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One of the key areas of technical debate in the cryptocurrency and blockchain technology space over the years has been scalability. The most prominent example of the level of contention that can arise in these sorts of technical discussions has to be Bitcoin’s block size controversy, which was eventually resolved when the Segregated Witness (SegWit) upgrade was added to the world’s most popular cryptocurrency network without the additional change of a hard-forking increase to the block size limit.

The main reason there is such intense debate around the technical attributes of blockchains is that these platforms do not scale in a manner similar to traditional database systems, due to their need to remain decentralized. There tends to be a tradeoff made in terms of decentralization (and therefore censorship resistance) when cryptocurrency network parameters are tweaked to increase capacity because more transactions on the network means greater resource requirements for operating a full node and verifying that the rules of the network are being properly followed.

Over time, it has become clearer that a multi-layer approach to scaling may be the best option on the table. Although, there are still plenty of crypto asset networks that are sticking to their guns with base level, on-chain scaling. Let’s take a closer look at the differences between different blockchain layers and examples of how stacking these layers on top of each other can lead to the best of both worlds.

A Multi-Layer Approach to Scaling Blockchain Networks

During Bitcoin’s internal debate over whether a hard fork to raise the block size limit should be implemented and adopted, many of the developers behind Bitcoin Core and other forms of Bitcoin-related software came to the conclusion that a multi-layer approach will be needed to scale this new form of money to the entire world. This is to say that the system will simply not be able to retain its valuable properties of censorship resistance and permissionless access by simply storing more transactions in each new block mined on the network.

For this reason, secondary network protocols, such as sidechains and the Lightning Network, were seen as important building blocks for bitcoin as a form of digital cash going forward. While on-chain Bitcoin transactions offer a level of decentralization not found in any other payment system in the world, it’s clear that this high level of censorship resistance is not needed for every daily transaction. With a multi-layer approach to scaling, cryptocurrency users are able to make tradeoffs when making different types of transactions. For example, it may not make sense to force Bitcoin nodes to store a record of your morning coffee purchases in an immutable database for the rest of history.

Examples of Layer 1 Crypto Protocols

Obviously, a large number of different blockchain networks have launched over the years, dating all the way back to the initial launch of the Bitcoin network in January 2009.

A blockchain is needed at the base of any cryptocurrency network that is going to be viewed as credible by the market; however, these base blockchains can have a wide variety of different features and attributes. For example, Litecoin, which was the second blockchain to gain any real level of notoriety after Bitcoin, simply took the Bitcoin codebase and made some minor tweaks such as cutting the time between blocks from 10 minutes to 2.5 minutes and using an alternative algorithm for proof-of-work mining.

On the other hand, Ethereum, which is the second largest cryptocurrency network when measured by market cap, made a much larger number of alterations to the blockchain concept, most notably cutting block times down to roughly fifteen seconds and implementing a much more expressive programming language for the development of more flexible smart contracts.

Layer 2 Crypto Protocols

While base blockchain protocols were originally viewed as platforms for making simple transactions, it has become clear over time that they are perhaps better viewed as the final judges for the execution of smart contracts. Instead of broadcasting all network activities to every node on the network to be stored in the official ledger of events for all of history, it makes more sense to use the base blockchain as rarely as possible to improve the efficiency and scalability of the overall system.

The Lightning Network is perhaps the layer-2 crypto protocol that is easiest to understand because it focuses on the relatively simple concept of online payments.

Instead of adding every single daily transaction of every Bitcoin user to the blockchain, the Lightning Network allows users to effectively open tabs with each other and make endless numbers of transactions with each other, while only touching the base blockchain when initially setting up a payment channel or resolving some sort of dispute.

For example, instead of making an on-chain Bitcoin transaction with your local cafe every morning when you grab your coffee on the way to work, you can simply open a payment channel with the cafe (or someone else who already has an open channel with the cafe) on the first purchase and then have a limitless number of transactions with the cafe without having to touch the blockchain.

In addition to saving space on the Bitcoin blockchain, the Lightning Network also enables much faster and cheaper payments for Bitcoin users. Additionally, the assurances associated with payments on the Lightning Network aren’t much worse than what is made available with a traditional, on-chain transaction.

Beyond the Lightning Network

While the Lightning Network is focused on payments, there are a number of other secondary layers available on top of the base Bitcoin blockchain such as Liquid and RSK. Both of these systems are known as federated sidechains, which means they are backed by federations of entities in control of a multi-signature Bitcoin wallet that controls all of the coins on the secondary network. Of course, this is an oversimplication of the security assumptions involved with federated sidechains, and advancements such as RSK’s Powpeg show that extra protections can be put into place to make these platforms more secure. However, the key takeaway here is that users are opting into a secondary protocol layer to gain access to new features while also making tradeoffs in terms of security.

Outside of Bitcoin, the largest amount of development work that has taken place in terms of layer two protocols can be found on Ethereum, most notably in the form of rollups.

These rollups allow the execution of smart contracts to take place off of the base Ethereum blockchain, with the transaction data associated with those smart contracts eventually settling back down to the layer one blockchain.

There are two types of rollups in development on Ethereum right now: optimistic rollups and zero-knowledge rollups.

Conclusion: One Man's Layer 2 Protocol is Another Man's Trash

One final point that should be clarified when it comes to layer two protocols is that all of these different scaling options are not created equally, and there is no set definition of a layer-2 crypto network. For example, transactions made via the Lightning Network come with a level of censorship resistance and security that is not quite at the same level as on-chain transactions; however, the assurances that are found on the Lightning Network are much higher than what is available via traditional, centralized transaction servers.

Some people refer to transactions made on centralized exchanges as examples of layer two networks, as they allow users to trade custody of coins in an off-chain manner, while others have much higher requirements when it comes to a platform operating as a true layer-2 crypto system.

At the end of the day, the point remains in both cases that users are able to opt into different systems based on their specific needs on a blockchain network, and this sort of multi-layer approach to scaling is the key takeaway when it comes to understanding the upper layers of cryptocurrency networks.

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