Layer 2 crypto protocols are a category of blockchain protocols that operate alongside, or "on top of," existing Layer 1 protocols such as Bitcoin and Ethereum.
The goal of Layer 2 protocols is to enhance the efficiency, speed, and scalability of Layer 1 blockchains by offloading some of the transaction processing to secondary networks, while still maintaining the security and integrity of the underlying Layer 1 blockchain.
Layer 2 protocols are different from Layer 1 protocols in that layer 1 protocols are designed to handle all the transactions on the blockchain, from basic transfers of cryptocurrency to the execution of smart contracts. This means that the Layer 1 blockchain must be able to process a large number of transactions in real-time, which can lead to congestion and high fees. Layer 2 protocols, on the other hand, are designed to handle a smaller subset of transactions, typically low-value transactions or those that require quick settlement times. This allows Layer 2 protocols to operate more efficiently and at a lower cost than Layer 1 protocols.
The importance of Layer 2 protocols lies in their ability to improve the scalability and transaction speed of Layer 1 blockchains, while still maintaining the security and decentralization that makes blockchain technology so valuable.
By offloading some of the transaction processing to secondary networks, Layer 2 protocols can reduce the burden on Layer 1 blockchains, leading to faster and cheaper transactions for users. Additionally, Layer 2 protocols can enable new use cases for blockchain technology, such as microtransactions and high-frequency trading, which would not be feasible on Layer 1 blockchains.
There are several different types of Layer 2 protocols, each with its own approach to offloading transaction processing from the Layer 1 blockchain. Here are some of those:
State Channels (Payment Channels)
In a state channel, two parties deposit cryptocurrency into a smart contract on the Layer 1 blockchain and then open a connection between themselves on a Layer 2 network. Transactions are processed on the Layer 2 network, and only the final state of the transaction is recorded on the Layer 1 blockchain. This allows for fast, cheap transactions between parties without the need for every transaction to be recorded on the Layer 1 blockchain.
Plasma is a framework for building Layer 2 chains on Ethereum. In a Plasma chain, a compressed representation of each block is committed to a smart contract on the Ethereum blockchain at regular intervals. This allows for faster, cheaper transactions on the Plasma chain, while still maintaining the security of the underlying Ethereum blockchain.
Rollup chains accumulate and settle transactions on a Layer 2 network. At regular intervals, a summary of the transactions is "rolled up" and posted on the main Layer 1 blockchain. There are two types of Rollup chains: Optimistic Rollups, which assume that all participants are honest but allow for transactions to be disputed if necessary, and Zero-Knowledge Rollups, which provide cryptographic proof of transactions without revealing every detail.
Sidechains are separate blockchains that are interoperable with the main Layer 1 blockchain. They allow for faster, cheaper transactions by offloading some of the transaction processing to the sidechain, while still maintaining the security and decentralization of the main blockchain. Sidechains have their own consensus method for adding blocks and require a sufficient number of validators to ensure the security of the network.
Bridges are connections between different blockchains that allow for interoperability and the transfer of assets between them. They are often used to connect Layer 1 and Layer 2 blockchains, allowing for faster, cheaper transactions on the Layer 2 network while still maintaining the security and integrity of the Layer
The top five L2 crypto coins by market cap as of March 2023 are:
Polygon is a Layer 2 scaling solution for Ethereum that aims to make transactions faster and cheaper. It operates as a network of side chains connected to Ethereum, allowing for greater scalability without compromising on security. Polygon also supports multiple popular wallets, DeFi protocols, and exchanges. It has gained significant popularity in recent times, with a growing number of projects migrating to its network.
Optimism is a Layer 2 scaling solution built on Ethereum that uses optimistic rollups to scale the network. It allows for fast and cheap transactions without compromising on security. Optimism also supports smart contracts, which is a major advantage over other scaling solutions. It is considered to be one of the most promising Layer 2 solutions in the crypto space.
Arbitrum is another Layer 2 scaling solution built on Ethereum that uses optimistic rollups. It aims to provide a simple and secure way for developers to build dApps on Ethereum, while also offering fast and low-cost transactions. Arbitrum also supports smart contracts and is compatible with Ethereum, which makes it easier for developers to build and deploy their projects.
zkSync is a Layer 2 scaling solution built on Ethereum that uses zero-knowledge proofs (zk-proofs) to achieve scalability. It allows for fast and cheap transactions without compromising on security, and also supports smart contracts. zkSync is designed to be developer-friendly and can be easily integrated with existing Ethereum dApps.
Hermez is a Layer 2 scaling solution for Ethereum that uses zk-rollups to achieve scalability. It aims to provide low-cost and fast transactions, while also maintaining high security standards. Hermez is focused on supporting payments and token transfers, making it a great option for projects that require fast and efficient transactions. It also offers a user-friendly interface, making it easier for users to interact with dApps built on its network.
As more people use blockchain networks, the demand for faster and cheaper transactions will continue to grow. Layer 2 protocols offer a way to address these challenges without compromising the security and decentralization of the main chain.
As a result, Layer 2 protocols are a crucial part of the blockchain ecosystem, offering new solutions to improve the scalability of blockchain. As the technology continues to evolve, we can expect to see new Layer 2 solutions emerge, driving innovation in the crypto space.