Bitcoin Layer 2: What is it and what are the top Networks?

Layer 2s have become an extremely hyped narrative in the world of blockchain and decentralized assets, being discussed with increasing regularity. So, what exactly are they?

A layer 2 blockchain refers to an infrastructure layer within a distributed network that aims to alleviate the burden of the network base layer by performing specific computations. In its most simplistic form, it’s a small network on top of a big network, helping to ease some of the load.

This article will discuss Layer 2 blockchains built on the Bitcoin Network and how they function as scalability solutions to improve transaction throughput. 

Blockchain Layers Contextualized

There are three basic tasks that a blockchain must be able to perform.

1.  It must be able to execute transactions
2.  It must be able to reach a consensus on the settlements of said transactions
3.  It has to ensure the availability of the transaction data stored in its blocks

To perform these tasks successfully, blockchain architecture is comprised of five internal  infrastructure layers: 

• Hardware Layer: Where the physical computers that power network nodes are
• Data Layer: Where all of the block data is stored and accessed
• Network Layer: Where nodes communicate and relay data to one another to perform network activities
• Consensus Layer: Where the consensus mechanism is hosted and specific nodes execute and settle proposed transactions
• Application Layer: Where DApps are developed that function through accessing and utilizing block data stored on the Data Layer

These layers, which are found within each blockchain and make up their architectures, are distinct from the layers that categorize what type of blockchain it is. For example, a blockchain can either be a Layer 0, 1, or 2 blockchain. Layer 3 blockchains are more or less just execution environments for DApps or cross-chain interoperability solutions like bridges to enable advanced off-chain computations that don’t feature the same quintupled architecture layers like L0, L1, or L2 chains.

While each blockchain type is comprised of five internal architectural layers, they serve different purposes. Layer 0 chains, like Polkadot and Cosmos, provide a base layer or software development kits (SDKs) for other blockchains to build on top of. 

Layer 1 chains, like Ethereum or Bitcoin, are the most common form of blockchain and mainly perform the three basic tasks of data availability, consensus, and transaction execution and settlement, all in a decentralized manner. Most Layer 1s, like Bitcoin specifically, and Ethereum pre-merge, were built with monolithic architecture meaning that all nodes in the network function to perform tasks simultaneously, sharing the responsibility of consensus, data availability, and transaction execution and settlement between them. This burdened nodes and led to blockchain congestion, as well as environmental and sustainability concerns due to power consumption.

Newer Layer 1 blockchain projects are now built with a modular architecture, where node responsibility is no longer shared but vertically disintegrated. This adjustment allows network tasks to be performed by smaller subsets of nodes, alleviating computational demands (and therefore energy consumption). However, before the rise of mainstream modularity in late 2022, Layer 2 blockchains emerged as a scalability solution to alleviate the network congestion experienced by monolithic L1s. 

Layer 2 Blockchains

In the same way that L0 chains create the base layer environment for L1s to build on, L2s build on top of L1s to alleviate their network congestion and improve “throughput”. This throughput term refers to the number of new transactions processed and the rate at which they’re executed, validated, and settled on-chain. 

Layer 2s, regardless of the type, alleviate L1 network congestion by delivering an off-chain execution environment for settling similar transaction types off-chain. These are then grouped and executed independently off-chain, after which a concise record of their execution is generated, like a receipt. Naturally, this is then stored and validated on-chain.

Earlier in the article, remember we talked about how the Consensus Layer of a blockchain is where nodes perform consensus and transactions are executed and settled? Well, Layer 2 chains enhance Layer 1 scalability by dividing the execution and settlement of transactions. L2 chains perform transaction execution off-chain, while transaction settlement is still achieved on-chain. What does this look like?

Ethereum Layer 2 blockchains like Optimism, Arbitrum, and Polygon all use “rollup” technology to scale. This is where similar transaction types are batched together, or rolled up, into a single record. The execution of the rollups, where all proposed transactions in the record are carried out, occurs off-chain. This generates a receipt of the rollup which is then validated on-chain, and stored on the Data Layer so that the settlement of all the transactions in the rollup occurs on the main blockchain.

By separating the consensus layer of Layer 1s to perform transaction execution off-chain and maintain transaction settlement on-chain, L2s enhance blockchain scalability by enabling Layer 1 consensus nodes to take on more transactions at once and prioritize more complex and computationally demanding transactions.

State Channels

While both Bitcoin and Ethereum Layer 2 networks function as sidechains built on top of the L1, Bitcoin L2s do not use rollup technology to scale network activities, instead, they use state channels; this is the biggest difference between Ethereum and Bitcoin Layer 2 networks. 

State channels are private off-chain channels that allow users to conduct multiple peer-to-peer (P2P) transactions. Only the final state of the transactions conducted in the channel is settled and stored on-chain.

To open a state channel, users create an initial on-chain transaction that locks funds into a multi-signature address. A multi-signature address requires signatures from all parties involved in the transaction to unlock the deposited funds.

Once the address is funded and all-party signatures are received, the state channel is opened, and users can conduct their transactions in the off-chain channel. Each time users exchange funds within the channel, the distribution of the locked funds in the on-chain multi-sig address updates, creating a new "state" of the off-chain channel. These states represent the balances between the transacting users. State channels use revocation mechanisms to invalidate previously generated states, ensuring the validity of the most recently generated and agreed upon state.

When users decide to close the channel, they create a final on-chain closing transaction that reflects the most recently generated state of the off-chain channel. This state is then recorded on-chain for validation and the locked funds are distributed to participants accordingly. After the multi-sig address is emptied, it stays as a record of the transaction but is no longer used to secure funds. 

Best Bitcoin Layer 2 Networks

Lightning Network

The Bitcoin Lightning Network is a scaling solution for the Bitcoin Blockchain that reduces the cost of transactions on the network. 

The Lightning Network revolves entirely around state channels and enables users to securely and privately transact off-chain. Where a direct channel between the sender and receiver does not exist, the Lightning Network can also utilize a series of interconnected payment channels that manage payment routing. Through this process, the Lightning Network significantly enhances Bitcoin's scalability, speed, and affordability, making it a pivotal advancement in blockchain technology.

Stacks

Stacks is another Layer 2 network that improves Bitcoin Network scalability through an innovative Proof of Transfer (PoX) consensus protocol. In Stacks’ case, miners on the Stacks L2 chain send BTC to smart contracts on the Bitcoin main chain and are rewarded with STX tokens on the L2 chain. 

Stacks security is directly integrated with the Bitcoin Network as all transfers through the PoX consensus mechanism are secured by transactions conducted on the Bitcoin L1 chain.

Merlin Chain

Merlin Chain is one of the only Bitcoin Layer 2 chains that utilizes rollup technology over state channels. Merlin uses Zero-Knowledge (ZK) rollups to improve network scalability. 

ZK rollups use zero-knowledge proofs to validate their contained data without revealing the data itself. It's like if you wanted to prove a statement true without exposing what the statement is saying, zero knowledge of the statement is needed to understand its validity. 

Establishing validity before transaction settlement can be computationally demanding (and incredibly expensive), but ZK rollups are more efficient in being stored on-chain because their logic is already valid; it’s just one less step that needs to be performed on-chain. 

With the testnet launched in early 2024 and the mainnet anticipated soon, Merlin Chain also incorporates decentralized oracle networks and on-chain BTC fraud-proof modules, enhancing security and transparency.

Final Considerations

Layer 2 networks have emerged as scalability solutions to enhance the throughput of monolithic Layer 1 chains and alleviate their network congestion. By offloading transactions and computations to secondary layers, Layer 2 blockchains improve the efficiency and throughput of the underlying network.

Bitcoin Layer networks that use state channels offer private and efficient off-chain channels for conducting multiple peer-to-peer transactions. Through the discussion of Layer 2 blockchains, including their architecture and functionality, we've highlighted their pivotal role in improving the performance of blockchain networks.

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