As the adoption of blockchain technology grows, the need for faster, scalable networks is increasing. At every bull market cycle, millions of new users flock to the crypto markets, for various reasons. Some wish to make a quick profit by using various trading strategies. Others are in it for the long run and are looking for a viable alternative to the current financial system.

In either case, blockchain networks are struggling to retain two of their most coveted advantages: high speeds and low-cost transactions. The increasing number of users ramps up the network requirements significantly, resulting in slow and costly operations.

Consequently, the Layer 1 vs Layer 2 debate has become progressively relevant nowadays. In this article, we take a closer look at Layer 1 vs Layer 2 scaling solutions and their pros and cons. We provide you with a comprehensive guide on their functionality and different versions. Finally, our list of the best Layer 1 vs Layer 2 protocols should give you a good overview of the main actors in this space.

Let’s begin with an introduction to scalability and why it’s important in this narrative.

A short introduction to blockchain scalability

Scalability in blockchain technology has been a hot topic since day one. In theory, blockchains are designed to be global, decentralized networks. Meanwhile, they are supposed to conserve their three key characteristics:

  • Decentralization – this is the main principle of blockchain technology. The decentralized ledger implies that there’s no single entity that can control the network. Instead, every change needs to be reached with a proper consensus of all the participants of the network.
  • Security – because there’s no single point of failure, blockchains are inherently secure. And of course, the more decentralized they are, the more secure they become.
  • Scalability – scalability implies that the blockchain can support a high number of transactions and future growth. This should be possible without it impeding its speed and operational costs.

However, the reality is quite different. Shortly after its release, many realized that the intended use case of the Bitcoin network was just a pipe dream. The proof of work (PoW) consensus mechanism used by Bitcoin scales poorly. As more users join in, the network executes transactions much slower. As a result, instead of becoming a global payment network for day-to-day transactions, Bitcoin has shifted towards becoming a store of value asset.

This issue has given birth to the blockchain trilemma. This implies that blockchains aren’t able to fulfill their three key characteristics simultaneously. For example, the Bitcoin and Ethereum blockchains need to compromise on scalability to be able to remain decentralized and secure.

Consequently, blockchain developers have been seeking various solutions to solve this issue. The space saw the emergence of Layer 1 vs Layer 2 solutions. Both attempt to avoid compromise on any of the three main features of blockchain technology.

Differentiating Layer 1 vs Layer 2

To better understand the different scaling solutions in this Layer 1 vs Layer 2 article, let’s clearly define both terms.

  • Layer 1 – In blockchain jargon, Layer 1 refers to the main blockchain architecture. This means that blockchains such as Bitcoin, Ethereum, and Cardano are all Layer 1 blockchains. The scaling of the blockchain directly depends on the code of the initial blockchain and its consensus mechanism.
  • Layer 2 – these are third-party solutions that are implemented to work in pair with the initial Layer 1 protocols. Their main goal is to improve the scalability of the underlying blockchain. They can also add additional features, such as smart contract capability, or improve upon their functionalities.

It’s worth noting that Layer 1 cryptocurrencies do not exclusively rely on Layer 2 solutions for scaling. There are two major protocol improvements that developers are using to speed up transactions on Layer 1 blockchains, without using third-party solutions.

Most popular Layer 1 cryptocurrencies scaling solutions

Older PoW blockchains would need to be reworked from the ground up to be able to provide a viable improvement. This could put the integrity of the network in jeopardy, and decrease its value and utility considerably.

Consequently, reaching a proper consensus over such network upgrades is challenging to say the least. The controversy over the block size of the Bitcoin blockchain has caused hard forks in the network. This resulted in even less-ideal solutions such as Bitcoin Cash and Bitcoin SV.

However, this doesn’t mean that such improvements are impossible, as you can see below.

Layer 1 protocols improvements

The original PoW consensus mechanism used by Bitcoin and Ethereum (among many others) has shown its limitations over the years. The rise of DeFi and the importance of the Ethereum blockchain in this ecosystem added a huge strain on the network, causing bottlenecks and skyrocketing gas fees.

Consequently, many newer networks are favoring the more energy-efficient proof-of-stake (PoS) consensus mechanism over PoW. These blockchains don’t rely on miners to execute the transactions. Instead, they require users to stake funds on the blockchain to secure it from 51% attacks.

For instance, developers have built Cardano and Solana around PoS to provide better scaling for mass usage from the get-go. Turing award winner Silvio Micali created the Algorand blockchain, which specifically attempts to solve the scalability trilemma through the modified Pure Proof of Stake. In Algorand’s case, the computation requirements of the network’s transactions are independent of its size.

Even Ethereum is currently undergoing a full shift towards PoS.

This upgrade, called Ethereum 2.0, is the next big step that should improve the scalability of the network. The switch to PoS is supposed to play on all of the three aforementioned characteristics; it improves decentralization, which in turn, heightens security and increases the capacity of the network to make it more scalable.

To achieve this, Ethereum will rely on an additional scaling solution, called sharding.

Sharding

Sharding is quickly becoming one of the most popular Layer 1 scaling solutions available. This process implies the partitioning of the blockchain, into smaller, more manageable databases, which are called shards.

In this occurrence, the nodes don’t have to compute the entire blockchain at once, just its relevant parts. The shards process data simultaneously, which increases the throughput of the entire blockchain by reducing bottlenecks.

The beacon (main) chain randomly attributes different computational tasks to the nodes, increasing decentralization and impartiality. In addition to Ethereum implementing sharding in its 2.0 iteration, other popular blockchains actively rely on this method, including Zilliqa and Tezos.

What are Layer 2 cryptocurrencies?

As we briefly mentioned, Layer 2 protocols are third-party software solutions that run on top of blockchains and improve their scalability. In this case, a portion of the work that is usually executed in the Layer 1 is shifted to another protocol, in order to alleviate the strain on the main blockchain.

Nodes process the data off-chain and report the results to the main chain in batches. Once the computation is complete, the Layer 1 blockchain records the transaction, ensuring that it benefits from the same security as other transactions on its network. The base blockchain will not intervene in these computations unless there’s a need to solve a block dispute and provide proof for the validity of the transactions.

These solutions sometimes employ proprietary tokens for the governance of the Layer 2, as well as for the gas fees for the transactions executed on its sub-network. Transactions are optimized so that they can retain minimal gas fees.

They are also executed much faster, as the off-chain calculations will focus on a single process, instead of having to take account of the entire history of the underlying blockchain.

Most popular Layer 2 protocols scaling solutions

At the time of writing, there are four major schools of thought that Layer 2 solutions are adopting.

State channels

State channels facilitate the off-chain communication between peers, which in turn, increases the overall speed of transactions and reduces their cost.

Once the state channel is opened between two (or more users), all the transactions are executed externally, right until the channel is closed. In brief, here’s how this works:

  • Two (or more) users open a transaction channel through a multi-signature smart contract.
  • Users sign transactions and send them to one another, keeping a record for future reference.
  • Once the parties are done transacting, they close the channel and the smart contract adds the records of their transactions to the blockchain.

Examples of such state channels are the Bitcoin Lightning Network, Celer, and Ethereum’s Raiden network.

Nested blockchains

Nested blockchains are blockchains that are deployed on top of an existing blockchain. The Layer 1 protocol sets the parameters for the transactions and the network of secondary blockchains verifies them, without interfering with the operations of the main blockchain.

Developers can create multiple levels of these child chain networks, further increasing the speed at which transactions are executed. Omise GO uses such Plasma nested chains solutions to alleviate the transactions on Ethereum. In this system, each nested chain takes care of particular types of transactions, clearly separating the tasks to make the process more efficient.

Sidechains

Sidechains are separate blockchains that run in parallel with the main blockchain and are used for large batches of transactions. They generally have a different consensus mechanism than the original blockchain, which can be optimized for better scalability.

The main advantage of sidechains is that they are fully compatible with the smart contracts of the parent chain. This means that developers can deploy dApps with little to no modification on the sidechain and directly benefit from the increased speed. Moreover, if the security of the sidechain is compromised in any way, this won’t affect the original blockchain at all.

A prime example of a successful side chain model is the Polygon network (formerly Matic).

Rollups

Rollups are scaling solutions that are compatible with the Ethereum Virtual Machine. They break down the transaction into two parts – data and execution. The Layer 2 protocol executes the transaction, compressed the computation data, and posts it on the main blockchain.

This results in a highly scalable and highly secure network, as the Layer 2 solution benefits directly from the security features of the original chain.

There are two different types of rollups, which mainly differ regarding their security protocols. To ensure that the data posted on the main blockchain is valid:

  • Optimistic rollups assume the data is valid by default and require a fraud proof in case of a dispute of the data integrity.
  • Zero-knowledge rollups provide a validity proof with every batch of transactions.

Will Layer 2 solutions prevail?

One might believe that with the release of scalable Layer 1 blockchains, Layer 2 solutions might become obsolete in the near future. After all, why would high-performance blockchain like Solana or Cardano require Layer 2 solutions, if they are already scalable, to begin with?

Well, this would be true in a perfect world, where every new protocol is entirely flawless. But even the most future-proof Layer 1 solutions of today might reach their limits someday. When comparing Layer 1 vs Layer 2 solutions, the latter provide the advantage of not having to modify the original blockchain protocol to implement scaling improvements.

Moreover, we can assume that the Bitcoin and Ethereum blockchains still have quite a few bright years ahead of them. Bitcoin is increasingly being considered as a durable asset and is used as legal tender in El Salvador, with the help of the Lightning Network.

Ethereum remains the #1 smart contract blockchain and is the home of more than 90% of the DeFi ecosystem. Even after the migration to PoS, we can expect current Layer 2 solutions to continue to work alongside Ethereum 2.0. It would be unrealistic to think that thousands of developers would migrate to newer blockchains overnight.

As such, in the Layer 1 vs Layer 2 debate, both solutions remain viable in the near future.

Best Layer 1 cryptocurrencies

Below are some of the most notable Layer 1 blockchains currently in the space,

  • Bitcoin (BTC) – the original blockchain that jump-started the entire crypto industry.
  • Ethereum (ETH) – the first smart contract network, home to most of the decentralized finance ecosystem. Currently runs on PoW, but is shifting towards PoS. 
  • Cardano (ADA) – this PoS blockchain recently implemented smart contracts and should become an important player in the DeFi space in the future.
  • Solana (SOL) – an extremely scalable blockchain, with the fastest-growing dApps ecosystem in the past year. It uses a mix of PoS and proof of history consensus mechanisms to improve its transactions speeds.
  • Polkadot(DOT) – the “blockchain of blockchains”, which implements interoperability of sharded parachains. This allows the creation of a network of blockchains that can theoretically process 1 million transactions per second while retaining the security provided by the main Polkadot chain.

Best Layer 2 cryptocurrencies

These Layer 2 solutions are improving upon PoW blockchains such as Bitcoin and Ethereum:

  • Polygon (MATIC) – this Ethereum Layer 2 solution uses sidechains to provide full EVM compatibility paired with a PoS consensus model. The protocol uses the MATIC cryptocurrency for governance and gas fees.
  • Arbitrum and Optimism – these Layer 2 scaling solutions for Ethereum enhance the functionalities of the Ethereum smart contracts through optimistic rollups.
  • Lightning Network – a state channel solution that has been deployed for Bitcoin and Litecoin to allow near-instantaneous transactions. Its implementation has served as a base for the Chivo Bitcoin wallet in El Salvador.
  • Loopring (LRC) – a zk-rollup Layer 2 solution with a goal to create fast and low-cost decentralized exchanges and payment systems on Ethereum.

Summing up

In this Layer 1 vs Layer 2 article, we explained the differences between these two types of protocols. Additionally, we compared the most commonly used scaling solutions for both layers and listed some of the most notable Layer 1 vs Layer 2 chains on the market.

This led us to conclude that in the Layer 1 vs Layer 2 debate, the blockchain space needs both types of solutions to be able to solve the scalability trilemma. No solution is perfect and interoperability between these them will be essential in providing a sustainable blockchain ecosystem.