The Role and Rise of Layer 2

What is Layer 2?

Layer 2 (L2) is an essential expansion layer for blockchain technology, built on top of the main chain (Layer 1). Handling most transactions off-chain reduces the strain on the main chain. The primary aim is to boost blockchain scalability and efficiency while preserving the security and decentralization of the main chain. With L2 solutions, users can benefit from lower transaction costs and faster processing speeds, making blockchain more appealing for everyday use.

There are various L2 technologies, each suited for different scenarios. For instance, State Channels enable frequent off-chain interactions, only settling on the main chain at the end, thus easing the on-chain load. Sidechains operate independently but connect to the main chain through a dual anchoring method. Plasma technology creates sub-chains to manage large volumes of transactions while relying on the main chain for security. Rollup technology (including Optimistic Rollup and ZK-Rollup) aggregates many transactions before sending them to the main chain, using fraud or zero-knowledge proofs to ensure transaction security and validity. Together, these technologies form the backbone of the L2 ecosystem, catering to various scalability needs.

While Layer 2 technology addresses scalability issues, it still faces significant challenges. State Channels require participants to be online continuously, complicating user experience; sidechains necessitate their own security measures, which can introduce asset risks; Plasma sub-chains are complex to design, limiting developers’ flexibility; and although Rollup solutions enhance transaction efficiency, they still need improvements in data availability and dependence on main chain security. Furthermore, the lack of standardization among different Layer 2 solutions can lead to fragmentation, complicating integration and interoperability. These issues hinder the broader application potential of Layer 2.

The evolution of Layer 2 is critical for the widespread adoption of blockchain, especially in sectors like finance, gaming, and social networks where frequent interactions are essential. Advancements in data availability technologies (like validity proofs) and cross-chain interoperability are expected to lower user entry barriers and increase blockchain accessibility. Additionally, enhancements in Layer 2 will unlock new possibilities for Web3 applications, enabling more complex use cases. Ultimately, Layer 2 is a key driver for transitioning blockchain technology from experimental phases to large-scale applications.

The Rise of Layer 2

Layer 2 (L2) technology emerged in response to the performance limitations of blockchain, particularly the Ethereum mainnet (Layer 1), which struggled with high transaction volumes. As decentralized finance (DeFi) and non-fungible tokens (NFTs) gained popularity, transaction fees and confirmation times on the mainnet surged, negatively impacting user experience and scalability. L2 solutions were developed to alleviate the main chain’s load by processing some transactions off-chain, thus improving speed and reducing costs.

In recent years, L2 technology has advanced significantly, with solutions such as State Channels, sidechains, Plasma, Optimistic Rollup, and ZK-Rollup becoming prominent. Rollup technology, in particular, has garnered attention for its ability to package numerous transactions and submit them to the mainnet, ensuring their validity and security through fraud or zero-knowledge proofs. These solutions enhance transaction throughput while maintaining the mainnet’s security and decentralization.

During the last bull market, Layer 2 rapidly gained traction and became a key player in the public blockchain space. Here are some notable examples:

1. Arbitrum
   Arbitrum, developed by Offchain Labs, is a Layer 2 solution based on Optimistic Rollup that aims to speed up transactions and lower costs on the Ethereum network. Its main feature is processing most transaction data off-chain, significantly boosting throughput and reducing fees.
   As of 2024, data from DeFiLlama shows Arbitrum has approximately $2 billion in total locked value (TVL), making up 60.62% of the Layer 2 market, far surpassing its competitors. During the airdrop in March 2024, it recorded 3 million daily transactions, showcasing strong user engagement. Arbitrum also launched the Arbitrum Orbit project, allowing developers to create customized Layer 3 solutions, further enriching its ecosystem.

2. Optimism
   Optimism is another significant Layer 2 solution based on Optimistic Rollup, focusing on reducing transaction fees and increasing throughput on Ethereum. It batches transaction data for submission to the main chain, using a delayed fraud proof mechanism to ensure data validity.
   Reports indicate that Optimism Collective’s revenue reached 15,700 ETH (around $40.82 million) in October 2024, with the OP Mainnet contributing about 81.5%. Its Superchain ecosystem accounts for roughly 37% of transaction volume in the Layer 2 market, highlighting its competitive edge. Optimism encourages developer and community involvement by fostering decentralized governance, further propelling its market growth.

3. zkSync
   zkSync, developed by Matter Labs, is a Layer 2 solution based on ZK-Rollup that utilizes zero-knowledge proof technology for efficient and secure transaction processing. Unlike Optimistic Rollup, zkSync verifies transaction validity directly through zero-knowledge proofs, eliminating delays associated with fraud proofs and enabling faster confirmations.
   Reports show that the zkSync Era mainnet opened to the public in March 2024, reaching a total locked value (TVL) of $480 million within two months, with a weekly growth rate of nearly 20%. The number of unique addresses on zkSync has also surged, exceeding 920,000 by May of the same year, outpacing Arbitrum and Optimism, indicating strong user growth momentum. Its efficient architecture and low fees make zkSync a preferred platform for DeFi developers and users.

Comparison of Current Layer 2 Solutions

Comparison of Layer 2 Solutions (Source: DChain Community)

Currently, there are four main types of Layer 2 solutions: Optimistic Rollups, ZK-Rollups, State Channels, and sidechains. Each solution has its unique features, benefits, drawbacks, and use cases. Below is a detailed comparison of these four primary technologies.

Optimistic Rollups

Optimistic Rollups Technical Solutions (Source: Chainlink)

Optimistic Rollups is an Ethereum-based Layer 2 scaling solution designed to enhance transaction throughput and reduce costs. The core mechanism involves batching many transactions and submitting the results to the main chain instead of verifying each one individually. This significantly reduces the load on the main chain, leading to better efficiency and throughput. Because of its “optimistic” approach, the system assumes that all submitted transactions are valid unless challenged. This greatly lowers computational and storage costs, making Optimistic Rollups an efficient scaling option.

In this model, transaction data and state updates are processed off-chain, with final results submitted to the Ethereum main chain using “fraud proofs.” Participants can challenge suspicious transactions within a set timeframe; if successful, the transaction is revoked, and penalties are imposed on malicious users. While this introduces some delays, it ensures security and decentralization while lessening reliance on the main chain. Transaction costs are also significantly lower since not all data needs to be fully submitted to the main chain.

One major advantage of Optimistic Rollups is compatibility with existing Ethereum smart contracts. Since they only change how transactions are verified and not how they are executed, developers can migrate their current smart contract code to Optimistic Rollups without any modifications. This ease of transition allows developers to quickly adapt and leverage the efficiency of Layer 2 for more competitive services.

However, there are challenges. The main drawback is longer confirmation times, as transactions must wait for verification during the “fraud proof” period, which can take several days. This makes Optimistic Rollups unsuitable for applications requiring fast transaction confirmations. Additionally, the fraud proof mechanism relies on network participants to actively identify and challenge invalid transactions, which can lead to inefficiencies.

Notable public chains using Optimistic Rollups include Optimism and Arbitrum, both of which are leaders in Layer 2 solutions. Optimism optimizes Ethereum’s transaction processing by batching submissions and using fraud proofs to ensure accuracy. Its goal is to support more efficient decentralized applications (dApps) by lowering costs and increasing throughput. Several DeFi projects, like Uniswap and Synthetix, operate on Optimism, benefiting from reduced fees and faster processing.

Arbitrum, also based on Optimistic Rollup, employs a similar design but with enhancements in performance and optimization, allowing for more efficient transaction processing while maintaining high compatibility with Ethereum smart contracts. It is widely used in the DeFi space and is the preferred Layer 2 platform for many decentralized finance protocols, with a rapidly expanding ecosystem. Both platforms contribute to the growth of the Ethereum ecosystem by offering lower fees and higher speeds.

These Optimistic Rollups chains not only support large transaction volumes but also maintain high compatibility with main chain applications, enabling existing Ethereum projects to migrate easily and enjoy Layer 2 benefits.

ZK-Rollups

ZK-Rollups Technology Solution (Source: Chainlink Educational Documentation)

ZK-Rollups is another Ethereum-based Layer 2 solution that aims to improve throughput and reduce costs using zero-knowledge proof (ZKP) technology. Unlike Optimistic Rollups, ZK-Rollups generate mathematical proofs during transaction processing to ensure data validity. They bundle multiple transactions into a single batch and submit the results to the main chain using zero-knowledge proofs, eliminating the need for individual verification. This allows ZK-Rollups to significantly increase transaction throughput while providing enhanced security and lower confirmation times.

In ZK-Rollups, transaction data and state updates are processed off-chain, but the correctness of the transactions is confirmed on-chain through zero-knowledge proofs. Although these proofs require intensive computation, they enable the Ethereum main chain to quickly verify transaction validity without long waits for fraud proofs. Because of the efficiency of zero-knowledge proofs, ZK-Rollups can process large volumes of transactions almost in real-time, greatly reducing confirmation delays. This makes them particularly suitable for applications needing low latency, such as real-time payments, gaming, and high-frequency trading.

One of ZK-Rollups’ key advantages is their strong security and scalability. Unlike Optimistic Rollups, ZK-Rollups do not depend on fraud proofs; they directly verify transaction correctness using zero-knowledge proofs. This not only makes the verification process more efficient but also enhances overall system security. Furthermore, by processing large amounts of data off-chain, ZK-Rollups effectively reduce the load on the Ethereum main chain while significantly lowering transaction costs, excelling in high-throughput, high-frequency trading scenarios.

However, ZK-Rollups face some challenges. First, zero-knowledge proof technology is complex, requiring developers to have higher technical skills to build and deploy ZK-Rollups-based applications. Second, while ZK-Rollups provide greater security and scalability, there are still limitations regarding compatibility with existing smart contracts. Adapting current Ethereum smart contracts for ZK-Rollups may require additional modifications, complicating development and migration.

Prominent public chains utilizing ZK-Rollups include zkSync and StarkWare, which are currently leading platforms in the market. zkSync optimizes the computation process for zero-knowledge proofs, offering fast and low-cost transaction confirmations and being adopted by various DeFi protocols like Curve and Aave. StarkWare promotes efficient on-chain data verification through its ZK-Rollups platform based on STARK technology, widely used in decentralized exchanges (DEXs) and other DeFi applications. Both platforms accelerate Ethereum’s ecosystem growth by providing low-latency, high-security transaction environments, driving the adoption of Layer 2 solutions.

These ZK-Rollups chains enhance transaction throughput and deliver higher security and lower costs, making them significant innovators in blockchain scalability. As ZK-Rollups technology evolves, more DeFi applications and decentralized platforms are expected to adopt them to improve scalability and performance.

State Channels

Celer’s Technical Solution: A Practical Implementation of State Channels (Source: tokeninsight)

State Channels are another Layer 2 scaling solution designed to enhance blockchain throughput and reduce transaction costs by processing transactions off-chain. The core concept is to shift interactions between participants off the main chain and only submit the final state to the blockchain after transactions are completed. This allows participants to engage in numerous instant interactions off-chain, avoiding the need to submit each transaction to the main chain, thereby reducing delays and costs.

In State Channels, participants first lock a certain amount of funds on the main chain to create a channel. After that, transactions can occur frequently off-chain, with all state updates and data exchanges happening off-chain. Only the final state is submitted to the main chain for settlement once the transactions are complete. Because transactions occur off-chain, State Channels can significantly increase transaction speed and reduce costs, making them particularly suitable for applications requiring frequent transactions and low latency, such as online payments, gaming, and lightning payments.

One of the key advantages of State Channels is their high efficiency and low transaction costs. Since transactions between participants do not need to be submitted to the main chain each time, the network load is greatly reduced, lowering each transaction’s cost and increasing throughput. Additionally, State Channels provide a high level of security assurance with the main chain, as the final state updates are submitted for verification through cryptographic signatures. They offer users a low-cost, efficient way to interact while ensuring decentralization and security.

However, State Channels also have challenges. First, they require participants to be online in real-time since transactions occur off-chain and must occur when both parties are available. Second, State Channels work best in scenarios with frequent interactions and fewer participants; larger applications may not be suitable. Another challenge is that State Channels require participants to lock funds, which might inconvenience some users, especially those with high liquidity needs.

Typical implementations of State Channels include Raiden Network and Connext. Raiden Network is a payment network based on State Channels on Ethereum, designed to provide high-throughput payment processing. It allows users to conduct instant payment transactions off-chain, only submitting the final state to the Ethereum main chain upon settlement, thus enabling low-cost micropayments. Connext extends DeFi and payment applications through State Channels, providing an efficient, low-cost payment solution. Both have made significant contributions to reducing transaction costs and increasing transaction speeds, promoting the application of Layer 2 solutions.

These State Channel solutions greatly enhance throughput by conducting transactions off-chain and reduce the burden on the main chain, making them especially suitable for fast, low-cost payment applications. As technology matures, State Channels will provide solutions for more applications needing rapid and frequent transactions, becoming an important part of Layer 2 scalability.

Sidechains

Polygon Technical Principle Diagram (Source: CSDN)

Sidechains are a type of Layer 2 scaling solution that enhances the main chain’s functionality by creating independent blockchains. This allows for higher transaction throughput and greater flexibility. Unlike other Layer 2 solutions, sidechains operate with their own consensus mechanisms and blockchain structures, enabling users to transfer assets from the main chain to the sidechain for transactions and processing. Cross-chain bridges typically facilitate this transfer, allowing users to move their assets back to the main chain whenever they choose.

One major advantage of sidechains is their flexibility. Because they have independent consensus mechanisms, developers can tailor the parameters of the sidechain, such as block time and transaction fees, based on specific needs. This adaptability makes sidechains particularly well-suited for applications that demand high throughput, low latency, or specialized features. For instance, some sidechains may be optimized specifically for gaming, NFTs, or other industries to better meet diverse requirements.

Another key benefit is the scalability of sidechains. Since they function independently of the main chain, they do not consume the main chain’s resources directly, allowing them to handle a significant volume of transactions or computational tasks. This makes sidechains ideal for large decentralized applications (dApps) and high-frequency trading platforms, as they can deliver enhanced performance without impacting the main chain. Compared to other Layer 2 solutions, sidechains generally offer more flexibility and scalability due to their design not being restricted by the main chain.

However, sidechains also encounter certain challenges. Firstly, their security differs from that of the main chain; sidechains depend on their own consensus mechanisms and network participants for security, which may make them more vulnerable to attacks or issues than the main chain. To protect asset security, sidechains need strong cross-chain bridges and verification mechanisms. Secondly, while sidechains can offer improved throughput and flexibility, cross-chain operations may sometimes introduce delays and complexities, especially when transferring assets between multiple sidechains.

Examples of typical sidechains include Polygon (formerly Matic Network) and Liquid Network. Polygon is an Ethereum-compatible sidechain network that enhances the development of DeFi, NFTs, and other decentralized applications by providing higher transaction throughput and lower fees for Ethereum. It achieves this through its PoS (Proof of Stake) consensus mechanism and Plasma framework, which support a large volume of transactions and data processing. Liquid Network, developed by Blockstream, is a sidechain designed to offer faster transaction confirmations and enhanced privacy for Bitcoin. It allows for instant confirmation of Bitcoin transactions through its independent sidechain network and consensus mechanism, providing better privacy protections for users and making it suitable for enterprise-level applications and high-frequency trading.

These sidechain solutions improve performance and scalability by offloading transactions and data processing from the main chain, while also offering greater flexibility for developers and users. As sidechain technology continues to advance, it will play an increasingly vital role in the blockchain ecosystem, particularly in applications requiring high throughput and flexibility.

Core Limitations of Layer 2

While Layer 2 technology significantly enhances blockchain performance and reduces transaction costs, it also has some core limitations. Here are several key constraints associated with Layer 2 projects:

Security Issues

Layer 2 solutions typically rely on the main chain for basic security, but there can be differences in their security designs. For instance, Optimistic Rollups and state channels depend on network participants to challenge suspicious transactions via a fraud-proof mechanism after transactions are submitted to the main chain. However, this mechanism doesn’t always effectively prevent malicious attacks. Attackers might exploit system vulnerabilities to execute “malicious transactions” and quickly withdraw, while the process of submitting fraud proofs can take time, leading to delays in addressing real-time attacks. Additionally, the security of Layer 2 solutions often relies on a smaller network of validating nodes, meaning that if these nodes are compromised, it could jeopardize the entire network’s security. Thus, while Layer 2 technology offers efficient scaling solutions, its security may sometimes be less robust than the main chain’s.

Cross-chain Compatibility and Interoperability Issues

Current Layer 2 solutions are generally built around a single main chain, particularly Ethereum’s Layer 2 solutions like Optimism and Arbitrum, which primarily focus on optimizing Ethereum’s performance. However, cross-chain operations pose serious interoperability challenges. Different blockchains utilize various consensus mechanisms and protocols, complicating asset transfers and information exchanges. Cross-chain bridge technology is still evolving; while projects like Cosmos and Polkadot attempt to provide cross-chain support, they do not directly interoperate with most Layer 2 technologies. This situation forces users to rely on third-party bridging protocols for cross-chain operations, which may carry potential security risks. Furthermore, compatibility differences between various Layer 2 solutions can result in delays and complexities in the movement of assets and information across different chains, making operations more challenging for users.

User Experience and Technical Barriers

The complexity of Layer 2 technology is a significant barrier to its widespread adoption. While these solutions can provide higher transaction throughput and lower fees, transferring assets from the main chain to Layer 2 can involve multiple steps for users. For example, users must first bridge assets from the main chain to Layer 2 before trading or operating within the Layer 2 network. Additionally, the interfaces and usage methods of Layer 2 networks often differ from those of the main chain, requiring users to operate through specific wallets or platforms, which can be challenging for non-technical users. For developers, migrating existing applications to Layer 2 also necessitates modifications to the code to ensure compatibility and efficient operation in the new environment. To leverage the benefits of Layer 2, developers need to understand the underlying architecture of each Layer 2 technology, which raises the technical barriers to development.

Funds and Resource Locking Issues

Some Layer 2 solutions, such as state channels, require users to lock a certain amount of funds as collateral. While this mechanism helps ensure the integrity of both parties during transactions, it also presents challenges. First, users cannot freely access these locked funds, limiting their liquidity. The opportunity cost of locked funds can be significant for some users, especially when they want to utilize these assets for other investments or transactions. Additionally, the number of participants may be limited by the operation of state channels; having too many participants can slow down fund movement and complicate management. Although smart contracts and automation tools can enhance fund management efficiency, fund locking remains a burden that cannot be overlooked in certain Layer 2 solutions.

Trade-offs Between Decentralization and Scalability

In designing Layer 2 solutions, balancing decentralization and scalability is a critical issue. To improve scalability, some solutions (like Optimistic Rollups) adopt a more centralized design, especially in executing fraud proofs and challenge mechanisms, often relying on a subset of core nodes to validate transaction effectiveness, which may impact decentralization. Other solutions (like ZK-Rollups) maintain a higher level of decentralization by utilizing zero-knowledge proof technology, but their computational complexity is higher and demands more computational resources. This means that while ZK-Rollups theoretically provide better security and decentralization, their scalability is constrained by the computational bottlenecks of zero-knowledge proofs. Therefore, finding a balance between decentralization, security, and scalability remains a crucial challenge for Layer 2 technology, necessitating further innovation and optimization to achieve higher scalability while ensuring network security and decentralization.

Conclusion

While Layer 2 technology offers effective solutions for enhancing blockchain scalability, it still faces numerous limitations. Although it can improve transaction throughput and reduce costs, the complexity and dependencies of Layer 2 networks remain significant issues, particularly regarding cross-chain interoperability and data security.

Additionally, transaction confirmation times and verification mechanisms can limit the real-time requirements of certain applications. Despite advancements like Optimistic Rollups and ZK-Rollups that aim to improve efficiency, delays, and fraud-proof mechanisms still affect system performance, making it challenging for Layer 2 solutions to fully replace Layer 1 in high-frequency trading or scenarios requiring instant confirmations.

In the future, as technology continues to evolve and improve, the limitations of Layer 2 solutions are expected to be eased. More efficient cross-chain protocols, improved user experience designs, and enhanced security measures will drive further adoption of Layer 2 technology. They may play an increasingly important role in the blockchain ecosystem.