A Shifting Paradigm in Blockchain Layer Architecture

In recent months, I am getting more and more technical questions around why a Layer 2 (L2) Blockchain architecture is more advantageous for high through-put eco-systems as compared to traditional public or private Layer 1 (L1) chains with the likes of the Ethereum network, etc. The technology that goes behind a L2 architecture has mystified even the seasoned Blockchain, and Smart Contract developers, due to its deep rooted leverage on multiple principals drawn from Game Theory, Micro & Macro Economics, and Financial Industry Models.

Let’s begin with a simple understanding of what a Layer 2 (L2) Blockchain architecture is all about. Layer 2 refers to any off-chain network, system, or technology built on top of a blockchain (commonly known as a Layer-1 network) that helps extend the capabilities of the underlying base layer network. Layer-2 networks can support any blockchain to introduce enhancements such as higher transaction throughputs (Reference: https://chain.link/education-hub/what-is-layer-2).

One core requirement for a network, system, or technology to be considered a layer 2 is that it inherits the security of the blockchain it is built on top of. Transaction data must, in some shape or form, be verified and confirmed by the underlying blockchain network rather than a separate set of nodes. For example, sidechains are often not considered layer 2s because they usually deploy their own consensus mechanisms and validators, leading to a different set of security guarantees than that of the base layer chain.

For blockchains that sacrifice scalability to achieve higher decentralization and security, layer 2s enable greater transaction throughput, which can lead to lower fees. Layer 2s can be seen as one solution to the problem of scalability, enabling fast and scalable execution without compromising on decentralization or security.

Since the emergence of blockchain technology in 2008, thousands of researchers and developers have worked to solve pressing limitations in blockchain scalability to match growing adoption. These limitations have historically resulted in high fees and slow execution times, diminishing the ability of blockchains to operate at scale.

Coined by Ethereum Co-founder Vitalik Buterin, the “blockchain scalability trilemma” posits that blockchains are incapable of scaling effectively while keeping the underlying network both secure and decentralized. Instead, there must be tradeoffs between these three features—today’s blockchain networks can fulfill two out of the three conditions, but not all three simultaneously.

Layer 2s are an emerging technology built on the premise that this scalability limitation exists because blockchains are tasked with too many things. This is because blockchains today fulfill three core functions: execution, data availability, and consensus.

·?????? Execution—transaction processing and throughput. Measured by the number of computations (of which transactions are a subset) per second a blockchain can process.

·?????? Data Availability—storage requirements for nodes and validators on the network for transactions, state, and other data. Measured in standard storage terms such as megabytes, gigabytes, etc.

·?????? Consensus—broad agreement by nodes and validators on the state of the network and ordering of transactions. Measured in terms of decentralization and time-to-finality, or the time it takes for all nodes to agree on a particular state change.

So now in terms of the key technologies that work behind the scene to enable a Layer 2 (L2) Blockchain are:

1. State Channels

• Technology Overview: State channels allow participants to conduct multiple off-chain transactions, which are later settled on the main chain as a single transaction. This reduces the load on the L1 blockchain, leading to faster and cheaper transactions.
• Deep Technology Aspects: Multi-Signature Contracts - Used to establish a state channel, where both parties sign off on the state updates. Hash Time-Locked Contracts (HTLCs): Ensure that funds are transferred securely within a predefined timeframe. Off-Chain Transactions: Transactions are conducted off-chain and only the final state is broadcasted to the L1 blockchain.

2. Rollups

• Technology Overview: Rollups aggregate and compress multiple transactions into a single batch that is then submitted to the L1 blockchain. They come in two main types: Optimistic Rollups and Zero-Knowledge (ZK) Rollups.
• Deep Technology Aspects: Optimistic Rollups: Fraud Proofs - Assume transactions are valid by default but allow users to submit fraud proofs if they detect an invalid transaction. Challenge Period: A timeframe in which users can challenge potentially fraudulent transactions before they are finalized. ZK Rollups: Zero-Knowledge Proofs: Use cryptographic proofs to validate batches of transactions without revealing details, ensuring privacy and reducing data size. Validity Proofs: A proof that transactions within the rollup are valid, submitted along with the rollup batch.

3. Sidechains

• Technology Overview: Sidechains are independent blockchains that operate in parallel with the main L1 blockchain. They handle transactions independently but periodically communicate with the L1 chain to settle transactions.
• Deep Technology Aspects: Two-Way Pegs - Allow assets to be transferred between the L1 blockchain and the sidechain, ensuring assets maintain their value and state. Cross-Chain Communication: Protocols that enable seamless interaction and data transfer between the sidechain and the main chain. Custom Consensus Mechanisms: Sidechains often use different consensus algorithms (e.g., Proof of Authority, Delegated Proof of Stake) to optimize for speed and efficiency.

4. Plasma

• Technology Overview: Plasma is a framework for creating scalable applications by creating "child" chains that can operate autonomously while relying on the L1 blockchain for finality and security.
• Deep Technology Aspects: Plasma Chains - Autonomous child chains that process transactions and periodically submit the results to the L1 blockchain. Exit Mechanisms: Allow users to withdraw their assets from the Plasma chain to the L1 chain, ensuring funds' safety in case of a chain failure. Fraud Proofs: Similar to Optimistic Rollups, users can challenge invalid transactions on the Plasma chain, relying on the main chain to enforce the correct outcome.

5. Nested Blockchains

• Technology Overview: Nested blockchains operate as a hierarchy of blockchains, with a parent chain managing multiple child chains. The parent chain delegates work to the child chains, which execute transactions and report the results back.
• Deep Technology Aspects: Hierarchical Structure - A multi-layered structure where child chains handle specific tasks or sets of transactions, reducing the load on the parent chain. Parent-Child Communication: Protocols that enable child chains to report their transaction outcomes back to the parent chain. Security Inheritance: Child chains inherit the security of the parent chain, ensuring the overall system's integrity.

6. Sharding

• Technology Overview: Sharding involves splitting the blockchain network into smaller, more manageable pieces called shards. Each shard processes a subset of the network’s transactions, improving throughput.
• Deep Technology Aspects: Data Partitioning - The blockchain is divided into shards, each responsible for a specific portion of the data. Cross-Shard Communication: Protocols that enable shards to interact and share data without compromising security. Consensus Mechanisms: Shards often have their consensus mechanisms, coordinated by a central beacon chain or root chain.

7. Optimized Consensus Mechanisms

• Technology Overview: Some L2 solutions involve using alternative consensus mechanisms to achieve faster transaction processing while maintaining security.
• Deep Technology Aspects: Proof of Stake (PoS) Validators are selected based on their stake in the network, allowing faster block generation compared to Proof of Work (PoW). Delegated Proof of Stake (DPoS): A variant of PoS where a limited number of delegates are elected to validate transactions, increasing throughput. Proof of Authority (PoA): A consensus mechanism where a few trusted nodes validate transactions, ensuring quick consensus with less computational cost.

8. Interoperability Protocols

• Technology Overview: Interoperability protocols enable L2 solutions to interact with different blockchains, enhancing the versatility and utility of the L2 architecture.
• Deep Technology Aspects: Cross-Chain Bridges - Enable the transfer of assets and data between different blockchains, ensuring compatibility and usability across platforms. Atomic Swaps: Allow the exchange of one cryptocurrency for another without the need for a centralized exchange, ensuring trustless transactions across chains. Inter-Blockchain Communication (IBC): Protocols that enable blockchains to exchange data and value, facilitating interoperability between different blockchain ecosystems.

9. Data Availability Solutions

• Technology Overview: Ensuring data availability is crucial for L2 solutions, particularly for rollups, where transaction data must be available for users to verify.
• Deep Technology Aspects: Data Availability Proofs - Cryptographic proofs that ensure data is available and can be reconstructed if needed. Distributed Storage: Storing transaction data across multiple nodes or networks to ensure that it remains accessible and secure.

10. Zero-Knowledge Proofs (ZKPs)

• Technology Overview: ZKPs enable one party to prove to another that a statement is true without revealing any information beyond the validity of the statement itself.
• Deep Technology Aspects: zk-SNARKs - A type of ZKP used in ZK Rollups to ensure the validity of transactions without revealing transaction details. zk-STARKs: A more scalable alternative to zk-SNARKs that offers similar privacy and security benefits without the need for a trusted setup.

These deep technologies collectively enable Layer 2 solutions to enhance the scalability, security, and efficiency of blockchain systems, making them more suitable for widespread use, especially in high-demand environments like financial services. As a nascent and continually developing technology, most Web3 infrastructural components, including base blockchains and Layer 2s, have yet to reach the inflection point where it is definitively known which approach best suits the needs of the industry. However, thousands of developers and researchers continue to work tirelessly to find viable solutions via the expansive ecosystem of blockchain networks, DAG solutions, and layer 2s that exist today in order to bring the promises of Web3 to the forefront of society.

By: Hamid Rashid (PhD Candidate, IIUM Institute of Islamic Banking and Finance (IIiBF)