In crypto, I’m sure you’ve come across these two terms a lot. Let’s take a closer look at what that exactly means.
The foundational level of a blockchain architecture is referred to as Layer 1. It serves as the foundation of a blockchain network. Blockchains at Layer 1 include Bitcoin and Ethereum.
What are the characteristics of a Layer 1 blockchain?
Decentralization: These networks are often decentralized, with no one entity in charge and consensus-based decision-making.
Consensus Mechanisms: The inherent consensus mechanisms of these blockchains govern how new blocks are added and how transactions are confirmed. Both Proof of Work (PoW), which is what Bitcoin uses, and Proof of Stake (PoS), which many more recent blockchains have adopted, are common techniques.
Native cryptocurrency: Layer 1 blockchains typically contain their own native currency (for example, ETH for Ethereum, BTC for Bitcoin), which is used to speed up transactions, pay miners or validators, and occasionally serve as a "fuel" for running network operations.
Security: At this layer, the security of the entire network is maintained, including transaction finality and attack resistance.
Smart Contracts: Some Layer 1 blockchains, like Ethereum, support smart contracts, which are self-executing contracts with the terms of the agreement directly written into code.
Scalability Issues: Many Layer 1 blockchains, particularly the more seasoned ones, experience scalability issues. They have a limited capacity for processing transactions per second, which has prompted the creation of Layer 2 solutions to get around these restrictions.
Public vs. private: Layer 1 blockchains can be either private (limited access, frequently used for particular enterprise solutions) or public (available to anyone to participate, like Bitcoin or Ethereum).
Networks constructed on top of other blockchains are referred to as Layer 2. The Lightning Network, which is a Layer 2 if Bitcoin is a Layer 1, is an illustration of a Layer 2. Or you may have heard of Polygon (Matic), which is a Layer 2 on the Ethereum network.
Now, what does built “on top of” mean exactly? The phrase "built on top of" doesn't mean that the Layer 2 is physically stacked or located on the Layer 1. Instead, it refers to the idea that the Layer 2 derives its security and decentralization properties from the underlying Layer 1 and interacts with it, often by locking up assets on Layer 1 and then mirroring or representing them on Layer 2.
The basic goal of Layer 2 solutions is to make Layer 1 blockchains more scalable. The majority of public blockchains struggle with scalability; they can only handle a certain amount of transactions per second. Transaction fees and confirmation times may rise as interest in and use of these blockchains expand. By shifting some of the transactional burden off the main chain, layer 2 solutions aid in the alleviation of these issues.
There are different types of Layer 2 solutions as well.
State Channels: These are similar to opening a bar tab in that you carry out a number of operations off-chain before settling the outcome on-chain. The Bitcoin Lightning Network is one illustration.
Plasma: This is a framework for creating scalable apps. In Plasma, the amount of transactions on Layer 1 is dramatically decreased because only merkle roots of the off-chain state are transferred to the main chain.
Rollups: These combine or "roll up" several transactions into one, significantly boosting throughput. Examples include optimistic rollups and zk-rollups.
Sidechains: These distinct blockchains operate side-by-side with the primary chain and have their own consensus algorithms. Between the main chain and sidechains, assets can be transferred. The xDai chain is one illustration.
So in summary, Layer 1 blockchains are the fundamental blockchains that contain all the consensus mechanism and the native cryptocurrency, while Layer 2 blockchains are essentially scaling solutions that utilize the Layer 1, but are much faster with cheaper fees.