How Layer 2 Scaling Improves Ethereum

ResearchMar 25, 2022
How Layer 2 Scaling Improves Ethereum

Despite mass adoption and around 1.25 million daily transactions, Ethereum has room for improvement. First, this public blockchain is so expensive that users compare gas fees to Uber surge prices. Secondly, it is relatively slow due to very few Ethereum transactions per second. Both problems have the same solution — Layer 2 scaling.

As an ecosystem for spending crypto, building apps, and launching tokens, Ethereum is imperfect. Scaling solutions improve its usability, affordability, and speed. Transactions become nearly instant while gas fees approach zero. Discover the fundamentals of existing Ethereum Layer 2 networks in our guide.

What is Layer 2 Ethereum Scaling?

The primary Ethereum network, or Layer 1, is where all transactions happen. Its throughput (15 TPS) does not match the demand, and each transaction takes up to five minutes on average. The more users, the higher the congestion and the longer the delays. Ethereum’s performance ceiling hinders growth, and gas fees can reach $200.

These limitations are particularly frustrating compared to widespread centralized systems. Visa alone processes about 2,000 transactions per second. This shows how much Ethereum needs to change to achieve broader adoption. If it is ever to grow to serve billions of users, scaling is inevitable.

In 2023, the network is expected to implement Ethereum 2.0, an upgrade with enhanced scaling performance. In the meantime, Layer 2 solutions are already making the network faster, cheaper, and more usable. Each of them is an Ethereum-connected blockchain (or sidechain).

How Top ETH Layer 2 Solutions Work

Without exaggeration, L2 solutions are game changers. They are particularly useful for transaction-intensive systems and processes — smart contracts, payments, DeFi yield farming, and NFT minting. Now, users do not have to pay exorbitant gas fees when they add or remove liquidity or claim rewards. Here is how Layer 2 scaling works:

  1. An L2 sidechain processes a series of transactions.
  2. These microtransactions are grouped into a single rollup block.
  3. The L2 sidechain sends the rollup block to the Layer 1 crypto network at once.
  4. The transaction fee for the rollup block is split between the participants.

As you can see, Layer 2 networks bundle transactions before execution to bring down the costs. This explains why they are also referred to as “rollups”. Instead of sending 1,000 separate transactions, a rollup groups them, handles the computation, and submits its results.

Optimistic rollups “assume” that their data is valid and incentivize watchers who detect and prove fraud. ZK (Zero Knowledge) rollups submit validity proof themselves, which eliminates the risk of relayer cheating. Due to the absence of the “fraud-proof” window, transactions are essentially instant.

Disadvantages of Ethereum Scaling Solutions

As you can see from this example of Layer 2 crypto hierarchy, combining microtransactions into bundles is key to cheaper use. L2 networks provide Ethereum with a much-needed boost, helping it maintain popularity despite its inherent flaws. Yes, they also have their own limitations.

No Interoperability

Unfortunately, l2 Ethereum sidechains cannot communicate with one another yet. They are, in essence, separate markets. Thus, liquidity providers looking for lower gas fees may face a dilemma — to choose only one L2 sidechain or split liquidity between two or more of them.

The second scenario requires thoughtful allocation. Suppose Uniswap opened markets on two eth Layer 2 sidechains, and you divided your liquidity between them. What if one of them never took off? You would miss out on transaction fee rewards.

Security Concerns

Liquidity disparity is another challenge in Ethereum scalability. As smaller sidechains accumulate less liquidity, they are less reliable than the main chain. To afford comparable security guarantees, they need as much or more staked liquidity tied up in the consensus process.

The Best Layer 2 Ethereum Projects

Ethereum settles an impressive volume of transactions — it processed $1.5 trillion in Q1 2021 alone. Clearly, the public interest in the network is high despite its drawbacks — that is, low speed, high costs, and inconvenience. To catch up with Visa, which processes $2 trillion per quarter, Ethereum needs an upgrade.

The power of Layer 2 crypto sidechains is undeniable. Given the current results, they can outpace Visa's volumes easily in the near future. Here are the most active Layer 2 scaling solutions as of March 2022.

Polygon Network

Previously known as MATIC, this ZK powerhouse is #1 on the list of Ethereum Layer 2 projects. It has received high acclaim and financial support from Coinbase Ventures and many smaller projects. Its popularity soared during the NFT boom, and TVL has already approached $9 billion.

Not only does Polygon have negligible transaction fees. It also gives users free tokens when they bridge assets, so they perform several transactions at zero cost. In terms of transactions per second, Ethereum gets a strong boost — from 15-45 up to 65,000 TPS. Polygon’s PoS has a peculiarity: transactions on the sidechain are periodically check-pointed to Ethereum by the validators.

This network hosts the most popular decentralized protocols, including Aave, Curve, and Sushi. QuickSwap, an AMM DeFi exchange resembling Uniswap, is a low-cost alternative to Ethereum DEXes. Polygon aims to become the default chain for everyday transfers, while value storage and high-volume transactions will still happen on Ethereum.

Optimism

Initially, Optimism fell behind Polygon due to development issues. Currently, its adoption rate is impressive — Uniswap, Synthetix, and the Lyra exchange (for crypto options) are already on board. This project has strong support from Andreessen Horowitz, a famous private American venture capital firm.

The mainnet called Optimistic Ethereum (OΞ) is live. It hosts the Uniswap V3 market, which has accumulated upwards of $6.5 billion in TVL. This proves early success of Ethereum Layer 2 protocols. The throughput ranges from 200 to 20,000 TPS.

Arbitrum

Traders and yield farmers are not the only users affected by high gas fees. Developers of DeFi apps based on Ethereum have to pay for smart contract executions, which are costly even in test phases. The Arbitrum l2 blockchain-primarily addresses their needs through acceleration and cheaper use. It raises the throughput to 40,000 TPS.

This Optimistic rollup lets developers get their projects off the ground at a relatively low cost. Currently, the protocol's mainnet beta release is only available to developers. Uniswap, Sushi, and Consensys have already tested or launched their blockchain layers on this protocol. A public release is expected in the near future.

Layer 1 vs. Layer 2

Layer 2 blockchain is not the only solution to Ethereum’s inherent flaws. There is an alternative — competing Layer-1 networks that handle more activity. Like Polygon, systems like Solana, Avalanche, Terra, and Binance Smart Chain enable faster transactions at a lower cost. Some of these stand-alone networks connect to Ethereum tech via EVM compatibility.

The first downside is increased centralization. For example, Solana has fewer nodes than Ethereum, and over 50% of its tokens are owned by Solana Labs, investors, and developers. In comparison, the Polygon sidechain views decentralization as “non-optional”.

Secondly, Layer-1 networks cannot “borrow” from Ethereum’s security. They need their own cohort of miners or PoS validators. These independent blockchains have indefinite responsibility for validating and securing all transactions.

Final Word

Ethereum supports thousands of apps for DeFi, NFTs, and gaming. It settles transactions worth several trillion dollars annually, and the TVL has exceeded $170 billion. With ETH 2.0 still in the works, Layer 2 blockchain projects facilitate its further growth. Complementary networks like Polygon dramatically increase Ethereum’s throughput and reduce gas fees. Unlike Layer-1 blockchains, they achieve these goals without sacrificing centralization.

Disclaimer:

The information provided by CoinLoan (“we,” “us,” or “our”) in this text is for general informational purposes only. All investment and financial opinions expressed by CoinLoan in this text are from the personal research and open information sources and are intended as educational material. All outlined information is provided in good faith. However, we make no representation or warranty of any kind, express or implied, regarding the accuracy, adequacy, validity, reliability, availability, or completeness of any information in this text.

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