Demand for the Ethereum network is increasing from year to year, the main growth driver being the DeFi sector and the NFT boom that occurred this year. To meet the demand of millions of users, Ethereum must offer fast, low-cost transactions. Against the background of these needs, an ecosystem of Layer 2 solutions is evolving around Ethereum, opening up various opportunities for Ethereum’s expansion.
Why does Ethereum need L2 technology?
Many cryptocurrency users have already heard of the blockchain trilemma, also called the scalability trilemma. This is where the three main qualities people look for in Distributed Ledger Technologies (DLT) can work against each other. Improving two qualities only occurs by sacrificing the third quality.
- Decentralization;
- Safety;
- Scalability.
The Ethereum blockchain is characterized by reliable security and true decentralization, but achieving scalability remains the primary challenge. To address the scalability issue, Ethereum developers are introducing Ethereum 2.0. Its Proof of Stake consensus mechanism is set to dramatically increase transaction throughput at a basic level. At the moment, a gradual transition of the Ethereum 1.0 blockchain to Ethereum 2.0 is underway; however, a complete transition should not be expected until 2022.
This does not mean that the transition to Ethereum 2.0 will not need Layer 2’s. Ethereum will still need L2 solutions to process hundreds of thousands or even millions of transactions per second in the future. Back in 2020, Ethereum co-founder Vitalik Buterin admitted that he didn’t expect a quick solution to the scalability problem. He urged developers to focus on Layer 2 solutions that reduce network load and increase transaction speed.
Why is Ethereum scalability important?
Scalability is one of the reasons why mass adoption of cryptocurrencies in the blockchain industry is currently impossible. As the demand for cryptocurrency grows, the need to scale blockchain protocols will also intensify. In essence, the term blockchain scalability describes the ability of a system to constantly maintain stability and performance, regardless of the total number of users.
Ethereum’s scalability has been one of the most talked-about topics since the network’s launch. The scaling debate always flares up after a period of great network congestion. One of the first cases of network congestion was the bull market in 2017. At that time, transactions related to CryptoKitties congested the entire Ethereum network, which led to a significant increase in gas fees. In 2020-2021, network congestion intensified again due to DeFi development, yield farming, and the NFT boom.
There are two main ways that can be used to solve the Ethereum scalability problem:
- On-chain scalability. The blockchains Cardano, Cosmos, Solana, and Ethereum 2.0 offer such solutions; however, pending the complete transition of Ethereum to its new blockchain, other methods are required.
- Layer 2 solutions. The purpose of their integration is to expand the functionality of L1 technology by processing transactions outside the mainnet.
L1 vs. L2 solutions
Layer 1 is the blockchain, where all transactions are currently completed. Layer 2 is another layer built on top of the Layer 1 blockchain. Here are some of the critical characteristics of L2:
- Layer 2 does not require any changes at L1;
- It can be built on top of Layer 1 using its existing elements, such as smart contracts.
- Layer 2 takes over some transactional load, effectively offloading the system.
The Ethereum blockchain can currently handle between 15-45 transactions per second. Level 2 scaling can significantly increase the number of transactions; up to several thousand transactions per second, depending on the solution.
L2 scaling solutions for Ethereum
To improve Ethereum throughput, developers implement L2 scaling solutions on top of L1. Let’s find out more about how L2 scaling solutions work.
- State channels. These are Layer 2 scaling solutions for conducting multiple transactions between users outside the mainnet. The Ethereum blockchain processes only the initial and final state of transactions in the channel established between users. This method significantly reduces the load on L1; channels can process thousands of operations per second, providing a high level of system security.
- Plasma is a separate blockchain anchored to the main chain using smart contracts and Merkle Trees. The technology allows you to create unlimited copies of the main blockchain.
They offload Ethereum, opening up the possibility of fast and inexpensive transactions. The main disadvantage of this solution is the fact that funds take a long time to withdraw.
- Sidechains are independent blockchains that run parallel with the mainnet and are tied to Ethereum L1 via a two-way bridge. If a security breach occurs on the sidechain, it does not affect the main blockchain and other sidechains. Interoperability with the Ethereum network is provided by Ethereum Virtual Machine (EVM) support. It must be noted that the throughput of sidechains can reach 10,000 TPS, but at the expense of security and decentralization.
- Rollups are Layer 2 scaling solutions that reduce the load on the network by performing transactions outside of Ethereum on sidechains. The mainnet only records data about completed transactions. There are two main types of Rollups with different security models: Zero-knowledge rollups and Optimistic rollups.
- Zero-knowledge rollups, also known as ZK-Rollups, run off-chain computations and send the validity proof to the chain.
- With Optimistic rollups, all transactions are valid by default until proven otherwise if a problem occurs. This security model is called fraud proof. In addition, Optimistic rollups operate based on an EVM-compatible virtual machine (OVM – Optimistic Virtual Machine), which interacts with existing Ethereum smart contracts. The implementation of Optimistic rollups can stimulate the growth of the DeFi sector at the current stage of development due to this option.
- Zero-knowledge rollups, also known as ZK-Rollups, run off-chain computations and send the validity proof to the chain.
- Validium’s solution uses validity proofs, just like ZK-rollups, but the data is not stored on the main Ethereum network. Validium chains work in parallel, allowing the network throughput to reach 10,000 TPS.
L2 projects to follow
Various projects have stepped up efforts to create L2 scaling solutions. The current dynamic of the DeFi sector development requires faster and less costly alternatives to deploy. L2 projects are designed to reduce transaction fees and reduce the load on the main Ethereum blockchain, on which most of the dApps are built. Let’s take a look at a few notable L2 projects.
Arbitrum
The Arbitrum Layer 2 scaling solution was launched in 2021 by Offchain Labs and is gaining popularity. The platform is designed to provide high throughput, enabling developers to deploy and operate smart contracts at a low cost while maintaining security.
The main advantages of the project are the compatibility of Optimistic rollups with the EVM. This means that Layer 1 dApps can easily integrate Arbitrum’s L2 technology. Another plus is the high network throughput and low transaction costs, with low requirements for computing resources and security guarantees provided by the main Ethereum network. Finally, an essential difference between Arbitrum and most other L2 projects is the absence of its utility token. Instead, Arbitrum’s main network uses ETH to pay fees.
The Arbitrum has integrated with major DeFi projects such as Uniswap, SushiSwap, Curve, and 1inch. The project website has a complete list of DeFi services integrated with Arbitrum. The DeFi Llama portal has about 50 DeFi projects based on Arbitrum’s L2 solution; its TVL is around $1.9B.
Polygon Hermez
The main L2 network Polygon (previously Matic Network) launched in 2020, and in 2021 acquired the Hermez Network, an Ethereum scaling solution based on ZK-Rollups.
The main advantages of the project are the fast speed of transactions and low transaction fees. In addition, other solutions are deployed in the Polygon ecosystem, such as Polygon Commit Chain, Polygon SDK, Polygon Avail, which will help ensure smooth communication between various decentralized products, and services and eliminate the problem of blockchain interoperability.
In addition to integrating ZK-Rollups, Polygon plans to implement Optimistic Rollups and Validum Chains security models.
Many DeFi services choose Polygon, and new projects are constantly added. According to DeFi Llama, its TVL is currently $5.52B.
Layer 2’s are here to stay
With the Ethereum blockchain transitioning to Ethereum 2.0 in the upcoming year, there will be significant changes in the network. We hope to see a solution to the scalability problem, increase throughput, and reduce transaction fees; however, this is just the beginning, as developers will need to make changes at the protocol level, achieve sustainability, and run user experience testing. While Ethereum’s scalability solutions are under development, Layer 2 projects will also continue to evolve and may become permanent solutions.
Layer 2 technologies make DeFi sector applications more user-friendly, which is essential if DeFi comes to be used alongside traditional financial services. With decentralized apps offering greater functionality, users can transfer assets quickly while keeping costs down thanks to L2 scalability solutions. Experts from INC4, with experience in over 90+ blockchain projects, can build smart contracts, decentralized exchanges, wallets, and dApps. Contact us if you have a Layer 2 solution or any other DeFi project you wish to develop or improve—we’ll get to work with speed and professionalism.
