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Decentralized finance (DeFi) is selling like hotcakes in the crypto world. It has so many advantages over centralized financial systems that it could result in a paradigm shift of customers moving to DeFi.
Ever since Ethereum, one of the biggest crypto coin developers, started producing decentralized applications, people saw its advantages. Gradually, this blooming digital money platform has made its way into the decentralized network.
The Ethereum blockchain runs on miners that process Ethereum transactions, and it produces blocks against a fee.
During its inception, transactions were low. However, today they have skyrocketed. Though a large number of transactions are taking place together, they are now coupled with insufficient disk space in layer 1, which leads to congestion and jamming of networks.
Moreover, the transaction processing speed of Ethereum is currently at 15 transactions per second. This can prevent applications from working at total bandwidth.
Another major issue in the Ethereum ecosystem is the high gas price amid neck-to-neck competition and millions of transactions.
It led to an increase in the cost of trading on decentralized exchanges. This price surge in transaction fees made several people stop trading on Ethereum.
A change was inevitably needed to make completing transactions economically viable again.
Decentralized networks – the trilemma problem
Traders are faced with the blockchain trilemma, having to settle for only two of the three: security, decentralization, and scalability. All these challenges culminated in the introduction and popularity of L2, or layer-2 DeFi networks for cryptocurrencies.
For example, Bitcoin chooses security and decentralization for its customers and ends up compromising on scalability. The problem lies in the fact that you cannot expect to have all three in your system without L2 in DeFi networks.
How are L2 solutions coming to the rescue?
Upgrading Ethereum layer 1 (L1) with Ethereum layer 2 makes all the difference. The presence of a second DeFi layer frees up the L1 in the following ways:
- Takes transactions off the chain
- Offloads the transaction to L2
- Enables interaction of transaction
- Records the remainder of the whole transactions back to L1
This provides the following benefits:
- Higher transaction processing capacity
- Lower gas
- Faster confirmation time
- ZK-rollups: implementation by Loopring, Starkware, Matter Labs zkSync, Aztec 2.0
- Validium: implementation by Starkware, Matter Labs zkPorter
- Plasma: implementation by OMG Network, Matic Network, Gazelle, Leap DAO
- State channels: implementation by Connext, Raiden, Perun
Rise of layer 2
Ethereum layer 2 is an additional layer on the existing layer 1 running on the previous network. It resolves the most crucial problem which users face with just L1: scalability. There had been several rounds of chatter about transaction fees, congestion, processing time, etc. The introduction of L2 solutions resolves these issues.
The following are the L2 propositions for Ethereum:
- Simpler and less expensive fees
- High processing output
- Quicker confirmation
L2 solutions in Ethereum won a lot of mainstream users. An estimation reveals that around 4,000 transactions can be processed in L2 in a second. Most L2 solutions revolve around servers or nodes – validator, operator, sequencer, block producer, etc. In a blockchain, the developers implement these solutions for businesses, users, or a third party.
Main L2 scaling solutions
A payment channel or state channel is a bilateral communication between users, helping them to interact in a blockchain. Lightning Network and Raiden are the commonly used state channels used to execute several microtransactions within a timeframe, broadcast data, decrease transaction fees reasonably and subsequently reduce the on-chain stress.
This is another L2 scaling solution, acting as an alternative to transferring tokens to the sidechain to complete the transactions. This technique is implemented at scale in the Matic Network. This helps to enhance efficiency and reduce congestion – all without interfering with the protocol of the main chain.
Again, one of the rising scaling solutions is being implemented with ZK proofs. These are used to record and confirm ownership of a piece of detailed information without revealing the actual data. It is pretty similar to Plasma. However, it bundles hundreds of transactions and processes them more efficiently.
Plasma is like a collection of child chains, which are similar to side chains but lack the capacity to do complex operations to increase security and keep the funds safe. Instead, it is a non-P2P, proof-of-authority network that employs a single-tiered construction, which means that it or its child chains don’t serve as a parent of any chain.
Is Polygon the savior?
Polygon, a rising star in India and among the world’s top crypto tokens, is another scaling and interoperable framework for blockchain.
It transforms the old Ethereum network into a full-fledged, multi-chain system without any advantages of Ethereum, such as security and the ever-growing ecosystem. The most significant advantage of Polygon is that it is built to scale and has many potential use cases, such as interoperability to link the Ethereum network to other Ethereum-compliant networks.
In its initial success, Polygon has already hit a high of 7.4 million transactions in a day, higher than giants such as Ethereum.
Polygon also allows developers to tailor specific characteristics of their blockchain networks, which helps them fine-tune certain restrictions and limitations.
L1 vs. L2: What’s the ultimate difference?
In the decentralized world, a layer-1 network refers to a blockchain such as Bitcoin, Ethereum, etc. At the same time, a layer-2 protocol is a third-party integration added on top of a layer-1 blockchain to make it more efficient and scalable.
Even though the L1 solutions were made to decentralize P2P transactions, they ultimately failed to solve the trilemma problem, and here’s where the L2 solutions come into the picture.
The main difference between these two is that L1 solutions are more secure and prefer to keep the network decentralized.
On the other hand, L2 remains focused on confirmation time, transaction speed, and lower gas fees by handling all the burdens of the main blockchain. Since it is a third-party integration, it comes with a slight trade-off in terms of L1 security and decentralization.
While it may seem as if these two solutions were competing against each other, the opposite is true. L1 and L2 are two sides of the same coin, designed to co-exist and improve the blockchain networks.
L2 helps to remove barriers of L1 and enable it to reach its full potential and show its real raw power. There are many L2 solutions; each one comes with its pros and cons.
On the other hand, Ethereum 2.0 is also underway, which only means that once it is up and running, the days of L2 solutions may come to an end as ETH 2.0 solves most of the hurdles of L1.
Till that day comes, we can only speculate.
Harsimran Kaur carries over seven years of experience in digital marketing, Bitcoin and fintech. She is also an author of various blogs on digital marketing and advanced technologies, including blockchain. She has a very good grasp on blockchain technologies like the Ethereum network (everything from DApps to smart contracts and the Ethereum Virtual Machine), the Bitcoin network, DeFi, yield farming, and almost any other network that is similar.
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