The Impact of Layer 2 Solutions on Cryptocurrency Transactions

Layer 2 or as they often say L2 in the field of blockchain technologies are innovative solutions that work on top of the main Layer 1 network. Thanks to them, specialists were able to solve the problem of scalability, increase the speed and efficiency of the work performed. Today, Layer 2 solutions are responsible for unloading the main network, reducing the cost of transactions, and increasing the speed of their processing. Particular attention in the system and all technologies that are used at level 2 in the blockchain network is given to security. It is believed that L2 should inherit all the security elements present at the basic level on which it is built. That is, all transaction data will undergo a multi-stage check and be confirmed by the main blockchain network, and not by any other sets of nodes.

This technology appeared as a result of identifying problems and errors that exist today at the Layer 1 level. As an option, Ethereum, one of the main blockchain networks is distinguished by fairly high security and decentralization indicators. But at the same time, practical use has shown the presence of serious problems at the scalability stage. As the number of users and, accordingly, transactions began to increase, the network faced serious overloads, which ultimately had a negative impact on the speed of transactions and contributed to an increase in transfer fees. To eliminate this and improve the user experience as a whole, but at the same time maintain high security indicators of the basic network, the technologies that became the basis of Layer 2 solutions are designed.

During the development of L2, the attention of specialists was focused on solving the so-called "trilemma" of the blockchain. In this case, we are talking about the compliance of all the tools working today in this niche with three key requirements: security, decentralization, performance. The basic blockchain itself is a priori capable of having only two of these characteristics. But to ensure the third key indicator, Layer 2 networks began to be used.

We will talk about this technological solution in today's review. We will tell you what is special about L2 solutions in the field of cryptocurrency, get acquainted with the main technologies that are used in this area and make a brief comparison of them. We will give an example of how L2 solutions change crypto transactions, what problems can be encountered at the transition stage in practice and how this affects users and developers. Let's talk about the main prospects of the Layer 2 solutions market. The information provided will be useful to anyone interested in cryptocurrency, who would like to ensure the highest possible security, performance and decentralization when executing transactions.

What are the features of L2 solutions in the crypto sphere?

The fact that blockchain has one very serious problem, namely scalability, was assumed by the product developers back at the stage of the emergence of this technology, that is, back in 2008. And since then, active work has been underway to eliminate it. Gradually, the problem began to worsen in parallel with the demand for its use steadily increasing. As a result, consumers faced fairly high fees and delays in transactions. In such conditions, the operation of the blockchain became too difficult, gradually moving towards critical indicators.

The blockchain trilemma, which we mentioned in the introduction to the review, was invented by Ethereum co-founder Vitalik Buterin. In his conclusion, he reported that it was impossible to ensure decent scalability while maintaining high security indicators and good decentralization. That is, the blockchain systems that existed at that time could not simultaneously fulfill all 3 conditions of this trilemma:

1. Decentralization.
2. Security.
3. Performance.

In any case, one of them will always work worse than the other two, not fulfilling the obligations imposed on it.

This is how Layer 2 networks appeared on the market. Their task is to significantly improve scalability without violating the high security and decentralization characteristic of Layer 1 solutions, which will ultimately have a positive effect on the speed of the blockchain and its efficiency. This is how the solution to the trilemma appeared. Modern blockchain networks now perform most of the transactions outside the main network, which has led to a significant reduction in the load on it. Moreover, all money transfers have become much faster and cost users significantly less. But again, the highest security indicators for which the main blockchain is responsible have remained unchanged.

In practice, such results were achieved thanks to a combination of advanced modern technologies. In particular, Layer 2 solutions use rollups, batch transactions, payment channels. These are the methods by which all monetary transactions are transferred from the main network to an additional one, and then the results are synchronized with the base blockchain at regular intervals, thereby maintaining the integrity of the data and ensuring its protection.

In addition, Layer 2 solutions will also play a significant role in the subsequent development of various DeFi financial services, as well as decentralized applications dApps. They become available to a wide segment of the user audience due to excellent throughput and minimal transaction fees, which is provided by L2 networks.

We will not say that Layer 1 solutions turned out to be a failure, that mistakes were made during their development, because this is not the case. This is a reliable basis for various decentralized applications, smart contracts and the same DeFi services. But when such networks began to be used by millions of users, the embedded capabilities turned out to be insufficient.

Here you can give one simple comparison. Let's assume that a very good highway is built within one city, but with 2 lanes. Until a certain period of time, while the town was small, the capabilities of such a road were more than enough to ensure comfortable traffic. But at some point, this settlement expands massively, thousands of new people move into it. The entire infrastructure is adjusted to the metropolis, except for the roads: they still remain two-lane. What do we have as a result? Traffic jams, increased gas costs, discontent among people.

This is exactly what happened to the basic level of the blockchain. It became inconvenient for users due to very slow transactions and increased gas fees, which have reached sky-high levels. Why did this happen and how did blockchain developers manage to allow such a problem in principle? It's all about the same scalability trilemma that we already talked about above, namely the impossibility of implementing all 3 key points within one blockchain. One of them is always left out. If we talk directly about Ethereum, then here the developers made a choice in favor of decentralization and security, but they simply sacrificed scalability. But the main thing is that they did not leave their users alone with this problem, but spent a long time looking for ways to solve it. This is how Layer 2 appeared.

What did we end up with in practice? Significant unloading of the base level, instant execution of transactions, reduced fees, but maintaining the impeccable reliability of Ethereum. That is, with the help of L2, the developers built another "highway" parallel to the main one, thereby solving the problem of traffic jams and all the problems associated with them.

Within the framework of Layer 2, specialists managed to implement solutions that prepared the blockchain system for mass implementation. This means that NFT, DeFi, Web3 were able to work as efficiently, safely, quickly and accessible to every user as possible. This is what the consumer market expected from these networks.

Getting to know the main technologies of Layer 2 solutions

Practice shows that most developers will always face the limited capabilities of networks if the number of transactions or users increases. To solve this problem, rollups are often used at the Layer 2 level. These are technologies that process user transactions outside the main chain. At the same time, the basic level of the blockchain only performs minor checks confirming the activity of the network, as well as storing transactions that have not been processed for a certain period of time.

In the workflow, rollups are collected into one large block. A huge number of transactions are carried out simultaneously, and their results are then recorded in the base blockchain. Thanks to this, it became possible to significantly reduce the load on the entire network, reduce the time for processing transactions, and along with this, the commission for these operations. Support for this technology is provided by various applications and platforms that are also based on Ethereum. Most decentralized applications for games and finances also began to support these technologies, which has significantly improved the user experience.

Among the key features and advantages of rollups, it is first of all worth highlighting the fact that all transactions are carried out here outside the main network. Layer 2 solutions take on the execution of absolutely all transactions. This includes operations that are performed between users, as well as all those actions that are carried out on behalf of the main blockchain with smart contracts. Due to the fact that the number of validators is significantly reduced, and the power of the equipment itself is higher, rollups manage to provide a fairly high throughput of all operations in comparison with those blockchains that are provided at the base level.

As we have already said earlier, the functionality of the main blockchain now includes only checking all the evidence that will be transferred to the rollup smart contracts in order to confirm all the activities that will be observed on Layer 2. It will also be responsible for storing unfulfilled or unprocessed transactions in a form such as calldata. Such a technical solution has significantly reduced the load on the base blockchain. It now requires significantly less memory resources to carry out computational operations and process transactions.

The cost of such operations has also significantly decreased. Previously, each transaction was carried out on its own, that is, regardless of its amount, a commission was charged in full. Now a large number of operations are collected in one package and the same commission is charged for it, and its amount is divided between all participants. And this is already more than a tangible material benefit.

Today, various rollup technologies are used to solve scalability problems at the Layer 2 level, in particular:

1. Optimistic Rollups, that is, optimistic rollups.
2. Plasma Chains.
3. ZK Rollups.
4. State Channels.

Now we will dwell on each of these technologies in more detail in order to understand what the fundamental differences are here and what advantages are characteristic of each individual option.

What is Optimistic Rollups

Optimistic Rollups is the technology that will allow all transactions to be performed in the Ethereum base network without overloading it. This is the 2nd level (Layer 2 solutions) that we are talking about in today's review. They work as a separate L2 layer, allowing the network to cope with even increased loads without problems, while providing excellent interaction speed, minimizing commission costs. A distinctive feature of optimistic rollups is that they make absolutely all operations that occur at the Layer 2 level valid. There is no additional verification of each transaction directly at the moment of its addition. They execute them and publish them in the underlying network in the form of packages, providing resource savings.

In practice, Optimistic Rollups work as follows:

• The user starts a transaction on optimistic rollups.
• All data passes through a special entity called a "sequencer".
• Transactions are verified. In this case, we are talking about the so-called “state roots”. These are special cryptographic marks that display the current state of the network.
• If everything is OK, then it is added to the package and transmitted to the Ethereum base layer. If you believe that the transaction was incorrect, you can file a complaint through the “Special Fraud Proof” (fraud proof).

But still, users may face certain risks here. If the entity through which the data will be transmitted disappears at some point in time or begins to behave dishonestly, problems will arise. This can only be excluded if you publish all information about your own transactions on the Ethereum base layer. Thanks to this, the system will be able to perform verification, which means the security of transactions and the likelihood of fraudulent actions and manipulations will be significantly reduced.

We would also like to draw your attention to the exit from the optimistic rollup. In particular, if you decide to withdraw your money, you will have to wait for it. That is, you start the entire withdrawal process itself, and then wait about 1-2 weeks. This is done in order to minimize the actions of intruders. During this time, the system simply waits for a complaint about an incorrect transaction. If they do not arrive, then everything is fine and the money is withdrawn to your account.

What is Plasma Chains

Plasma Chains is another scaling technology that can be used as an additional layer to the basic Ethereum, reducing the load on it. From time to time, the most important changes occurring in the main network will be published here. One of the rather original ideas implemented here is the partial concealment of data on the transactions being performed. That is, here you will not be able to find out all the details of the operation, but only the so-called state commitments, that is, the final state. Despite the fact that there is a fairly good unloading of the base layer, the final flexibility of the system in relation to data is still significantly reduced.

In this case, there is a risk that some of the information that may be needed in the dispute resolution process will be unavailable. As a result, users may face problems, since they will be able to prove their own rightness. But there is also a “Special Fraud Proof”, using which you can prove the legitimacy of your actions.

What is ZK Rollups

ZK Rollups is a more technically complex and, by rights, technological solution compared to the Optimistic Rollups system. The main difference here is that all transactions are not executed in turn, as is provided for in the optimistic rollup, but using the so-called Zero-Knowledge Proofs, that is, zero proofs. They allow us to show that the transaction was correct, but at the same time all the information about it will not be disclosed. As a result, the time for transfers is significantly reduced, and resource costs are minimized. Moreover, the transferred data remains protected.

The operation of ZK Rollups can be described as follows:

• A separate 2-level network is formed, in which all calculations will be carried out.
• The basic blockchain network confirms the result of calculations using such technology as zero trust.
• As a result, the amount of processed information is significantly reduced, and the need to transfer it to the basic level of the system is eliminated. This reduces the cost of the transaction, the load on the main network.

Compared to Optimistic Rollups, this technology no longer requires a long wait when withdrawing funds. Now the system will initially see the correctness of the operations performed thanks to a special proof. Thanks to this, the withdrawal of funds in systems based on ZK Rollups will be almost instantaneous, and the security of such operations is significantly increased. That is why we can say that we have a more advanced and technological solution at the Layer 2 level.

What are State Channels?

State Channels are the latest of those solutions that are presented today in rollup technologies designed to ensure scaling of the underlying blockchain. The essence here is that several users (at least two) agree on interaction with each other. This eliminates constant access to the underlying network. That is, as a result, it is possible to form direct interaction with partners, bypassing the blockchain itself.

In order to open such a channel, it will be necessary to launch a smart contract. Initially, it involves investing a certain amount of money. It turns out that interaction with the main network will be observed only at the initial and final stages, while everything else will be carried out directly without direct access to the base system. That is, in any case, the final state should be recorded, and everything that happens between them is, so to speak, outside the system. For those who make micro-payments or use other applications very often, where interaction is mainly between the same participants, this technology will be optimal in practice.

In order for you to determine which of these technologies will be optimal for you, study a brief comparison of all available options.

Brief comparison of technologies

Here are the main points of each of the Layer 2 technologies that must be taken into account when choosing the most suitable solution for yourself:

1. Optimistic Rollups. A very fast rollup, cheap, easy to use. However, there are significant risks here, since the system can be deceived and get a certain benefit for yourself.
2. Plasma. Fast, simple, creates child blockchains, but in terms of flexibility there will already be a number of limitations.
3. ZK Rollups. It is distinguished by high security and speed. But in order to implement the work here, certain knowledge and skills will be required.
4. State Channels. An excellent option for those who very often perform different transactions in the network, especially with the same people.

All these solutions have their advantages and disadvantages, which must be taken into account, as well as compared with the tasks that need to be solved in practice.

The practical impact of Layer 2 solutions on crypto transactions

After the Layer 2 network was launched, it was possible to solve the trilemma that was not feasible at the basic level of the blockchain. All applications in the DeFi and NFT sphere, requiring the fastest and really cheap processing of transactions, felt a significant benefit from this solution. As a result, the crypto market received:

1. Minimum fees and prompt financial transactions. This is achieved by transferring most of the information and calculations from the base to the second level, as well as batch processing of transactions. Thanks to this, the Ethereum environment has become an ideal solution for mass applications, eliminating the need for excessive costs. Now, when creating and trading NFTs, using DeFi protocols in work, people will be able to launch transactions with maximum benefit for themselves and efficiency.
2. High confidentiality rates and ease of use for users. Anonymity of transactions, especially in areas such as DeFi, is an urgent need. It is important to ensure unhindered interaction with platforms without disclosing sensitive information. It is also very convenient that all control over gas, storage of private keys is transferred to the blockchain. This is what makes this solution accessible to the widest possible user audience.
3. Use of advanced innovative solutions. It is possible to ensure compatibility with the Ethereum virtual machine, but at the same time provide higher performance indicators. Thanks to this, it became possible to build and launch more complex, but at the same time reliable applications. Previously, it was not possible to implement this without transferring all computing power to a new level.

Now all protocols used in DeFi work much faster and with minimal financial costs. At the same time, NFTs received cheaper and faster trading, creation of collections, which had a positive impact on the availability and liquidity of the market as such. And all this is the result of the implementation of Layer 2 solutions as an additional link to the base blockchain.

And what about the security risks when using Layer 2 solutions?

Unfortunately, any, even fairly advanced and innovative technologies have both advantages and disadvantages. In particular, if we talk about security for Optimistic Rollups, then the most serious threat here can be considered the overcommit mechanism itself - the so-called "honesty assumption". We have already said that there is no full verification of all transactions. They will be processed at the Layer 2 level of solutions as obviously correct until someone refutes them. That is, the system will perceive all transactions as correct. And only if a corresponding complaint about an error or fraud is received, the dispute mechanisms will be launched.

The entire process of processing such applications will take several days. In most cases, attackers can take advantage of such a delay in order to find a way to complete their manipulations and withdraw funds from the system. A similar problem will be relevant for decentralized applications, the same dApps, directly involved in transactions or sending confidential data. And these are quite significant risks.

In the case of other solutions presented at the L2 level, in particular ZK-Rollups, Plasma, the situation is somewhat different, because it uses its own technology to verify transactions. This is what makes the transfer of money and sensitive information more secure, and also eliminates the possibility of various manipulations by intruders. But there is another danger here, in particular, in the form of errors in the code or other cryptographic problems, which can ultimately also cause the loss of important information or material resources.

Possible problems when conducting transactions between levels L2 and L1

One of the rather sensitive moments in the scaling experts call the transfer of data between the Layer 2 level and the base blockchain. The point is that at this stage the information must be re-checked for correctness, and also necessarily agreed with the current state of Layer 1. And it is this transition that is characterized by increased vulnerability, since it involves synchronization of two separate networks. In the event that even the smallest errors or deviations are made in the interaction mechanisms, inconsistency will be observed. This will become an "entry point" for attackers and can cause inconsistencies in operation.

Today, there are already a number of mechanisms that, at the stage of interaction with Layer 1, may require third-party intervention by orchestrators or validators, which will contribute to increased centralization. In the event that a number of large validators or the base provider become vulnerable, then absolutely the entire network is at risk.

Unfortunately, in practice there have already been cases when, due to a violation of the logic of coordination of interaction between the L2 and L1 levels, money or confidential data was lost. This mostly applied to systems that were not given sufficient attention to testing, especially in conditions of increased loads. This will be very relevant for solutions related to Optimistic Rollups, namely, delays in conducting a transaction. If during this period of time there are system failures or any third-party impacts, the risk of losing funds or confidential data increases several times.

What impact will Layer 2 solutions have on developers and users?

Developers of products related to all the technologies and solutions we talked about in today's review should clearly understand that such a system does not guarantee 100% security. Yes, what we see today in ZK-Rollups, Plasma will have higher security indicators compared to the same Optimistic Rollups. But, in turn, they require higher computing resources, which ultimately has a direct impact on the cost of transactions. Direct use of optimistic rollups implies the presence of risks due to delays and potential failures at the stage of disputing transactions.

In turn, users with may also face a number of problems, in particular, the loss of money as a result of an erroneous or risky transaction. This also includes a fairly long wait for transaction confirmation, as well as problems that may arise due to the unavailability of Layer 2 services in the event of synchronization failures or hacker attacks.

Prospects for Layer 2 solutions: what to expect from the market in the foreseeable future

All these transformations and development of the infrastructure that are currently observed in the context of Layer 2 solutions have a direct and fairly close relationship with the integration with Ethereum and Bitcoin. We are talking about the leading cryptographic currencies today, which in itself speaks of the prospects and effectiveness of such work. This is what is designed to improve scalability indicators, minimize transaction costs. Experts agree that many technologies and solutions related to Optimistic Rollups, ZK-Rollups will develop further, increasing their own stability and reliability. They have every chance of becoming excellent platforms for conducting transactions, combining high throughput and minimizing time delays and material costs.

Today, the integration of Layer 2 solutions in the Ethereum sphere, namely within version 2.0, has already been launched and continues to actively develop. This is what opens up quite a lot of prospects and opportunities for all solutions presented in the DeFi and NFT niche.

In the Bitcoin environment, not everything is clear yet. In particular, there is not too much active support for Layer 2 solutions in the context of smart contracts. But still, they are increasingly used to conduct cheap and fast transactions. This means that in the foreseeable future, the entire infrastructure for using L2 will expand, develop, affecting more and more niches and areas.

The prospects for further development largely depend on how much attention and effort will be paid to optimizing the operation of security systems, transferring information and financial transactions between different networks, and reducing centralization. This is all that will ensure stable and effective development of the Layer 2 solutions market and will allow them to compete with the core network, enter the blockchain ecosystem of the next generation and take a worthy place in it.

Summing up

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