at the root level will be the most ideal. Applications and solutions developed on top of Layer 1 are intrinsically tied to its foundational architecture and principles. This means that their core features, functionalities, and advantages are often a direct result of the Layer 1 blockchain’s capabilities. They, further serve as the bedrock, establishing standardized protocols that allow diverse applications and even other chains to communicate and share data seamlessly.

While Layer 1 chains are predominantly permissionless, granting the freedom for anyone to create tailored solutions and applications without needing external consent, it’s pivotal to recognize the diverse scenarios coexisting within our societal framework. Blockchains inherently advocate inclusivity. Entities like defense agencies or private corporations often deal with delicate transactions and operations. Such organizations can benefit from the capabilities of L1, utilizing advanced tools like zero-knowledge proofs to maintain discretion.

Although current L1s have areas for improvement, numerous private entities have harnessed blockchain through distinct private and consortium L1 chains, which prioritize adaptability over absolute decentralization. As they modify this technology to fit specific requirements, the emergence of a highly scalable, cost-effective public L1 chain would further empower these entities to innovate and refine their offerings seamlessly. You could imagine a layer 3 or layer 4 evolving that will work on improving the interoperability, easier application development frameworks, breakthrough off-chain storage systems compared to existing systems today.

Frequently Asked Questions (FAQs)

1. What is the Difference Between a Layer 1 and Layer 2 Blockchain?

Layer 1 blockchains are the main blockchains that serve as the foundation of a blockchain network. They handle the core functionalities of a blockchain, such as transaction processing, consensus, and smart contract execution. Examples of layer 1 blockchains include Bitcoin, Ethereum, and Shardeum. Layer 2 blockchains, on the other hand, are built on top of layer 1 blockchains and provide add-on features and functionality. Layer 2 solutions are designed to moderately alleviate the limitations of layer 1 blockchains in terms of transaction throughput, transaction fees, and processing times. They can include technologies such as state channels, rollups, and sidechains. Example of such networks include Polygon, Arbitrum, Lightning Network.

2. What is a Layer 1 Blockchain Example?

An example of a layer 1 blockchain is Ethereum, a widely used blockchain platform for decentralized applications (dapps) and smart contracts. Ethereum is a layer 1 blockchain because it operates as the primary blockchain that processes transactions, executes smart contracts, and maintains its own consensus mechanism. Ethereum has its native cryptocurrency, Ether (ETH), which fuels transactions and smart contracts on the platform.

3. What is a Layer 2 Blockchain Example?

An example of a layer 2 blockchain is the Lightning Network, a layer 2 solution built on the Bitcoin blockchain. The Lightning Network is designed to enable faster and cheaper bitcoin transactions by creating off-chain payment channels between users. Transactions can be conducted relatively quickly and with lower fees than on-chain bitcoin transactions. The Lightning Network operates as a layer 2 solution because it relies on the Bitcoin blockchain as the base layer for security and final settlement while processing most transactions off-chain within the Lightning Network’s payment channels.