Ethereum has firmly established itself as a cornerstone of the cryptocurrency industry. It has revolutionized how blockchain is used and given birth to unique innovations once thought possible only in theory.
However, Ethereum faces significant challenges threatening its long-term usability. The network has inherent limitations when it comes to scalability and efficiency.
The blockchain is often congested, leading to slow transaction times and high gas fees — impeding user experience and limiting the network's ability to handle large volumes of transactions.
This congestion is especially problematic given Ethereum's central role in hosting various decentralized applications, from DeFi protocols to NFT marketplaces.
The more Ethereum succeeds, the more demand for scalable solutions to overcome these hurdles is needed to maintain it as the blockchain of choice for smart contracts.
The most prominent solutions are “Layer 2” technologies built on top of the Ethereum blockchain.
In this article, you’ll discover why Ethereum needs Layer 2 technologies, explore their role in addressing the network's challenges, and learn about their impact on the future of the network.
The Limitations of Layer 1
At the heart of Ethereum's architecture lies its Layer 1 – the main blockchain. This foundational layer is where all transactions and smart contracts are processed and verified. It's the core of Ethereum, offering unparalleled security, decentralization, and transparency.
However, the network's capacity to handle an expanding array of applications and a growing user base is increasingly under strain. High transaction fees and prolonged transaction times have emerged as significant barriers, stifling scalability.
These issues stem from the blockchain's inherent design, which, while robust and secure, limits the number of transactions it can process simultaneously. As a result, during periods of high demand, users experience increased fees and slower transaction speeds, limiting the growth and expanded usage of the network.
Layer 2 - A Scalability Solution
The Ethereum community has turned to Layer 2 solutions to address these challenges. These are networks (or technologies) built on top of the Ethereum blockchain, designed to increase its capacity without compromising security.
Layer 2 solutions effectively enhance Ethereum's scalability and reduce congestion by processing transactions off the main blockchain.
One of the primary methods used by these solutions is known as 'rollups.' Rollups gather multiple transactions into a single transaction and process them off-chain before submitting the final result to the main Ethereum blockchain. This approach drastically increases the number of transactions processed and reduces the individual cost of each transaction.
Prominent Layer 2 solutions like Arbitrum and Optimism have showcased the potential of this technology, enabling up to 40,000 transactions per second (TPS), a remarkable leap from the limited capacity of Layer 1 (27 TPS).
Why Layer 2 is Crucial for Ethereum's Growth
Transitioning to Layer 2 solutions is essential for Ethereum’s sustainability and future expansion. As decentralized finance (DeFi) and digital collectibles such as non-fungible tokens (NFTs) continue to gain popularity, Ethereum needs to handle the increasing transaction load.
Layer 2 platforms like Arbitrum, Optimism, and zkSync are not just supplementary enhancements; they are becoming the mainstays of Ethereum's infrastructure. These platforms offer the scalability and speed necessary to accommodate the next generation of DeFi applications and NFT marketplaces.
The 90-fold growth in transactions on these platforms since 2021 underscores their rising importance and the community's shift towards more scalable solutions.
Innovations and Developments in Layer 2
Four key types of Layer 2 solutions exist for Ethereum:
- Optimistic Rollups
- State Channels
Optimistic Rollups are a type of Layer 2 solution that assumes transactions are valid by default, only executing a more intensive verification process in case of disputes.
Optimistic Rollups mean transactions are presumed to be honest unless proven otherwise, streamlining the validation process. In the event of a dispute, the rollup can perform a more detailed computation to verify the transaction's legitimacy, ensuring the integrity of the network while maintaining efficiency.
With Optimistic Rollups, users enjoy faster transaction speeds and lower fees, making them ideal for applications that require high throughput.
zk-Rollups, short for Zero-Knowledge Rollups, work by bundling hundreds of transactions off-chain and generating a cryptographic proof. This proof, known as a SNARK (Succinct Non-Interactive Argument of Knowledge), is then posted to the main Ethereum blockchain as a single transaction to be validated.
The key advantage of zk-Rollups is their ability to offer both scalability and privacy, as the zero-knowledge proofs enable transaction validation without revealing any underlying data.
State Channels are another form of Layer 2 technology, where two or more parties transact in a private channel off the main Ethereum chain. These transactions can occur rapidly and without incurring gas fees for each action.
Once the parties finish transacting, the final state of these transaction settlements happens on the Ethereum blockchain.
State Channels are useful for applications that require high-frequency, low-latency interactions, such as gaming or microtransactions.
Plasma is a framework for building scalable applications by creating child blockchains anchored to the main Ethereum blockchain.
These child chains can process transactions independently, significantly reducing the load on the main Ethereum network.
Plasma is designed to facilitate secure, scalable, and fast transactions, making it suitable for complex applications that demand high throughput.
Layer 2’s Impact on Ethereum’s Economy
By offloading transactions from the mainnet, Layer 2 solutions could cause a shift in Ethereum's economic dynamics. As Layer 2 platforms grow in popularity, they have the potential to “steal” revenue from Ethereum's mainnet.
This shift might affect the incentives for validators on the Ethereum network, altering the staking dynamics and potentially impacting the value of ETH.
However, it also presents an opportunity for more efficient price discovery and a better user experience on the Ethereum network.
Layer 2 solutions allow Ethereum to scale effectively, support innovative applications, and help maintain its position as a leader in the blockchain space — offsetting the negatives from any “stolen” market share.
Join The Scalability Race
Layer 2 solutions address the critical challenges of scalability and efficiency, setting the foundation for Ethereum's future growth.
As the blockchain landscape continues to expand, Ethereum's embrace of Layer 2 technologies ensures its ability to adapt and thrive, catering to the ever-increasing demands of its diverse user base.
You can invest in the market's most prominent Layer 2 solutions via Bake’s “Ethereum's Scaling Race” Bundle. Arbitrum (ARB), Optimism (OP), and Polygon (MATIC) bundle together to give you an optimized stake in the three leading projects at the forefront of Ethereum’s scalability race.
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