Layer 2 Solutions For Ethereum

Alisa Tkach

Scaling the race.

Scaling the race.

When it comes to discussing the future of decentralization and the application of such innovative solutions as blockchain-based games, DeFi and all the other instruments that would make Web 3.0 a reality, every argument in favor eventually stumbles across the same issues that have been troubling virtually all existing blockchain networks ever since their inception. Be it sharply spiking transaction fees, low scalability possibilities, security problems, or any other technical challenge – the answer is always the same: blockchain is currently imperfect.

That being said, it does not mean that developers are content with tolerating the current state of affairs. Numerous groups, projects, blockchains and even companies are engaged in the development of solutions that would help decentralized networks overcome their limitations. Given that some in the blockchain community believe that the Bitcoin network is hopeless in providing the necessary scalability and transaction processing times that would allow it to be leveraged as the main platform for Web 3.0 applications, all eyes fall on its closest competitor and the largest blockchain network in existence – Ethereum.

A Broader Look

The Ethereum network is vast and is home to over 87% of all decentralized applications on the market. That makes it the most widely used network of all blockchains. And that means its congestion is extremely high, which leads to the same pitfalls over and over again.

The recent frenzy on the crypto market has overloaded the Ethereum network and sent fees sky high. When the profitability of a transaction becomes virtually on par with the commission that has to be paid for fixing said profits, traders will not be willing to spend such amounts and will keep holding their assets. This means that the economy will be suffering from losses and discontented users will be blaming the network, complaining and thus limiting turnover.

The biggest problems that Ethereum currently faces are directly linked to its scalability, which goes hand in hand with transaction costs. The ethereal arrival of Ethereum 2.0 is not a godsend and is certainly not a panacea for the current situation. First of all, because the transition from PoW to PoS will simply reduce the amount of available ETH on the market and will thus limit supply, leading to an increase in demand and another spike in coin and transaction prices in the end.

However, there are solutions that do not require direct integration into the Ethereum network for adding congestion, but can be applied to it off-chain to facilitate transaction processing.

In With L2

Layer 1 is what we call the Ethereum mainnet with all of its nodes, infrastructural elements, miners, smart contract processing, add-ons, etc. The mainnet is the foremost processor of transactions, and that means it can get congested with requests. Given its limited computational capabilities, transaction processing speeds fall and prices rise.

The most optimal solution for alleviating the burden faced by L1 is introducing L2 solutions, also called rollups. Layer 2 solutions are designed to help blockchains and applications scale horizontally without additional strain by delegating all processing procedures to modules that are located outside the main network, or Layer 1. L2 solutions can benefit from the protection and security of the mainnet, but without using up its processing power, having their own.

Given that L2 solutions are deployed as superstructures of L1, they can facilitate the operation of such applications as blockchain-based games, which can be utterly meaningless if current transaction processing times and commissions are considered. In addition, any updates to L2 will not require any expense on the part of the mainnet and will not lead to any disruptions, global updates or significant changes.

The deployment of L2 will lead to the posting of data related to the transactions on Layer 1, while handling transaction processing outside of it. In essence, a smart contract of a rollup from Layer 1 can enforce correct transaction execution on Layer 2 by relying on the data that is already available on Layer 1.

The Types

There are several types of rollups available, including Zero Knowledge Rollups, Optimistic Rollups, and Hybrid Rollups. Though their principle of operation is slightly different, they all perform the same function and aim to achieve the same goal – freeing up Layer 1 from having to process transactions and allowing its processing power to be used for other, application-oriented purposes.

Zero Knowledge rollups rely on SNARK, or Succinct Non-Interactive Argument of Knowledge cryptographic proof generation when rolling up multiple smart contracts into a single packet. This allows them to do away with the need for transferring all transaction data involved, relying instead on validity proof. In addition to reducing block sizes from 32 to as little as 4 bytes, such rollups experience no delays when the funds involved are moved from L2 to L1, since they have already been verified. However, such rollups are extremely computation-intensive, meaning that they are useless for apps with low levels of on-chain activity.

Optimistic Rollups work in parallel with the mainnet and do not perform any computations at all. Instead, they simply propose that the mainnet validate the new state of a transaction, consequently writing them to the mainnet as calldata. Such rollups provide up to a hundred times higher scalability, but they take longer than ZK-rollups, since their transaction data can be challenged. Should a challenge be issued, gas will need to be spent to prove the transaction is not fraudulent, but will be reimbursed.

As for hybrid solutions, they have not yet been fully developed or explored. They mostly combine the benefits of both previously mentioned rollups and attempt to produce a hybrid L2 solution that would be “perfect”. Most hybrid L2 solutions are still at the research stage and analysis of their effectiveness is ongoing.

But How And Who Will Do It?

L2 solutions will require their own operators and network to run properly and avoid congesting L1. In essence, these will be the equivalents of miners, who will be receiving rewards for their operation.

The data involved will be secured by the same mechanisms and layers as those on L1, meaning that users may not even realize that they are on an L2 solution, since onboarding, operation streamlining and transaction processing will be seamless.

As for risks, L2 solutions face virtually all the same risks as L1 networks, which include the possibility of fraud, potential takeovers, bug exploits and so on. However, there is little fielding of L2 solutions in the real world to evaluate the threats involved. This means that a lot of work will have to be done before any L2 goes live anytime soon.

What To Use L2 Solutions For

The most basic application for L2 solutions is leveraging the speeds of blockchain networks for streamlining payments. Since Ethereum is the main contender for the role of the global decentralized infrastructure for DeFi and Web 3.0, this means that L2 can serve all the basic purposes crypto users seek on blockchains. That includes trading, borrowing, lending, staking, transferring – everything that coins and tokens can be used for.

Given that L2 solutions can match and even outstrip Visa by double in terms of transaction processing at speeds of around 2 to 4 thousand transactions per second, the use cases instantly expand into all manner of applications that require speed. This extends to the aforementioned blockchain-based games, such as gambling, e-gaming and any other application that requires instant reaction on the part of the player and the platform they are using. Traders will be able to appreciate the low fees that L2 will guarantee, while high gas prices during network congestion times may turn into a distant memory.

Basically put, L2 is the solution to speeding up the Ethereum, or any other blockchain network, which would allow any Dapp operating on it to run faster and cheaper.

A Panacea?

L2 rollups are already being hailed as the godsend and be-all and end-all of the problems plaguing Ethereum and all the other blockchains. However, despite their seeming advantages, L2 solutions have their limitations that can become yet another stumbling block on the path to unleashing the full potential of decentralization.

The current DeFi and general blockchain market is so popular, because it provides open finance opportunities for a broader mass of online users. This means that the blockchains involved are composable and interoperable. This allows users from one blockchain to exchange assets with users of other blockchains on a fair market value basis. True, the process is done with the help of intermediaries, which in themselves are operating on different blockchains at times, but that does not negate the fact of freedom of exchange.

The issue with L2 solutions is that not all of them are interoperable. Suppose one blockchain implements Optimistic rollups, while another implements a hybrid solution. This would simply mean that the blockchains will no longer be able to communicate and their users will have to find alternative, long ways of interacting. While L1 solutions are interoperable with all DeFi protocols, L2 solutions will be locked and restricted to their own chains. No effective solution has yet been found for making rollups interoperate.

Another major question pertains to liquidity. If chains decide to implement various L2 solutions, this would mean that overall liquidity will be fragmented and will not be pooled onto a general market. This would mean that the financial aspect of the Ethereum and other L2 utilizing networks will be limited, essentially meaning that by implementing any L2 solution, the blockchain in question may be cutting itself from the market.

This leads to another important issue that is directly related to the inevitable rise in competition among L2 solutions. As various networks start selecting the L2 solution that fits their needs, the solution providers will start competing with each other, thus creating friction. This, in turn, will lead to the creation of bridging services, which will also be competing with each other. In the end, such stiff competition on the market will be reflected on the users, resulting in long onboarding times, forcing users to have duplicate accounts to work on various L2 solutions, and ultimately resulting in a drop of transaction transfer times as users hop between networks in search of bridges.

The only truly viable solution would be the creation of a universal L2 solution that would incorporate a bridge capable of interacting with multiple blockchain networks simultaneously.

Summary

There are no silver bullets, just as there are no beasts to aim them at. The same applies to the blockchain industry, where every solution comes at a tradeoff. The only catch is that developers will have to find solutions that minimize said tradeoffs in favor of greater benefits for the end users to be competitive. Since blockchain networks are designed to lower transaction costs, it is logical for them to resort to solutions that would best cater to the needs of users. And this is where the burden of further network development falls back on the shoulders of L2 solution providers.

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