Understanding DeFi: A Discussion on Layer 2
If you carefully follow DeFi, you’ve probably heard of the phrase “Layer 2.” Crypto locals frequently refer to blockchains as “Layer 1” and “Layer 2,” but it’s essential to start at the beginning to grasp what they mean. Since they settle every transaction on their network, “Layer 1” chains like Bitcoin and Ethereum are frequently referred to as blockchains. The framework that is constructed on top of the blockchain is Layer 2. Solutions for layer 2 play a significant part in enhancing scaling. We have studied them for our product and worked closely with Layer 2 initiatives like Polygon (formerly known as Matic). We wanted to explain how they function for the community in our most recent Understanding DeFi guide and provide some examples of the current solutions that are being developed.
Layer 2: What is it?
The financial system Ethereum has developed is unlike anything the world has ever seen, but it has some well-known issues. Currently, 15 transactions per second are processed by Ethereum. This has caused many problems, like network congestion that sometimes makes gas prices go through the roof. Scalable, safe, and decentralized blockchains should all be used. Even though using more powerful nodes can speed up transactions, this strategy gives up decentralization. It will take some time until Ethereum 2.0 is fully implemented. However, it is hoped that it will increase scalability. Ethereum usage has reached a daily peak of almost 1 million transactions, so new solutions are now required.
Layer 2 is used for this purpose.
Ethereum is comparable to Bitcoin in that it is a Layer 1 protocol. It serves as the network’s settlement layer for all transactions. Layer 2 is added to the network’s primary chain to increase scalability. Layer 2 is added on top of the direct chain to improve scalability. Layer 2 solutions offer a way to increase the number of transactions in a chain while keeping the security of the main chain. The blockchain can handle thousands of transactions per second, which is very important if Ethereum is to become more popular.
Several Layer 2 solution examples.
There are multiple Layer 2 solutions for Ethereum, and each takes a different approach to increasing network scalability. Users can perform several transactions using channels. On Ethereum’s network, while only sending two transactions to Ethereum’s settler, several restrictions exist. Participants must be chosen ahead of time and must also put money into a contract requiring more than one signature. That means the network must be checked often to ensure the funds are safe.
Additionally, there isn’t much room for engagement because building up channels between users takes time. Still, it enables excellent throughput at a reasonable cost. Still, it allows superior throughput at an affordable price.
Plasma solutions build a supplementary chain to the main blockchain using Merkle trees. Since the blocks aren’t settled on the main chain, and there’s no need to keep data on the ledger, transactions can be done quickly and for less money. There are restrictions on what to do with plasma, though. Because the framework only allows certain transactions, it is impossible to do more complicated DeFi activities. Withdrawals can have problems and take longer than expected because operators have to store data and keep an eye on the network to ensure the funds are safe. OMG and Polygon are examples of Plasma solutions (the Polygon SDK is also set to support ZK roll-ups, optimistic roll-ups, and stand-alone Defi’sins).
Sidechains contain things like xDAI and Skale. With no connection to the main blockchain, sidechains run autonomously and have their consensus method. They utilize a two-way bridge to connect to Ethereum. They are compatible with the Ethereum virtual machine. Still Doesn’t has some drawbacks as well: it is less decentralized than the TDN network, Layer 1 does not decide on the consensus process, and sidechain validators may band together to commit fraud.
Roll-ups submit data to the Rollupsbase chain and process Layer 2 transactions. That means they can use Ethereum’s security to make transactions outside of Layer 1. Ethereum’s roll-ups come in two types: optimistic roll-ups, which run roll-ups on Ethereum, and ZK (zero knowledge) roll-ups, which combirollup multiple transactions into a single transaction. SNARK roll-ups are short, non-interactive command arguments made by ZK roll-ups. They are used to group transactions together.
In the popularity of Ethereum Optimism, Rollups are working on optimistic roll-ups right now, while Loopring and StarkWare are roll-up solutions from ZK. The roll-ups in favor of Ethereum Optimism are making optimistic roll-ups, and ZK has roll-up solutions like Loopring and StarkWare. Optimistic roll-ups enable composability, a key element of DeFi, but they are vulnerable to potential assaults and lengthier wait times. Fast transactions are possible with ZK roll-ups, but their reach is constrained. Just one trarollupsn is transmitted to Ethereum because this is cryptographic proof submitted to the foundation. Meanwhile, optimistic roll-ups coexist with the underlying chain and send transactions to Ethereum as call data.
— DefiDegen.L2 (💙,🧡) (@DefiDegenL2) November 5, 2022
While using zero-knowledge proofs, Validium is similar to ZK roll-up- technology in storing data off-chain. There will be no wait time for withdrawals, and the risk of attacks will be much lower. That will allow up to 10,000 transactions per second. However, not all smart contracts can be processed at once; creating ZK proofs requires a lot of computing power. Ethereum’s slack times can take longer. The Validium products StarkWare and DeversiFi are two examples.
In conclusion, various Layer 2 alternatives are now under development to resolve Ethereum’s scaling problems. These hybrid solutions combine different technologies to increase the network’s scalability. As new projects consider the pros and cons of running on Layer 2, the Ethereum ecosystem could change significantly. If Ethereum reaches its full potential and becomes a global trust layer, Network Solutions and others will likely be needed to help grow the network alongside Ethereum 2.0.