Fundamentals: What is a Layer 2 chain?
A brief introduction to Layer 2 chains.
Layer 2 blockchains are separate chains built on top of an existing Layer 1 blockchain, such as Ethereum, which allow users to transact on blockchains more quickly, while also reducing the cost of doing so. Currently, Ethereum can only handle 10-20 transactions per second. But L2 chains, like Arbitrum or Optimism, can handle between 2,000-4,000 transactions per second, opening up a wide range of use cases and functionalities for dapps built on Ethereum. Currently, there is more than $5.5 billion in total value locked in Ethereum L2 chains.
How do Layer 2 chains work?
L2 blockchains create what is called a “secondary framework” to Layer 1 blockchains. This means that L2s are constantly communicating with the main layer to bundle together large amounts of transactions, process them independently of the L1 blockchain, and then bring them back to be settled and recorded on the main layer. Because L2s require no structural changes to the main layer, they can do all of the “work” of processing transactions that would normally be handled by the L1 blockchain, while still leveraging that L1 blockchain’s network security.
Payment processors, like Visa, use a similar method to process the large amount of transactions that go through merchants. Instead of processing every single transaction from merchants separately, Visa acts as the L2 by bundling them together, then sending them into the banking system at regular intervals. The banks, which are the L1s in this scenario, then settle the transactions and keep a record of them.
Why are Layer 2 chains important?
One of the biggest issues facing the two largest blockchains is their lack of scalability. Both Bitcoin and Ethereum struggle to process large amounts of transactions, which is a major roadblock to mass adoption and making blockchains easier to use. When Ethereum, for example, becomes congested during times of high usage such as during a major NFT drop, gas fees can spike, making transactions more expensive for everyone using the blockchain at that time, regardless of if you’re participating in that drop or not. Blockchain congestion can also increase the likelihood of your transaction failing to be confirmed, which means you still pay gas fees but might lose out on the asset you were looking to buy. Using L2s allow popular Ethereum dapps to scale by reducing the load on L1s, which ultimately makes blockchains easier to use and more likely to be adopted because faster transactions expands the scope of the potential blockchain applications that can be built.