Layer 1 and Layer 2

Layer 1 is the term used to describe the underlying main blockchain architecture. Layer 2, on the other hand, is an overlapping network that sits on top of the underlying blockchain.

Think Bitcoin and the Lightning Network. Bitcoin is Layer 1 network while Lightning Network is Layer 2.

Now that we know the key difference, let's look at the Layer 1 and Layer 2 solutions that companies are currently working on. We'll start with Layer 2 solutions.

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Layer 2 Solutions

Let's look at the Layer 2 solutions below:

Status Channels

The status channel is a two-way communication channel between participants that allows them to conduct interactions that typically occur on the blockchain outside of the blockchain.

Doing this helps you cut down on waiting time as you are no longer dependent on a third party like a miner. The status channel works like this:

  • Part of the blockchain is closed by a multi-signature or some kind of smart contract that is pre-agreed by the participants.
  • Participants can interact directly with each other without sending anything to the miners.
    When the entire set of transactions is finished, the final state of the channel is added to the blockchain.
    Bitcoin's Lightning Network and Ethereum's Raiden Network are the two most popular state channel solutions. Both of these use Hashed Timelock Contracts (HTLCs) to execute status channels.

Lightning Network will allow participants to execute a large number of microtransactions in a limited time, while Raiden will also enable participants to execute smart contracts through their own channels.

Nested Blockchains

Currently, OmiseGO, an Ethereum-based dApp, is working on a nested blockchain solution called Plasma. The design principle of Plasma is quite simple:

  • The main blockchain sets the ground rules for this entire system. He is not directly involved in any operation unless he needs to resolve some disputes.
  • There will be multiple blockchains sitting on top of the main chain. These levels will be linked together to form a parent-child chain link. The main chain delegates work across its child chains. Child chains then execute these actions and send the result back to the main chain.
  • This solution not only significantly reduces the load on the root chain, but also exponentially increases scalability if executed properly.

Pros of Layer 2 Solutions

The biggest plus is that it doesn't mess with the underlying blockchain protocol.
To be able to perform multiple micro-transactions without wasting time and paying unnecessary transaction fees with miner verification with status channels and especially Layer 2 solutions such as Lightning Network.

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Layer 1 Solutions

Finally, we have Layer 1 solutions. What this essentially means is to improve the underlying protocol itself to make the overall system more scalable. The two most common Layer 1 solutions are:

  • Consensus protocol changes
  • Sharing
  • Consensus Protocol Changes
  • Many projects like Ethereum are moving from older, more complex consensus protocols like Proof-of-Work (PoW) to faster and less wasteful protocols like Proof-of-Stake (PoS).
  • Bitcoin and Ethereum use PoW, where miners solve cryptographically difficult equations using their computational power. While PoW is pretty safe, the problem is that it can be very slow. While Bitcoin can only manage 7 transactions per second, Ethereum can only manage 15-20 transactions per second on a good day. This is why Ethereum wants to switch from PoW to PoS.

Sharing

Shredding, or Sharding, is one of the most popular Layer 1 scalability methods that multiple projects are currently working on.

Rather than having a network run sequentially in each transaction, sharding divides these sets of transactions into small datasets called "shards". These parts can then be processed in parallel by the network.

Pros of Layer 1 Solutions

The biggest advantage of Layer 1 solutions is that there is no need to add anything on top of the existing architecture.

But it's still not without problems, which brings us to the next section.

Biggest Problems of Layer 1 and Layer 2 Solutions

There are two major problems with Layer 1 and Layer 2 scalability solutions.

First, we have a big problem with adding these solutions to already existing protocols. Ethereum and Bitcoin both have a market capitalization of billions of dollars. Millions of dollars are traded every day using these two cryptocurrencies. Therefore, it does not make sense to add unnecessary codes and complications to try these protocols and play with a lot of money.

Second, even if you build a protocol from scratch with these techniques built in, they may not be able to resolve the scalability dilemma.

The term scalability dilemma was first coined by Ethereum founder Vitalik Buterin. It is a trade-off that blockchain projects must make when deciding how to optimize their architecture, balancing decentralization, security, and scalability. E.g. Bitcoin wants to optimize security and decentralization, so they compromise on scalability.

So, What's the Solution?

The solution is to build a protocol from scratch with these built-in solutions. Also, this protocol should be able to resolve the scalability dilemma. Turing award winner Silvio Micali is building a project called Algorand that attempts to do just that. Algorand uses a consensus protocol called Pure Proof of Stake (PPoS).

Here's how PPoS works:

  • The leader and selected validators are selected from each step of the Byzantine Treaty.
    The computational cost incurred by a single user only includes generating and verifying signatures and simple counting.
    The cost does not depend on the number of users selected for each block. This number is fixed and is not affected by the size of the entire network.
  • The increased computing power directly improves performance, making Algorand perfectly scalable. This means that as the network grows in size, it maintains a high transaction rate without incurring extra costs.
    As a result;
  • Scalability is the biggest issue hindering the mainstream adoption of cryptocurrencies.

To make sure that cryptocurrencies are scalable and fast enough for day-to-day transactions, we need protocols built specifically to solve this problem.

This is why projects like Algorand are critical and we can only hope that other projects follow suit and provide a viable solution.