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Ask CryptoVantage: What is Bitcoin’s Layer 2?

Bitcoin’s “layer 2” refers to all systems, or protocols, built “on top” of the bitcoin network, meaning they follow the rules of the bitcoin protocol and utilize bitcoin’s blockchain. A protocol is just a set of rules or standards that must be followed. With huge amounts of money and energy spent securing the blockchain, the bitcoin network provides an excellent “base layer” for layer 2 protocols. These layer 2 protocols, such as the bitcoin Lightning Network, capitalize on bitcoin’s security, and implement new features that would not be possible on the base layer. While layer 2 protocols are not quite as secure as the base layer, they can still significantly increase the utility of bitcoin.

Bitcoin Layer 2 helps solve some of Bitcoin's bigger problems

Bitcoin Scalability & Decentralization

You might be wondering why we need layer 2 protocols in the first place. It comes down to a trade-off between bitcoin’s scalability and its level of decentralization. Scalability generally refers to the amount of use bitcoin can have at any given time, such as the number of transactions per day, or the number of possible users. However, we can only increase the scalability of bitcoin’s base layer to a certain point before it starts becoming more centralized. It’s important for bitcoin to stay decentralized because the more centralized it becomes, the easier it is to control and overtake the bitcoin network (read more about that here).

A common suggestion for increasing bitcoin’s scalability is to make bigger block sizes. This would allow more transactions per block or per unit of time. While this would make bitcoin more scalable from a “transactions per second” viewpoint, it would hurt bitcoin in a couple ways. First, increasing the block size to some arbitrary new limit would open the door to more protocol changes. The more the protocol changes, the more it can be controlled. The second way increasing the block size would hurt bitcoin is that it would get more and more difficult for people to use bitcoin because the computational requirements also increase with larger block sizes. Most users would know longer be able to afford to use bitcoin directly, and they would be forced to rely on third party “bitcoin service providers”, which goes against the reason bitcoin was created in the first place.

Another popular opinion on increasing bitcoin’s scalability is to move payments off the base layer, while using some mechanism to periodically “anchor” the payments to the base layer. This type of “off-chain” scaling can be divided into two general categories, sidechains and layer 2 protocols.

Sidechains involve moving payments to a completely separate blockchain, one that is anchored to the bitcoin blockchain using cryptography. Layer 2 protocols, on the other hand, don’t use a blockchain but use some other method to move payments off the bitcoin base layer.

Layer 2 Protocols

Layered protocols are something most of us use every day. The internet consists of seven main layers, with the “base layer” being the Physical Layer. The Physical Layer is what defines how information is represented by the electrical signals in our computers. The internet’s layer 2 is the Data Link Layer, which is a protocol or set of standards that allow different nodes/computers to transfer data amongst themselves. The Application Layer, which uses HTTP and is what allows you to read this article using your web browser, is the highest layer of the internet at layer 7. Rather than trying to package the entire internet into a single standard, layered protocols allow us to more efficiently organize the internet into layers with specific purposes.

In bitcoin, we can think of the base layer, or layer 1, as the Settlement Layer. The Settlement Layer controls the final settlement of balances amongst bitcoin users – it is the ultimate record of bitcoin transactions. Bitcoin’s layer 2 can be thought of as the Payment Layer. That is, we can make bitcoin payments using layer 2 without needing to worry about the limitations or costs of the Settlement Layer. Occasionally, we can settle our balances from the Payment Layer onto the Settlement Layer, after which we can rest assured that our balances are protected by bitcoin’s high level of security.

While there can be any number of layer 2 protocols, the Lightning Network is the one that currently has most of the bitcoin community’s focus. It is a promising layer 2 payment protocol which allows us to make a virtually unlimited number of near-instant transactions for almost no fees. While funds are stored on the Lightning Network they are somewhat less secure, but as soon as they are settled to the bitcoin base layer they have the same security as any other bitcoin funds.

Conclusion

Layer 2 protocols allow us to add new features to bitcoin without needing to change the bitcoin protocol. We benefit from most of the focus being on a single layer 2 protocol – if everyone tried to make their own layer 2 protocol, there would be no interoperability and these layers wouldn’t provide any value. Instead, there are many companies and developers all putting their resources toward a common goal – making bitcoin more scalable via the Lightning Network layer 2 protocol.